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Why online personalized pricing is unfair

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Abstract

Online retailers are using advances in data collection and computing technologies to “personalize” prices, i.e., offer goods for sale to shoppers at their reservation prices, or the highest price they are willing to pay. In this paper, I offer a criticism of this practice. I begin by putting online personalized pricing in context. It is not something entirely new, but rather a kind of price discrimination, a familiar pricing practice. I then offer a fairness-based argument against it. When an online retailer personalizes prices, it competes unfairly for the social surplus created by a transaction. I defend this argument against objections, and offer a simple remedy: online retailers should either disclose that they are personalizing prices, or stop doing so.

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Notes

  1. Marcoux (2006) suggests that personalized pricing is ephemeral in competitive markets. If one firm F1 tries to sell a good to a shopper at his reservation price, and this price is above the market clearing price, another firm F2 will offer to sell the good to him at a slightly lower price. F1 will then lower its price; F2 will make a counteroffer; and so on until the market clearing price is reached. This is true in perfectly competitive markets, but markets in the real world are imperfect in ways that make personalized pricing possible. Most importantly, there are information asymmetries in real markets. In our example, for F2 to offer the shopper a better price, F2 needs to know what F1 is charging. For F1 to make a counteroffer, it needs to know what F2 offered. But sellers will often be ignorant of what their competitors are charging. This is especially so online, where the prices being charged are known only to the sellers and buyers. In fact, we don’t need to infer based on market imperfections that it will be possible for firms to engage in personalized pricing. We know that it is possible for firms to engage in price discrimination because firms actually do so (Hannak et al., 2014; Mikians et al., 2012).

  2. In versioning, sellers charge more for different versions of the same product, but the differences in prices do not fully reflect differences in the price of production. The price difference between hardback and paperback books is a standard example. Hardback versions of books, which are typically released prior to the paperback versions, have significantly higher prices than paperback versions, but do not cost significantly more to produce.

  3. According to the “just price” tradition, associated with Aquinas, sellers should offer their goods for sale at a single price, viz., the just price. On the standard interpretation of this idea, this is a function of how much the good costs to produce. But a more recent strain of scholarship argues that, for Aquinas, the just price mostly is the market price, as determined by the forces of supply and demand. In this case, there is no disagreement between the just price tradition and modern thinking about prices (see and cf. Koehn & Wilbratte, 2012).

  4. It might wondered whether price discrimination has another positive social effect, viz., reducing inequality. Due to the diminishing marginal utility of wealth, it might be said, the rich are willing to pay more for any given good than the poor. When the rich pay more than the poor, rich consumers’ wealth is reduced by a larger amount than poor consumers’ wealth. As a result, the wealth gap between rich and poor shrinks. This argument is questionable. First, while rich people may generally have higher reservation prices than poor people, this will not always be the case. In a notable case of price discrimination, Staples charged less for office supplies to richer consumers, because it faced stiffer competition in that area (Valentino-Devries et al., 2012). Second, in addition to considering the wealth gap among consumers, we also need to consider the wealth gap between consumers and producers. When a producer personalizes prices, he attempts to capture all of the social surplus generated in a transaction with a consumer. So price discrimination results in a transfer of wealth from consumers to producers. Assuming that producers are wealthier than consumers, this represents a transfer of wealth from the (relatively) poor to the (relatively) rich, exacerbating inequality. The lesson to be drawn here is that the distributional effects of price discrimination are difficult to discern and will vary from case to case (cf. Elegido, 2011).

  5. Online price personalization may also raise concerns about privacy (Kokolakis, 2017; Krishnamurthy et al., 2007). I do not consider such concerns here, because it would take us too far afield. Moreover, the threats to privacy involved in online price personalization are similar to those involved in other familiar practices, such as online behavioral advertising. The objection I raise to online price personalization does not apply to online behavioral advertising—it is distinctive in this sense also.

  6. It might be thought that the problem with online personalized pricing is that the fight is not fair. The algorithm used to determine shoppers’ reservation prices in online personalized pricing, it might be said, is a lot more accurate than the “algorithm” used to determine their reservation prices in in-person personalized pricing. In online personalized pricing, there is a sophisticated mathematical formula that takes into account many variables. In in-person personalized pricing, it is the salesperson’s intuition, based on a few observable characteristics. In response, this oversells the technology used in online personalized pricing. It cannot read people’s minds; it is not that accurate. Indeed, an experienced salesperson may be able discern facts about shoppers that a computer cannot. The problem, I have argued, is that the salesperson has an unknown advantage.

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Acknowledgments

Versions of this paper were presented at Utrecht University, Oxford University, and Minnesota State University, Mankato. I thank members of those audiences for helpful feedback. Special thanks to Dick Timmer and several anonymous referees for instructive comments on previous drafts.

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Moriarty, J. Why online personalized pricing is unfair. Ethics Inf Technol 23, 495–503 (2021). https://doi.org/10.1007/s10676-021-09592-0

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