When is price discrimination from consumer data okay?

Price discrimination is the practice by which firms offer differential prices to customers, often based on some observed characteristic. Examples include discounts to students, the elderly, loyalty program members, bulk discounts, etc. There are different kinds of price discrimination and the extreme form (1st degree) amounts to the retailer charging the maximum amount that each customer is willing to pay, thereby extracting the greatest surplus. So far, there is nothing inherently wrong with this. Clearly, some consumers will end up paying less under price discrimination, while others may end up paying more. But that’s just how things work. If you’re a student, you get a discount, otherwise, you pay full price. Great to be a student.

But when is this bad? Certainly when it’s illegal. US law has deemed price discrimination based on some characteristics (e.g. race, sex, religion) to be illegal. But what about computer type? People were outraged when Orbitz was outed for presenting more expensive travel search results to Mac users, relative to PC users (http://online.wsj.com/article/SB10001424052702304458604577488822667325882.html). But why the outrage? What if it were true that some other site charged less for movie rentals for PC users than Mac users? Would people be equally outraged? In one case the PC user saves money, while in another the Mac user saves.

It can be argued that price discrimination whereby students enjoy discounts is efficient because it enables transactions that wouldn’t otherwise occur (i.e. students wouldn’t pay full price). On the other hand, practices like Orbitz (2nd degree), or other forms of 1st degree price discrimination may instead just transfer surplus from the consumer to the firm. But is this “unfair?” I suppose that depends whether you’re a retailer or consumer.

Back to the question: when is price discrimination okay? While some may argue that Orbitz was unfair, it surely can’t be disallowed based on fairness. If not, then what are the rules by which we should consider price discrimination okay or not okay? In addition to illegal activities, deceptive behavior that violates FTC regulations would probably be considered “not okay.” But those are easy cases.

What about discrimination based on consumer shopping and browsing behavior? Does the collection and use of shopping data in and of itself make for an objectionable practice? I hardly think so. While some may argue for property rights over one’s transaction data, doesn’t the retailer/firm also have a right to use and innovate (i.e provide discounts and sales) based on these data, too? (Notice the familiar nuissance argument here.)

So if we agree that simply the collection and use of consumer shopping behavior *for price discrimination* is acceptable, must the retailer disclose that practice? (I’m deliberately avoiding discussion of the sale or sharing of PII — that’s a separate matter). I recognize that information disclosure can be a powerful policy intervention, but it doesn’t strike me that a simple notice in this case would lead to any meaningful outcomes.

What about discrimination based on the source of shopping behavior data? If discrimination based on traffic patterns observed only on a retailer’s site is okay, what about discrimination based on information purchased from third parties? Does this suddenly violate fair business practices, or social norms? Does it now require disclosure?

I appreciate the arguments that both consumer advocates and economists make, and they’re not unfamiliar. Arguments from consumer advocates generally relate to issues of fairness: “I want to know what’s going on, so that if I care to shop elsewhere, I have that opportunity.” On the other hand, economists will argue for efficiency (more transactions, greater total welfare), and are generally agnostic with regard to the distribution of welfare. But I don’t necessarily think these are mutually exclusive positions. I believe that the rules of the (price discrimination) game should be clear, and that everyone plays fairly. By which I mean that players should follow the rules, and not complain if they don’t always win the game.

[As a side note, there’s a story about how MAC users are more generous than PC users (http://www.theregister.co.uk/2012/12/17/qgiv_online_donations_study/).]