If you have ever wondered whether you paid a fair price for a flight ticket or an apparel piece, you are not alone. Customers are often concerned about paying higher than the “fair value” of products and services. The fair value, however, is subjective. While customers expect the products to be reasonably priced based on costs and margins, firms may believe the fair value is the customers’ willingness to pay (WTP), which can vary for different customers. For example, a businessperson traveling for a time-sensitive meeting may be willing to pay higher airfare than a student traveler on a budget. Thus, the firm faces a critical dilemma: to set a high price to enjoy a higher profit margin and exclude low-WTP customers or charge a low price to increase demand at a lower profit margin. Either way, setting a uniform price for all customers cannot capture the full revenue potential.
In this situation, charging different prices to different customers brings the best of two worlds: The firm can set a high price for customers with high WTP to increase its profit margin and a low price for low WTP customers to increase demand. For instance, some believe it is fair to offer an airfare discount to students and charge a premium to business travelers. This pricing tactic, i.e., customizing prices based on individual customer attributes, is known as personalized pricing. With the abundance of customer information online through purchase history, social media activity, and browsing history saved in cookies, firms can learn about their customers and personalize prices.
In addition to the firm, personalized pricing can benefit customers. Some customers pay a lower personalized price than a uniform price set for all customers. In the airfare example above, a discount targeted to students enables them to afford the flight ticket. Of course, personalized pricing does not always reduce the price. A firm may charge a personalized premium from customers with a high WTP. While a higher price is usually perceived poorly by customers, it has benefits. For instance, when there is an inventory shortage, the price can be a tiebreaker between customers. Naturally, customers willing to pay a higher price may be prioritized over those who value the product or service less. A business traveler may be able to purchase the flight ticket at the last minute because it is not sold earlier to another leisure traveler at a lower price.
Personalized pricing is generally legal. However, it may carry unintended consequences. For example, the higher paying customers may find it unfair that they are being targeted for their WTP. Amazon received significant pushback from customers when it experimented with personalized pricing in 2000 and refunded customers later. Also, firms may unintentionally target customers based on protected attributes such as race and nationality. For example, Princeton Review targeted Asians twice as much as non-Asians when it personalized the prices based on Zip codes. Consequently, many customers remain concerned about personalization tactics.
Concerned customers may forgo a purchase or anonymize their identity by using VPNs, deleting their cookies, or refusing to log in to their accounts before seeing the price. These actions prevent firms from learning about their customers and providing them with a seamless experience even if they do not intend to use the customer’s individual information for pricing. To illustrate, consider an airline that sets a uniform fare for all customers to balance supply and demand. This airline can set a high price when a few seats are left without risking unsold tickets. A business traveler may receive this high price simply because of the shortage of remaining seats. But this customer may incorrectly interpret the high fare as a personalized price based on her purchase history and postpone her purchase or visit another seller. Simultaneously, a student may be unable to afford this high airfare without any promotions. The result would be empty flight seats not purchased by any of the customers, a lose-lose outcome for all stakeholders. The primary contributor to this undesirable situation is the customers’ lack of trust because of firms’ nontransparent pricing strategies. When a company like Amazon alters prices 2.5 million times a day, it is hard for customers to know the underlying intent of these price changes.
In a new research paper, we argue that this is an inherent concern for customers. We find that even the most strategic customers cannot uncover whether a price is personalized without additional information. Therefore, these customers are expected to wonder if they are paying a fair price. To alleviate these concerns, firms must set a uniform price for all customers significantly below optimal levels to encourage purchases. Yet, this low uniform price might be higher than what low-WTP customers would pay with personalized pricing. Concurrently, this low price can result in excessive customer competition for a limited number of inventories, hurting high-WTP customers. So, while reducing the price may alleviate customer concerns, it does not necessarily benefit the firm or customers.
Alternatively, the researchers propose that firms create transparency over their pricing strategies by disclosing inventory availability information to customers. Customers aware of an inventory shortage are less likely to associate a high price with personalized pricing. In other words, inventory availability information enables customers to decouple market-based pricing strategies from those policies targeting customers based on their attributes. Thus, disclosing such information can partially restore customer trust. But firms do not need to disclose complete inventory availability information to gain this trust. A simple binary disclosure policy—where the firm marks inventories low-in-stock when they are below a threshold—can suffice to alleviate customer concerns and benefit all the stakeholders, including the firm and customers.
Disclosing availability information is a double-edged sword for firms. Customers who learn that inventory is abundant tend to associate a high price with personalized pricing. But this is not necessarily problematic. With abundant inventories, firms automatically have the incentive to lower the prices to increase demand and clear their products. Although, in this case, the low price is not motivated by customer concerns, it is appealing because it assures customers that they are not being overcharged.
Nevertheless, an improperly set inventory disclosure policy can backfire and hurt the firm and customers. For example, whether a thirty percent inventory availability would be labeled “low-in-stock” is often up to the firm’s discretion. If the firm sets this inventory threshold too low or too high, it ends up in a situation where it often does not convey any meaningful information to customers. This can further hurt customer trust and limit the firm’s ability to set optimal prices. How this threshold should be set depends on the population of customers and market conditions.
There has been a growing interest in regulating personalization practices in recent years. Most of these efforts have focused on requiring firms to disclose how they collect and use customers’ data. These disclosures, however, are often not read by customers. Therefore, a market mechanism approach requiring firms to disclose inventory availability information may be more effective in creating transparency over pricing strategies with minimal market interference. Most firms already track their inventory availability as a key performance metric. Since disclosing this information can also be in the firm’s best interest, they may willingly implement such a policy. Nonetheless, externally auditing whether firms truthfully disclose inventory information is complex and requires taking proper measures by policymakers.
Arian Aflaki is an Assistant Professor of Business Analytics and Operations at the University of Pittsburgh.
Qian (Kenneth) Zhang is a Ph.D. candidate in Business Analytics and Operations at the University of Pittsburgh.
This post is adapted from their paper, “Is Your Price Personalized? Alleviating Customer Concerns with Inventory Availability Information,” available on SSRN.
