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JULY 31, 2003
By Jane Black Sharper Tools for Discriminatory Pricing Expert Andrew Odlyzko explains how tech advances are making it much easier to charge one price for you and another for your neighbor Why do corporations want your personal data? The simple answer, according to Andrew Odlyzko, the director of the University of Minnesota's Digital Technology Center, is that such information is the key to a holy grail of capitalism: discriminatory pricing. Economic theory posits that price discrimination -- where companies charge individuals based on their ability to pay and their value as a customer -- is desirable since it makes trade more efficient. Yet it rankles consumers, who perceive differential pricing as unfair. The fact that business travelers, whose corporations can arguably afford it, pay more for airline seats than a vacationer has made air travel more popular and routine. At the same time, the price discrimination that charges two people different prices for the same class of service infuriates those who pay more. In a paper to be presented at the Fifth Annual Conference on E-Commerce this fall, Odlyzko, a Bell Labs researcher for 26 years, doesn't argue for or against discriminatory pricing. He focuses on how technology can bring it to new levels of sophistication and prevalence. In 2000, Coca-Cola (COK ) tested a vending machine that would raise prices on a hot, humid day and lower them when temperatures fell. Today, Amazon.com (AMZ ) knows what, when, and how often customers buy and is experimenting with offering personalized bundles -- buy two books and get a discount, for example -- to induce people to buy more. Twenty years ago, neither experiment would have been possible. Managers who invest in privacy-eroding data-collection technology aren't always conscious that they're moving toward a world of widespread discriminatory pricing, Odlyzko says. Rather, they're trying out ways to use information to increase profits. But as corporations become more sophisticated in collecting and parsing consumers' personal information, success will lead them to more pervasive price discrimination. On July 28, I talked to Odlyzko about how data is being used to usher in a more efficient -- and privacy-invasive -- economy. Edited excerpts follow: Q: Your paper posits that private companies now have both greater incentive and ability to discriminate on pricing by collecting and analyzing customer data. How so? A: The greater incentive comes from the fact that in an information economy, an increasing fraction of the costs is fixed. It costs a large amount to create and market a movie, but very little to distribute it to a theater and on-demand to a customer at home. But different customers are willing to pay different amounts for the privilege of seeing a movie. In the last issue of BusinessWeek, there was a letter from a reader who advocated that Hollywood should start by charging $30 to see a new release at home, then reduce the price to $5 over time. He said he would happily pay $30 to see a new movie at home because it costs him $75 to see a movie in the cinema -- after he pays for the babysitter and popcorn and tickets. So here's one guy who says he's willing to pay $30 because that's much less than what he's currently paying to see a new release. On the other hand, you've got teenagers and adults who like the social atmosphere of a movie theater, the wide screen, etc. For them, you have to induce them to stay in and watch the movie, rather than going out, by offering them very low prices, maybe $3. If you can do both without getting them upset, then society wins. Q: So why does differential pricing upset customers? A: There's this central issue of fairness that comes up. People are very concerned that they'll pay more than someone else and be played for a fool. That's what we dislike about having to deal with the salesman in the car-buying process. That's why people got angry enough to file lawsuits when they observed that catalog companies had been offering different prices to different individuals. [The customers lost.] That's why people are sensitive to airline pricing -- and why they're concerned that it's spreading to other travel areas, such as hotels and rental cars.
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