The curse of knowledge: having access to customer information can reduce monopoly profits

• Author: Ngo V. Long,Joana Resende,Didier Laussel
• DOI: http://doi.org/10.1111/1756-2171.12336
• Published date: 01 September 2020
• Date: 01 September 2020

RAND Journal of Economics

Vol.51, No. 3, Fall 2020

pp. 650–675

The curse of knowledge: having access

to customer information can reduce

monopoly profits

Didier Laussel∗

Ngo V. Long∗∗,∗∗∗

and

Joana Resende‡

We show that a monopolist’s profit is higher if he refrains from collecting coarse information on

his customers, sticking to constant uniform pricing rather than recognizing customers’ segments

through their purchasehistory. In the Markov perfect equilibrium with coarse information collec-

tion, after each commitment period, a new introductory price is offered to attract new customers,

creating a new market segmentfor price discrimination. Eventually, the whole market is covered.

Shortening the commitment period results in lower profits. These results sharply differ from the

ones obtained when the firm can uncover the exact willingness-to-pay of each previouscustomer.

1. Introduction

According to the conventional theory of price discrimination, if a monopolist can partition

the customer base into segmented markets, he will be able to reap larger profits, even when in

each market segment, only linear pricing is used. Indeed, the standard model of third-degree

price discrimination has shed light on some frequently observed phenomena, such as discounted

prices for senior citizens on train travels, students’ discounts for admissions to movies, and so

on. Market segmentation in these examples is however rather crude, because ages or schooling

status are only rough proxies for more relevant characteristics such as income and preferences.

∗Aix-Marseille University,CNRS, EHESS, Centrale Marseille, AMSE, France; didier.laussel@outlook.fr.

∗∗McGill University; ngo.long@mcgill.ca.

∗∗∗McGill University.

‡Cefup, University of Porto; jresende@fep.up.pt.

The authors thank Editor Kathryn E. Spier and two referees for extremely helpful comments and suggestions. They

thank Helder Vasconcelosand João Cor reia-da-Silvafor insightful discussions. They are also g rateful to seminar partic-

ipants at Research School of Economics, ANU, and Hitotsubashi Institute for AdvancedStudy, Hitotsubashi University,

for stimulating discussion.This research has been financed by projects NORTE-01-0145-FEDER-028540 and POCI-01-

0145-FEDER-006890.

650 © 2020, The RAND Corporation.

LAUSSEL, LONG, AND RESENDE / 651

With the advance in digital technology, firms are increasingly able to collect and process

huge amounts of consumer-specific data, allowing them to classify consumers on the basis of

their purchase histories and browsing histories, their location, what they like or dislike on social

networks, their preferred sites and so on (EOP, 2015). This enables firms to implement strategies

that exploit the “consumer addressability” features described by Blattberg and Deighton (1991).

Thanks to the Invisible Digital Hand (Malkiel, 2016), price personalization, the monopo-

list’s old dream, has now become the norm in many sectors (Petrison et al., 1997; Mohammed,

2017). Depending on the firms’ technology options and on the regulatory restrictions (such as

the General Data Protection Regulation (GDPR) in the European Union), the information firms

are able to collect on consumers may be more or less fine.

In the literature on third-degree price discrimination, there is a presumption that with a more

refined market segmentation, the firm can tailor different prices to different consumer groups,

thus increasing its profit. However, this literature has overlooked an important issue: when cus-

tomers are heterogeneous with respect to their willingness to pay (WTP), their purchase histories

are endogenously determined by the firm’s dynamic pricing policy.Indeed, the number of distinct

market segments based on the monopolist’s grouping of customer types may well depend on his

current, past, and future pricing policies. Anticipating the firm’s future prices and grouping strat-

egy, lower-type customers may have an incentive to defer their purchases until later periods in

order to receive a better deal. The firm may have to counter this incentive by offering higher

informational rents to the new customers it wishes to serve in each period. Under these circum-

stances, a firm’sability to acquire customer infor mation might well be detrimental to its profit. In

other words, the ability to use information on customers’ WTP may be a curse to the monopolist.

Our article demonstrates that the “Curse of Knowledge” may arise within a coarse informa-

tion setting.1Wepropose a model where a monopolist is able to recognize former customers only

on the basis of the moment of their first purchase and uses this coarse information to engage in

third-degree price discrimination. Weshow that his use of customer information for intertemporal

price discrimination reduces his aggregate profit below the level he wouldget if such infor mation

were not available.

The equilibrium dynamics arising in this model with coarse information on customers’ pref-

erences are later compared to the ones arising in the polar case of full information acquisition

(FIA, for short), in which the monopolist is able to use consumers’ purchase history to uncover

their exact WTP, which enables him to engage in price personalization. These two cases lead to

diametrically opposed conclusions concerning the equilibrium dynamics and its Coasian or non-

Coasian features. Under FIA, the monopolist gains from his ability to acquire full information,

and his profit is even greater than that obtained by a full commitment monopolist under the coarse

information scenario. Interestingly, comparing profits across three scenarios (the FIA case, the

coarse information collection case, and the case of complete absence of customer records) shows

that firm’s profit can be non-monotonic in the degree of precision of information.

To derive the above mentioned results, we set up a model of a monopolist producing a ho-

mogenous good (or service) that must be consumed instantaneously. Consumers may purchase

and consume at each instant of time, whereas the monopolist is committed to making pricing de-

cisions at discrete points in time. The length of the time interval between two consecutive price

offers is called the commitment period. There is a continuum of consumers with heterogeneous

WTP for the good. The (type-dependent) consumers’ WTP is initially private information. In

the base-line model with coarse information, we posit that, as time goes by, the monopolist can

collect some imperfect information on the consumers’ WTP and use it to implement third-degree

price discrimination. If a consumer makes her first-time purchase in a given period n, the monop-

olist will label her as a vintage-nconsumer, clustering her with other consumers who havechosen

1As argued later, our model sheds light on optimal dynamic pricing in several real-world set-ups, including the

subscription-based business models, the telecommunications industry, the streaming music industry, the online video

industry, the online betting sector,and the pricing of football/baseball tickets.

C

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