Behavior‐ and characteristic‐based price discrimination

• Author: Stefano Colombo
• DOI: http://doi.org/10.1111/jems.12244
• Published date: 01 June 2018
• Date: 01 June 2018

Received: 28 April 2017 Revised: 29 September 2017 Accepted: 16 January 2018

DOI: 10.1111/jems.12244

ORIGINAL ARTICLE

Behavior- and characteristic-based price discrimination

Stefano Colombo

UniversitàCattolica del Sacro Cuore, Milan,

Italy (Email: stefano.colombo@unicatt.it) Abstract

We develop a model of behavior- and characteristic-based discriminatory pricing

where consumers are heterogeneous both in tastes and in price sensitivity.Each firm is

able to distinguish between the consumers that havebought from it and those that have

bought from the rival. Furthermore, each firm learns the price sensitivity of their own

consumers. We show that using this additional information may yield higher profits

than uniform pricing provided that consumers are heterogeneous enough with respect

to price sensitivity. We also discuss consumer surplus implications of such behavior-

and characteristic-based price discrimination, and we show that the impact of price

discrimination depends on both the consumer type and the level of consumers’ het-

erogeneity.

1INTRODUCTION

Behavior-based price discrimination is a widely observed pricing practice in many markets. It represents a peculiar form of price

discrimination: basically, the consumers are charged with different prices depending on their purchase histories. Therefore, in

the case of repeated purchases, the current price paid by a consumer may depend on which firm he has patronized before.

Among the many examples of industries where such practice is now commonly adopted, supermarkets, webretailers, air travel,

financial services, telecommunication, electricity, gas, and insurance companies stand out for a wide use of behavior-based price

discrimination techniques.1

The literature on behavior-based price discrimination has increased in the last years, following the real-worldtrend of increas-

ingly use of these pricing techniques by the firms. A widely discussed question is whether adopting price discrimination tech-

niques is profitable or not for firms. In a context of “standard” price discrimination,2higher flexibility in setting prices is usually

associated with higher profits in monopoly, but it is associated with lower profits in oligopoly (Thisse & Vives, 1988). Results

are more ambiguous when behavior-based price discrimination is considered. Villas-Boas (1999, 2004) considers an infinite-

horizon duopoly market with overlapping generations of consumers and demonstrates that this practice hurts the firms when

the consumers are patient. Fudenberg and Tirole (2000), in a two-period model with no switching costs, show that it hurts the

firms in the second period, but benefits them in the first period: the overall impact of behavior-based price discrimination on the

profits is negative. Shaffer and Zhang (2000) consider two firms with asymmetric market shares and show that behavior-based

price discrimination may benefit one or both firms depending on the degree of asymmetry in the industry. Pazgal and Soberman

(2008) consider the profitability of this pricing method when the firms may add value in the second period and find that the

profits turn out to be lower than under uniform pricing.3

We thank the Editor, the Associate Editor, and two anonymousreviewers for valuable comments that improved this article. I thank also Raphael Thomadsen,

Paolo Garella, Luigi Filippini, and Michele Grillo for useful comments on a previousversion of this article. I t hank participants to XXXI Jornadas de Economia

Industrial, Palma de Mallorca, 57 RSA-SIE,Milan, ASSET 2016, Thessalonika, IO Swiss Day 2017, IBEO Alghero 2017 Workshop, and in particular Alessandro

Pavan, Tore Nilssen, Andreas Hefti, Clara Graziano, and Paolo Vanin. Remaining errors are my own. This article is a completely renewed version of a paper

previously circulated as “Bidimensional behavior-based price discrimination.”

J Econ Manage Strat. 2018;27:237–250. © 2018 WileyPeriodicals, Inc. 237wileyonlinelibrary.com/journal/jems