Behavior-based price discrimination and consumer switching

Abstract

A common practice among utility companies is to offer discounts to consumers who use a rival's services in an attempt to induce them to switch suppliers. This chapter examines a two-period model of price competition on a Hotelling line that captures this type of price discrimination. In the first period, firms have no information about individual consumers' preferences and, therefore, they post a single price. In the second period, each firm gains information about consumers' first-period purchase decisions. We show that firms have an incentive to use this information to price discriminate. A firm charges a lower price to its rival's customers (`pays consumers to switch') whenever the firm is not too disadvantaged with respect to its marginal cost. Even when consumers' switching costs are non-trivial, a re-segmentation of the market prevails in the unique subgame-perfect equilibrium to the game. An analysis of the impact of this kind of price discrimination on consumer surplus, firm profits, and social welfare is also presented.

Citation

Arbatskaya, M. (2000), "Behavior-based price discrimination and consumer switching", Baye, M.R. (Ed.) Industrial Organization (Advances in Applied Microeconomics, Vol. 9), Emerald Group Publishing Limited, Leeds, pp. 149-171. https://doi.org/10.1016/S0278-0984(00)09049-0