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Too much flexi-pricing these days?

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E-commerce has led to a ‘surge’ in dynamic pricing. Whether that helps or hurts consumers remains an unresolved question

“Price discrimination sounds very different to economists’ and lawyers’ ears” writes Anne Perrot of the French Competition Authority. While economists might sympathise with how pricing similar goods differently for different markets might enhance market efficiency, to many others the whole idea reeks of unfairness. However, the reality is more complicated.

At its simplest, price discrimination takes advantage of differences in consumers’ willingness to pay for the same product. Sellers may exploit this difference for a variety of reasons — to increase profits and/or market share, to build brands and to strategically deter entry among others. Under conditions of monopoly or market power, price discrimination could be bad for welfare, but on the other hand, under competitive conditions, price discrimination might be attractive since it could lead to lower unit prices and reduce consumers’ search costs.

New pricing strategies

The text book typology of price discrimination — first degree, second degree and third degree — depends on how precisely firms can tailor prices according to each individual customer’s willingness to pay. This in turn depends on how much sellers know about their customers. Their ability to exploit this knowledge however is tempered by how much competition they face.

In the past, such targeting has been on the basis of broad and easily identified categories. For example, commercial customers usually pay more for electricity than their residential counterparts, cinemas charge more during weekends, and bulk customers end up paying lower unit prices gaining from volume discounts.

As commerce migrates to the Internet, sellers’ ability to discriminate on price is more than it has ever been, thanks to a virtual explosion in available data and dramatic declines in the cost of processing and storing information. Many e-commerce websites now customise prices based on individual users’ preferences that are unearthed based on their purchase histories, the brands of devices they use, or on their geographical locations. Naturally this raises crucial issues of privacy, fairness and potential antitrust issues.

More often than not, insufficient information about individual preferences has meant that firms let consumers “self-select” into groups. Auctions permit the greatest degree of price discrimination, with buyers jostling against each other to reduce the gap between what they are prepared to pay and how much they end up paying. Alternatively, consumers may be offered a menu of choices to pick from based on knowledge of their own demand patterns — such discrimination can be by way of quality or on the basis of quantity. Most of us are familiar with peak load pricing. Recall Uber’s “surge pricing”, the wild fluctuations in flight fares during festivals, and more recently during the shutdown of the National Highway in Haryana. Matching sudden bursts in demand with relatively inelastic supply can occur either through price adjustments, rationing, or a combination of the two.

Peak load pricing for example, nudges traffic to distribute more evenly during the course of the day, relieving pressure on the asset during rush hour. While the determination of whether certain short term price adjustments are equivalent to ‘gouging’ customers is for regulatory agencies to contemplate, other common examples also include volume discounts for bulk purchases and tiered electricity fares under which unit prices change based on electricity consumed.

Welfare benefits

Experiences such as these might occasionally pinch, but they can encourage sellers to provide more of the good in question and serve to cross-subsidise poorer users. There is evidence to suggest that under competitive conditions, price discrimination can further intensify competition and reduce individual firms’ market power, thereby disciplining the market. Moreover, mandating uniform pricing can discourage firms from serving certain classes of customers and focusing on users more willing to pay a higher uniform price.

For many of the benefits to emerge, certain conditions must first be satisfied — markets must be sufficiently competitive, antitrust regulation and institutions should be robust and buyers should not be at an information disadvantage against sellers.

In the real world, however, sellers often have disproportionately greater information than buyers, competition is not perfect and often difficult to gauge, and the emergence of multi-sided markets means competition regulators have their work cut out. Here, determining the effects of price discrimination on social welfare is a knotty task.

One of the bigger problems here is defining “consumer interest” - an inquiry where regulatory action must become more “art” than “science”. Ex ante regulatory action to pre-empt imagined harms may seem an overreaction. It is this impossibility of assessing hypotheticals that regulators across the world are struggling with in the case of net neutrality — fragmentation of the Internet and damage to innovation is propped up as an inevitable occurrence in its absence, while the threat to future investment in infrastructure is presented as a consequence of its presence.

Facebook episode

And while the standard panacea of competition is the magic potion for addressing failures in other markets, the market for content provision and the semi-intermediary space of Facebook’s Free Basics seems to defy easy prescriptions. The abundance of literature on competition in high tech markets suggests that monopoly status might not be as threatening because of how quickly such markets can “tip”. The inherent contestability in such markets is demonstrated by the spectacular rise of Facebook and Google against MySpace and AltaVista, but it also begs a few questions.

Would Facebook have emerged as the giant that it currently is inside the same boundaries that Free Basics imposes? On the other hand, does Free Basics possess enough power over the market to destroy the underlying principles of freedom and neutrality of the internet?

Perhaps a good rule of thumb is to look at whether the good or service in question possesses the characteristics of a General Purpose Technology or utility such as electricity or Internet access, in which case it might be better to err on the side of caution. In such cases, price discrimination based on content might automatically make it harder for these users to opt in to the “full internet”.

Instead, volume-based price discrimination (such as bulk discounts or charging heavy users more per unit) can still enable many of the efficiency and allocative benefits (including cross-subsidising poorer users) that price discrimination allows for. From this perspective, TRAI’s decision to limit its ban on price discrimination for content might seem practical, if slightly over-cautious.

Kathuria is director and chief executive at ICRIER where Shreeti and Urdhwareshe are research assistants. The views are personal

Published on March 14, 2016

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