Competition with Personalized Pricing and Strategic Product Differentiation

Consumers leave increasingly more digital footprints that improve firms’ ability to practice personalized pricing (first-degree price discrimination). We ask whether there exist strategic effects that reduce firms’ incentives to do so. To answer this question, we first note that it is optimal for a firm that price discriminates to set the purchasing price equal to marginal costs from consumers who buy from a rival. This is true independently of whether the rival has made any non-price commitments (e.g. strategic product differentiation). In contrast, if a firm uses uniform pricing, the rival has incentives to make strategic commitments that soften competition. Consequently, we find that firms might find it optimal to commit to uniform pricing to avoid being trapped in a highly competitive equilibrium. The key insight is that a firm’s incentives to undertake strategic price-softening behavior depend on the rival’s choice between uniform and personalized pricing, and not the firm’s own choice.