Equilibrium Market Segmentation for Targeted Pricing Based on Customer Characteristics

Recent advances in intelligent pricing softwares have created numerous opportunities for retailers to turn customer information into additional profits through targeted pricing: charging different prices to different market segments directly or indirectly based on customer demographics. However, rigorous theoretical analysis regarding what is the profit-maximizing set of variables remains scarce. This study develops a game-theoretic model to investigate this issue. Results of this model suggest that a monopoly retailer should use pricing variables with high explanatory power of the retailer's own demand: i.e., variables with large demand coefficients or high variances. In the duopoly case, the model suggests that the value of price discrimination depends on how the pricing variables may affect demand. When a pricing variable identifies a market segment that has high demand for both firms' products, the equilibrium profit of both retailers is higher than that in the monopoly case. As a result, retailers would price by that variable simultaneously in the equilibrium. In contrast, if a pricing variable identifies a market segment that has high demand for only one retailer's product, only one retailer would price by that variable in the equilibrium. The baseline model is also extended to discuss how duopoly retailers should choose between value-based and cost-based price discrimination variables