Personalized Pricing and Quality Differentiation

We develop an analytical framework to investigate the competitiveimplications of personalized pricing (PP), whereby firms chargedifferent prices to different consumers based on their willingness topay. We embed PP in a model of vertical product differentiation and showhow it affects firms’ choices over quality. We show thatfirms’ optimal pricing strategies with PP may be nonmonotonic inconsumer valuations. When the PP firm has high quality, both firms raisetheir qualities relative to the uniform pricing case. Conversely, whenthe PP firm has low quality, both firms lower their qualities. Althoughmany firms are trying to implement such pricing policies, we find that ahigher-quality firm can actually be worse off with PP. While it isoptimal for the firm adopting PP to increase product differentiation,the non-PP firm seeks to reduce differentiation by moving in closer inthe quality space. While PP results in a wider market coverage, it alsoleads to aggravated price competition between firms. Because thisentails a change in equilibrium qualities, the nature of the costfunction determines whether firms gain or lose by implementing such PPpolicies. Despite the threat of first-degree price discrimination, wefind that PP with competing firms can lead to an overall increase inconsumer welfare.