Consumer profiling, price discrimination, and consumer privacy

Abstract

This paper considers a monopolist who exercises first-degree price discrimination by acquiring consumer data to infer reservation prices. The monopolist uses profiling technology to obtain consumer information whose cost is a function of the fraction of consumers it profiles. We first describe the market equilibrium where consumers do not have access to privacy technology that prevents the monopolist from acquiring their data. The paper then introduces a costly privacy technology that allows consumers to prevent their information from being obtained and used by the monopolist.

Equilibrium analysis shows two important results that depend on the level of privacy costs. With sufficiently cheap privacy technology, we show that the monopolist profiles fewer consumers compared to when privacy is not an option for consumers. This reduces the incidence of price discrimination in the market. However, if privacy cost is sufficiently expensive, the monopolist profiles the same fraction of consumers as in the case when privacy was not an option. In this case, privacy technology does not reduce the incidence of price discrimination. Regardless of the level of privacy cost, however, the availability of privacy technology to consumers induces the monopolist to set a higher uniform price level for consumers it was not able to profile. Also, regardless of the cost of privacy, this combination of strategies on profiling and uniform price level reduces the incentive of consumers to use the privacy technology and results in an equilibrium where no consumers choose to privatize. Thus, in equilibrium, privacy technology only acts as a deterrent, and can only function as such, against aggressive consumer profiling and price discrimination if its cost is sufficiently low.

JEL classification: L12, D42, D82