Quality choice and behavior-based price discrimination

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Quality choice and behavior-based price discrimination Hoe Sang Chung1 Received: 19 December 2019 / Accepted: 10 July 2020 Ó Springer-Verlag GmbH Austria, part of Springer Nature 2020

Abstract This study examines the impacts of behavior-based price discrimination (BBPD) on profits, consumer surplus, and welfare when firms choose their product qualities. To this end, we consider a differentiated duopoly model in which firms first make quality decisions, and in the two subsequent periods, compete in prices according to the pricing scheme, namely, uniform pricing or BBPD. We show that when consumers are more than moderately forward-looking, firms choose lower quality levels under BBPD than under uniform pricing. The profit and consumer surplus effects of BBPD relative to uniform pricing depend on the level of consumers’ myopia and/or quality improvement costs. When consumers are sufficiently myopic or quality costs are high, BBPD reduces industry profits and raises consumer surplus. However, the reverse happens when consumers are sufficiently forward-looking and quality costs are low. Interestingly, BBPD is detrimental to both firms and consumers when consumers are sufficiently forward-looking and quality costs are moderate, or when consumers are moderately forward-looking and quality costs are low. Social welfare is always lower under BBPD than under uniform pricing. Keywords Behavior-based price discrimination  Consumer myopia  Quality costs

JEL classification: D43  L13

1 Introduction Owing to the development of more sophisticated techniques for acquiring, storing, and analyzing information on the customers’ past shopping behavior, firms can offer different prices to their own customers and those who purchased from rivals before. & Hoe Sang Chung [email protected] 1

Department of Economics, Kangwon National University, Chuncheon-si, Republic of Korea

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H. S. Chung

This form of price discrimination, termed behavior-based price discrimination (BBPD), is now widely used in many industries such as web retailing, supermarkets, air travel, telecommunication, restaurants, electricity, gas, banking, and insurance. There are two approaches to the analysis of BBPD. In the switching cost approach, the consumers’ past purchases reveal information about their switching costs (e.g., Chen 1997). In the brand preference approach, the consumers’ past purchases reveal information about their brand preferences (e.g., Fudenberg and Tirole 2000).1 Studies employing this latter approach investigate BBPD within various frameworks. For example, Chen and Pearcy (2010) investigate BBPD with the dependence of consumers’ intertemporal preferences, Esteves (2014) studies BBPD when firms use retention strategies to avoid consumer switching, and Esteves and Reggiani (2014) explore the pricing scheme by relaxing the perfectly inelastic demand assumption. Chung (2016) studies BBPD with experience goods, Carroni (2016) studies BBPD with asymmetric firms, and Carroni (2018) studies BBPD with