Consumer Profiling with Inventory Rationing

Problem Definition: We examine the impact of a selling firm's inventory decision in a model where the firm engages in consumer profiling and targeted pricing and consumers decide whether to hide their identity. Consumers who do not hide will be notified by an advertising email early in the selling season but may be offered a personalized price if accurately profiled. Consumers who hide their identity will be charged a uniform price but will not receive the early-season notification, and thus will likely experience a stockout. Assuming consumers make privacy choices based on rational expectations, we study the firm's optimal pricing and inventory decisions and the associated welfare implications. Academic/Practical Relevance: Recently, online retailers have been engaging in consumer profiling and targeted pricing. This trend has a two-fold effect on consumers: Consumers can receive the latest offers but their valuations can be disclosed to retailers who may price discriminate. Motivated by this, our work contributes to the literature by analyzing the implications of a firm's operational decision -- the inventory level -- on consumers' privacy choice, the consumer surplus and social welfare. Methodology: Optimization and game theory. Results: We characterize the conditions under which it is optimal for a firm to intentionally create an inventory shortage to discourage consumers from hiding. Interestingly, this inventory rationing strategy may lead to a win-win outcome where both the firm and consumers are better off compared to a setting in which an inventory shortage is not allowed. Additionally, a firm may not always benefit from a more accurate profiling technology when adopting the inventory rationing strategy. Managerial Implications: The win-win outcome occurs if the early-season advertising effectively induces early purchases. Hence, for better consumer protection, online retailers should be encouraged to invest in effective early-season advertising when capitalizing on an inventory shortage