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JULY 31, 2003
By Jane Black Sharper Tools for Discriminatory Pricing [Page 2 of 2] Q: Is there a correlation between more powerful technology and consumer backlash? A: Fear of discriminatory pricing isn't new: It was also a very big factor in the railroads at the end of the 19th century. Then, you had a huge industry -- even bigger than the information-technology industry today -- which was practicing price discrimination on a really gross scale. As with the Internet, railroads required huge investments up front, but the marginal costs were comparatively small. Nineteenth-century railroads didn't have the information technologies to allow for "frequent-ride" programs. Nor did they have the "positive passenger identification" system, complete with government-issued ID cards, to allow them to sell nontransferable advance purchase tickets with Saturday-night stay restrictions like the airlines have today. But they did have a variety of other tools for price discrimination, such as "versioning." That's when for a lesser price you offer an inferior service, usually one so bad that people will feel it's worthwhile to pay more. In the railroads' case, third-class carriages were uncovered and uncomfortable and in the front of the train, where passengers would be covered with cinders blowing from the engine. They also charged different prices for freight and gave preferential rates to powerful customers such as J. D. Rockefeller. U.S. customers revolted, and by 1887, railroad pricing was regulated. Studying 19th-century railroads is important because it represents one of the first large-scale experiments with price discrimination. Technology changes rapidly but human nature doesn't. Q: What types of price discrimination are common today? A: Senior-citizen and student discounts are a well-known type of price discrimination. The airlines have used price discrimination since the industry was deregulated about 20 years ago. You can also see price discrimination in scholarly journal publishing. As the journals move online, the incentive to price-discriminate and the ability to do so are both growing. Look at the JSTOR project -- a nonprofit that makes available electronic versions of archived issues of scholarly journals. The pricing for U.S. educational institutions varies because JSTOR prices the journals based on the value to the school, not the number of copies sold. So if you're a large institution that views an article many times, you pay more. Such usage data was simply not available in the print world. Thus more information about customers -- less privacy -- provided by modern technologies leads to more price discrimination. Q: Are there any benefits to eroding privacy and differential pricing? A: Standard economic doctrine has always noted that first-degree price discrimination -- where the seller knows exactly how much each individual buyer is willing to pay -- is ideal since it induces maximum production. But it has always been regarded as unattainable. Now, with improved technology, we can achieve it. It's important to note that it's not just the sellers who would benefit from higher revenues. There would be more intense competition, which would force lower average prices. There would also be more access to goods and services. In some sense, McGraw-Hill would like everyone to read its books, magazines, etc. Society would benefit from wider access and McGraw-Hill benefits from more customers. But in order to make that profitable, it has to charge different customers different prices. Q: Will people accept the price that comes with those benefits? A: The big issue is how the information about you is used. When grocery-store loyalty programs first came to the area of New Jersey that I lived in about 15 years ago, we talked about what it would mean when the stores and potentially their suppliers would know in great detail what your consumption habits are (see BW Online, 6/20/02, "How Grocery Stores Are Feeding Fears"). One colleague said he welcomed this, because he was a diehard Coke fan, and he was looking forward to not having to discard the Pepsi ads and coupons. After all, Pepsi and the grocery stores would know that he wouldn't drink Pepsi under any circumstances. I then asked him how he would feel if everybody else was getting 50% off discounts on Coke, while he had to pay full price (which would be jacked up to exploit guys like him). He wasn't sure that would be such a good idea. Q: When do you believe that differential pricing will become widespread? A: We'll see dramatic growth over the next decade due to continued ability to find out just how much people are willing to pay and the desire to control how products and services are used. Since most consumers object in principle, it's likely that price discrimination will grow -- but in a concealed form. The focus will be on tactics such as personalized bundling and loyalty programs, which tend to disguise the actual price that's charged. For example, online travel sites are also getting into dynamic packaging -- offering special discounts if you book a flight and hotel or hotel and a car. Bundling offers deliberately obscure the price of any one item. It's a small step from there to also take into account other information about the customer -- such as her wealth -- to adjust the price according to what the seller thinks can be extracted.
 Black covers privacy issues for BusinessWeek Online in her twice-monthly Privacy Matters column Edited by Patricia O'Connell Get BusinessWeek directly on your desktop with our RSS feeds.  Add BusinessWeek news to your Web site with our headline feed. Click to buy an e-print or reprint of a BusinessWeek or BusinessWeek Online story or video. To subscribe online to BusinessWeek magazine, please click here. Learn more, go to the BusinessWeekOnline home page  | | |
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