Once you know what to look for, you start to see price discrimination everywhere. Price discrimination is the practice of a firm offering different prices to different consumers for the same product, and where the different price doesn't depend on a difference in costs. A price-discriminating firm would want to charge a lower price to its more price-sensitive consumers, and a higher price to its less price-sensitive consumers.
One somewhat counter-intuitive example I use in my ECONS101 class is Delta Airlines charging higher prices to their frequent fliers (as noted in this Forbes article from 2015). The frequent fliers are less price sensitive (they have less elastic demand) because for them, there are few close substitutes for flying Delta Airlines. They have accumulated air miles on Delta, and they want to build up their balance. They don't get Delta air miles from other airlines, making them reluctant to switch to other airlines, even if the price is higher. Consumers who are not Delta frequent fliers are more price-sensitive (they have more elastic demand) because all other airlines are substitutes for Delta on the same route.
It seems that Delta Airlines is not alone in this counter-intuitive approach, as the New Zealand Herald reported earlier this week:
Users of McDonald’s popular mobile app have raised fears that frequent customers are being hit with higher prices than others, a practice they claim is “price gouging”.
The claims were raised on Reddit, where one user highlighted that he was being charged up to $3 more than his partner for some items, despite them both accessing the app on the same day, from the same location.
The only difference between their accounts? He had more than double the number of loyalty points, showing he had used the app more in the past.
To be clear, this isn't 'price gouging', it is price discrimination, pure and simple. McDonald's justified its actions as follows:
The Herald approached McDonald’s NZ for comment on the claims and a spokesperson said the differences might be due to lower prices being used entice customers to return to the app.
Noting that personalised deals had been in place since the loyalty programme was rolled out last year, the spokesperson said details of how benefits were offered and data was used is spelled out in the terms and conditions.
“Individual offers will differ between users, based on a variety of factors,” they told the Herald.
“Due to the personalisation of our app, not all customers will see the same deals, and as an example a deal may be offered to encourage use of the app on the customer’s next visit.”
Just like Delta Airlines' frequent fliers, frequent users of the McDonald's app are less price-sensitive. That might be because they want to build up points on the app (just like air miles), or it might simply be that McDonald's has found that the most loyal McDonald's users are less sensitive to price, and more likely to use the app. In both cases, for these consumers there are fewer close substitutes to McDonald's than there are for infrequent app users, and so the frequent users' demand is less elastic than the infrequent app users. McDonald's therefore offers lower prices to infrequent users of the app, because they are more price sensitive.
Despite any complaints that users of the app may have, none of this is illegal. Firms are free to offer different prices to different consumers. As noted in the article:
The Herald approached Consumer NZ about the claims of price gouging and the watchdog said it had not received any complaints about pricing on the app.
“The Fair Trading Act states businesses can’t mislead shoppers about prices, and the Privacy Act requires companies to disclose to consumers what data is being collected and how it’s being used,” a Consumer NZ spokesperson said.
“If McDonald’s is using personalised pricing, or their customers’ data to set different prices based on factors like what products they’ve searched for in the past, or their location – they should be upfront about it,” they added, pointing towards a Consumer guide to personalised pricing.
“While personalised pricing may not be inherently bad, it relies on businesses applying it fairly, responsibly, and transparently.”
Personalised pricing is a particular form of price discrimination (first-degree price discrimination), where every consumer may be charged a different price for the good or service (for more on this, see this post). If executed perfectly, the firm would charge a price equal to the maximum the consumer is willing to pay. Fortunately (for consumers, not for firms), personalised pricing is mostly a theoretical curiosity. However, the more data that firms have about consumers, the closer they can get to estimating their consumers' willingness-to-pay.
Apps like the McDonald's app are a very handy tool for firms to collect information about their consumers, what they are willing to pay for different goods and services (and what they are not willing to pay). That data can then be used to set prices in the future. It's a point that I've made before. Give it time - if consumers keep giving firms their data, pretty soon we'll all face personalised prices for most of the things that we buy.
[HT: Max from my ECONS101 class]
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