How and why: price discrimination in e-commerce

Price discrimination refers to retailers manipulating their prices for different segments in the market. Consumer-level information collected by companies already enables a high degree of personalized advertising. However, personalized pricing is a practice that many customers are unaware of in e-commerce. It basically means that some portion of buyers will end up paying more than others. While the reasons for such differentiation can be relatively benign, they can also be unethical.

What is price discrimination?

Price discrimination is a method that retailers use to adjust prices according to customers’ characteristics. The key factor to mention is that we refer to price differentiation for identical products or services. The cost for shipment or other cost variations in serving specific customers are not central here. Instead, we focus on price discrimination occurring beyond this, like judging clients’ willingness to pay according to their geo-location. In e-commerce, price discrimination typically borrows the technology behind personalized advertising. Thus, companies base their pricing on cookies, IP addresses, or whether a customer has made prior purchases. However, websites that offer discounts via coupons also participate in differential pricing to an extent.

Amazon was one of the first to explore price discrimination, offering lower prices to new customers in 2000. Home Depot explained that it adjusted prices according to clients’ ZIP codes and prices in its nearby brick-and-mortar stores.

However, we face price discrimination in our offline lives as well. Age-based pricing is a simple example that we treat as a norm. It means companies might offer discounts or free services to children or senior citizens. Additionally, educational facilities can provide discounts to particular groups, and travelers can obtain cheaper flight tickets when buying them in advance. Differential pricing strategies mostly fall into three categories.

Types of price discrimination

• First-degree pricing. This model means that retailers sell products at different prices for each customer. Companies judge each client’s maximum willingness to pay and present prices accordingly. This strategy allows retailers to extract all consumer surplus. However, first-degree pricing is rare, as businesses are unlikely to make highly accurate calculations on users’ reservation prices.
• Second-degree pricing. This type of price discrimination relies on quantity. Thus, companies will offer better deals when customers buy in bulk. For instance, many stores will give you discounts when purchasing three products instead of one. Additionally, second-degree pricing covers the differences that occur when buying larger sizes. For example, a large coffee cup might cost less than a small one if we take the price per gram.
• Third-degree pricing. It reflects price discrimination based on market segments. Thus, this strategy can group consumers according to their age, location, or previous purchases. Third-degree pricing is the most prevalent as it is relatively simple to implement, both offline and online. When visiting a store and requiring a student discount, you will need to present a valid student ID card. In the online world, a collection of identifiers give businesses insights into customers’ types. Therefore, retailers look at cookies, IP addresses, and account information to perform price discrimination.

How does price discrimination happen online?

At first glance, price discrimination might aid the price-sensitive clientele that has less monetary resources. However, it also means that companies predetermine which markets or consumers will pay more. In 2012, Orbitz estimated that Mac users spent 30% more a night on hotels. Thus, instead of price discrimination, it performed something called price-steering. In essence, it means showing high-priced goods for groups defined as more willing to pay. Hence, Orbitz’s assumptions about Mac users reflect how easy it is for retailers to use consumer-level information. Something as minimal as sharing your device type can mean that businesses treat you as a customer capable of paying more. In some cases, the calculation might be accurate, but presumably not in all scenarios.

Your location plays a vital role in how much money you will spend online. For instance, Steam, a popular video game distributor, relies heavily on players’ whereabouts. Let’s take the differential pricing for a game called Night of the Dead. You will notice that people living in Argentina, Turkey, or Russia will pay the smallest price (from $3 to slightly above $6). However, people in Israel, Switzerland, and Australia will spend close to $30. Thus, a person in Argentina pays only 10% of the price offered to an individual in Israel. Steam might base its price discrimination on regional sales trends, exchange rates, or publisher decisions. Minimum wage statistics can play a role as well. In Israel, the minimum wage is $1489, while in Argentina, it is $250 (when converted to USD).

Age-based price discrimination is typically acceptable (as in discounts for children or seniors). However, it can also cross the line and even end in age discrimination lawsuits. Tinder is well-aware of such consequences after introducing its pricing strategy for Tinder Plus. The company offered their premium tier services at lower prices to users up to 30 years old. Tinder then faced a discrimination lawsuit, concluding with a settlement to pay $11.5 million in compensation.

Is price discrimination legal?

Currently, there are no specific laws overseeing price discrimination. Thus, it is legal unless companies manipulate prices based on consumers’ race, religion, gender, and, in some instances, age.

GDPR does not name price discrimination specifically, but its treatment of personal data can be useful. Instead of banning it, GDPR could serve as a basis for more transparent price discrimination. If companies use tracking cookies, IP addresses, or account details to adjust prices, they should disclose such practices.

How can you escape price discrimination?

Price discrimination is prevalent in both the offline and online world. However, with companies continuously learning more about us, personalized pricing could turn more toxic. One issue is that consumers will pay higher prices without getting clear reasons behind such practices. Additionally, a rather simplistic argument works here as well. Not all consumers in the UK will be able to pay the same prices. On the other hand, not all people from regions deemed more price-sensitive will necessarily need a price cut.

Depending on the context in which price discrimination appears, you might be able to obviate it. If a service offers discounts to new customers, you can try clearing cookies and revisiting the products you wanted. If the differential pricing relies on customers’ locations obtained through IP addresses, you can use a VPN. It allows you to pick a specific region you want your IP address to pinpoint. Thus, you can save money on hotel bookings, plane tickets, car rentals, games, etc.