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Direct Marketing: Privacy and Competition
Abstract
Direct mail, telemarketing, and commercial email are key elements of the promotional mix. This research addresses the trade-off between the benefit to latent consumers (who, absent direct marketing, would not enjoy some product) against the costs of avoidance and intrusion on privacy guardians (who have no interest in the item). We find that guardians' avoidance and sellers' investments in collecting information are strategic complements. This implies that measures to conceal direct marketing will increase its cost-effectiveness and lead sellers to spend more. We compare the outcomes under monopoly and duopoly. Both market structures lead to outcomes that are not socially optimal, because sellers ignore the costs to privacy guardians. Competition leads sellers to increase spending on direct marketing and guardians to increase avoidance. The increased marketing raises the benefit to latent consumers, while the increased avoidance raises privacy guardian's costs. On balance, competition reduces welfare if the cost of intrusion is sufficiently high. Direct marketing can be regulated through taxes based on solicitations or sales. We find that, in the presence of competition, the tax on solicitations is relatively more effective.
... For example, Ghose and Chen (2003) examine these trade-offs in the context of personalization, where firms can adjust the level of personalization through privacy enhancing technology. In the same vein, Akcura and Srinivasan (2003) and Hann et al. (2003) study similar trade-offs in the context of target marketing. Hann et al. (2002) empirically quantifies the value of website privacy protection. ...
Information technology-enabled markets enhance retailers' ability to collect, aggregate, and transfer consumer information. These technological capabilities have raised concerns that this information could be used in ways the consumer would not anticipate or authorize. These concerns have been met with a variety of proposals including approaches placing the onus for protection on consumers, industry self-regulation, and government legislation of mandatory protec-tion standards. However, there has been no research to understand under what circumstances each of these regimes will produce optimal outcomes for customers, retailers, and society. Our research seeks to answer this question using analytic models of asymmetric information. Our results show that the optimal privacy protection regime depends critically on the characteristics of the market —the number of individuals who face a loss from privacy violations and the size of the loss they face. We find that regimes that place the onus on consumers are socially optimal when few people are sensitive to privacy violations or when the loss they face from privacy violations is low. Conversely, when many people care about privacy protection and the potential loss they face is high, mandatory standards are socially optimal. Finally, for intermediate values, seal-of-approval programs provide socially optimal privacy protection.
The authors examine consumer perspectives of data collection awareness and knowledge of name removal mechanisms, such as opt in and opt out, across mail, telephone, and Internet direct channels. The authors investigate consumer privacy states based on the fair information practices of notice (data collection awareness) and choice (knowledge of name removal mechanisms). Data from a national survey suggest that name removal preference varies by channel, consumer privacy state, channel-specific purchase experience, and consumer demographics. Empirical support is also found for alternative approaches (i.e., opt-in methods)for removing personal information from direct marketing lists.
The increasing availability of customer information is giving many firms the ability to reach and customize price and other marketing efforts to the tastes of the individual consumer. This ability is labeled as consumer addressability. Consumer addressability through sophisticated databases is particularly important for direct-marketing firms, catalog retailers such as L.L Bean and Land's End, credit card-issuing banks, and firms in the long-distance telephone market. We examine the strategic implications of consumer addressability on competition between database/direct marketing firms. We address questions such as: In a competitive environment, how should firms invest in addressability? Will future improvements in the degree of addressability increase or mitigate the intensity of competition between the firms? Will greater addressability always be beneficial for firms?
We model competition between two firms in a market where consumers differ on a horizontal attribute of product differentiation. The market comprises consumers located on a linear attribute space and firms located at the ends of the line. We represent the degree of addressability (or the reach of a firm's database) as the proportion of consumers at each point in the market who are in the firm's database. Consequently, the firm can offer these consumers customized prices.
Consumer addressability creates two effects that govern the competition between firms: a "surplus extraction" effect because a firm might address a consumer who is not reached by its competitor and a "competitive" effect that is created by the set of consumers who can be addressed by both firms. The key results of the paper pertain to when the addressability decision is endogenous. When the extent of market differentiation (or consumer heterogeneity in preferences for a product/brand attribute), as well as the incremental cost of addressability, are sufficiently large, firms make symmetric investments in equilibrium. Given high costs, firms choose sufficiently low levels of addressability. Low addressability and high levels of market differentiation both help reduce price competition, which facilitates symmetric choice of addressability by the firms in equilibrium. However, when market differentiation and the cost of incremental addressability become small, firms face the prospect of destructive competition. As a result, they strategically differentiate in their choice of addressability to mitigate this competition. Interestingly, even in the extreme case when incremental addressability is costless, not every firm chooses full addressability in equilibrium. This has useful implications for direct marketing. Given that the advances in information technology should improve the ability of firms to address their consumers, it might indeed not be desirable for all direct marketing firms to indefinitely pursue greater addressability as costs of doing so decline. The analysis also shows an interesting effect of market differentiation in addressable markets: Equilibrium profits can decrease with an increase in market differentiation when the marginal cost of addressability is sufficiently high. Finally, we discuss the competitive outcome that would result when firms compete with addressable as well as uniform posted prices.
Durable goods manufacturers often design product lines by segmenting their markets on quality attributes—attributes that exhibit a “more is better” property for all consumers. Since products within a product line are partial substitutes, and consumers can self-select the products they want to purchase, multiproduct firms have to carefully consider the cannibalization problem in designing their product lines. Existing research has analyzed the cannibalization problem for a monopolist who faces consumers who differ in their quality valuations. If lower-quality products are sufficiently attractive, higher-valuation consumers may find it beneficial to buy lower-quality products rather than the higher-quality products targeted to them. That is, lower-quality products can potentially cannibalize higher-quality products. The cannibalization problem forces the firm to provide only the highest-valuation segment with its preferred (efficient) quality. All other segments get qualities lower than their preferred (efficient) qualities. When the cannibalization problem is very severe, the firm may not serve some of the lowest-valuation segments.
However, not much is known about how and when the cannibalization problem affects product line design in an oligopoly. Also, consumers may differ not only in their quality valuations but also in their taste preferences. The objective of this paper is to fill these gaps by examining whether the cannibalization problem affects a firm's price and quality decisions in a model with consumer differences in quality valuations, as well as in their taste preferences, in both monopoly and duopoly settings. The paper addresses questions such as the following. With both types of consumer differences, should a firm, even a monopolist, provide efficient quality only to the top segment? Are there conditions under which other segments can also get their preferred quality levels? If so, how do consumer and firm characteristics affect the likelihood of different segments getting their preferred qualities? How does competition affect the firm's choice of qualities?
I develop a model in which the market is made up of two segments, with one segment valuing quality more than the other. Consumers within each segment are distributed over Hotelling's (1929) linear city. Consumers in the two segments can have different taste preferences (transportation costs). Firm locations in the two segments may also be different.
The paper begins with an analysis of the monopoly case. I find that when both segments are fully covered, the standard self-selection results of the high-valuation segment getting its preferred quality and the low-valuation segment getting less than its preferred quality do hold. Interestingly, when both segments are incompletely covered, under some conditions, the monopolist's price and quality choices are not determined by the cannibalization problem. In these cases, the monopolist finds it optimal to provide each segment with its preferred quality. Thus, the equilibrium quality levels in a second-degree price discrimination situation resemble the third-degree price discrimination solution. I characterize the relevant conditions in terms of consumer characteristics.
I then consider the case of two firms competing in the market, each offering two products—one for the high-valuation segment and the other for the low-valuation segment. Here also both types of outcomes are possible, depending on consumers and firm characteristics. Under some conditions, the cannibalization problem does not affect the firms' price and quality choices, and each firm provides each segment with that segment's preferred quality. Each firm finds it optimal to serve both segments. When these conditions do not hold, only the high-valuation segment gets its preferred quality. I interpret the conditions necessary for these results to exist in terms of characteristics of the consumers and the firms.
An interesting insight from the analysis is that as the taste preferences of the low-valuation segment become weaker (their “transportation cost” becomes lower), the more intense competition in the low-valuation segment makes it more attractive for the high-valuation consumers to buy the products meant for the low-valuation segment. This worsens the cannibalization problem, and the low-valuation segment may not get its preferred quality. On the other hand, when the taste preferences of the high-valuation segments are sufficiently weak, more intense competition in the high-valuation segment reduces that segment's incentives to buy the product meant for the low-valuation segment. This mitigates the cannibalization problem and makes it more likely for the low-valuation segment to get its preferred quality.
Similarly, when firms are less differentiated in the low-valuation segment, stronger competition between the firms makes the cannibalization problem worse, and the low-valuation segment may not get its preferred quality. When the differentiation between the firms is sufficiently weak in the high-valuation segment, the high-valuation segment is more likely to be better off buying the product meant for it. As the high-valuation segment's incentives to buy the lower-quality product are reduced, the low-valuation segment is more likely to get its preferred quality.
Our research investigates the competitive ramifications of individual marketing and information management in today's information-intensive marketing environments. The specific managerial issues we address are as follows. First, what kinds of incentive environments do competing firms face when they can only target individual customers imperfectly? Second, does the improvement in an industry's targetability intensify price competition in the industry such that all competing firms become worse off? Third, should a firm share its customer knowledge so as to improve its rival's targetability? Fourth, how should an information vendor sell its information that can improve a firm's targetability? Finally, do competing firms have the same incentives to invest in their own targetability?
To answer those questions, we develop a simple model à la Narasimhan (1988), in which each of the two competing firms have their own loyal customers and compete for common switchers. We assume that each firm can classify its own loyal customers and switchers correctly only with a less-than-perfect probability. This means that each firm's perceived customer segmentation differs from the actual customer segmentation. Based on their perceived reality, these two competing firms engage in price competition. As an extension, we also allow the competing firms to make their investment decisions to acquire targetability.
We show that when individual marketing is feasible, but imperfect, improvements in targetability by either or both competing firms can lead to win-win competition for both even if both players behave noncooperatively and the market does not expand. Win-win competition results from the fact that as a firm becomes better at distinguishing its price-insensitive loyal customers from the switchers, it is motivated to charge a higher price to the former. However, due to imperfect targetability, each firm mistakenly perceives some price-sensitive switchers as price-insensitive loyal customers and charges them all a higher price. These misperceptions thus allow its competitors to acquire those mistargeted customers without lowering their prices and, hence, reduce the rival firm's incentive to cut prices. This effect softens price competition in the market and qualitatively changes the incentive environment for competing firms engaged in individual marketing. A “prisoner's dilemma” occurs only when targetability in a market reaches a sufficiently high level.
This win-win perspective on individual marketing has many managerial implications. First, we show that superior knowledge of individual customers can be a competitive advantage. However, this does not mean that a firm should always protect its customer information from its competitors. To the contrary, we find that competing firms can all benefit from exchanging individual customer information with each other at the nascent stage of individual marketing, when firms' targetability is low. Indeed, under certain circumstances, a firm may even find it profitable to give away this information unilaterally. However, as individual marketing matures (as firms' targetability becomes sufficiently high), further improvements in targetability will intensify price competition and lead to prisoner's dilemma. Therefore, it is not only prudent politics but also a business imperative for an industry to seize the initiative on the issue of protecting customer privacy so as to ensure win-win competition in the industry.
Second, we show that the firm with a larger number of loyal customers tends to invest more in targetability when the cost of acquiring targetability is high. However, the firm with a smaller loyal base can, through information investment, acquire a higher level of targetability than the firm with a larger loyal base as long as the cost of acquiring targetability is not too high. As the cost further decreases, competing firms will all have more incentives to increase their investments in targetability until they achieve the highest feasible level.
Third, an information vendor should make its information available nonexclusively (exclusively) when its information is associated with a low (high) level of targetability. When the vendor does sell its information exclusively, it should target a firm with a small loyal following if it can impart a high level of targetability to that firm.
Finally, our analysis shows that an information-intensive environment does not doom small firms. In fact, individual marketing may provide a good opportunity for a small firm to leapfrog a large firm. The key to leapfrogging is a high level of targetability or customer knowledge.
The rapid advance in information technology now makes it feasible for sellers to condition their price offers on consumers’ prior purchase behavior. In this paper we examine when it is profitable to engage in this form of price discrimination when consumers can adopt strategies to protect their privacy.
Our baseline model involves rational consumers with constant valuations for the goods being sold and a monopoly merchant who can commit to a pricing policy. Applying results from the prior literature, we show that although it is feasible to price so as to distinguish high-value and low-value consumers, the merchant will never find it optimal to do so.
We then consider various generalizations of this model, such as allowing the seller to offer enhanced services to previous customers, making the merchant unable to commit to a pricing policy, and allowing competition in the marketplace. In these cases we show that sellers will, in general, find it profitable to condition prices on purchase history.
This article analyzes the equilibrium-pricing strategies of brands engaged in a pricing game. Each brand has a monopoly market (loyal consumers) and competes with others in a common market called brand switchers. In the case of a duopoly, it is shown that the behavior of the brand switchers characterizes the equilibrium behavior of the duopolists. This article focuses on two key comparative statics: namely , the depth of discounts away from a "regular" high price and the probability of giving a deal or the frequency of deals. How these properties vary with the size of the loyal markets and the behavior of the brand switching population is discussed. Copyright 1988 by the University of Chicago.
In this paper, a firm discriminates between two classes of customer who have a different cost of information by coupling a list price with an offer to match the pr ice of any other shop. If the list price elsewhere is lower, the firm will be successful in discrimination. The list price of each firm is increasing in the number of sellers and the total sales are decreasi ng in the number of sellers. Furthermore, if sellers coordinate, they discriminate more efficaciously and increase their profits by increa sing their total sales. Copyright 1987 by the University of Chicago.
This research addresses the tensions that arise between the collection and use of personal information that people provide in the course of most consumer transactions, and privacy. In today's electronic world, the competitive strategies of successful firms increasingly depend on vast amounts of customer data. Ironically, the same information practices that provide value to organizations also raise privacy concerns for individuals. This study hypothesized that organizations can address these privacy concerns and gain business advantage through customer retention by observing procedural fairness: customers will be willing to disclose personal information and have that information subsequently used to create consumer profiles for business use when there are fair procedures in place to protect individual privacy. Because customer relationships are characterized by social distance, customers must depend on strangers to act on their behalf. Procedural fairness serves as an intermediary to bu...
Most of the privacy debate pertains to personal information being collected and disseminated in databases without consumer consent or perhaps even knowledge. The author asserts that a more important issue is how these databases are used to impose marketing costs on consumers without their consent. All marketers realize it is costly to communicate to potential consumers, but they often forget that consumers bear some marketing communications costs as well. The author suggests that economic efficiency would be enhanced by requiring marketers to internalize at least some of the consumer costs, particularly those likely to be borne involuntarily. Current regulations address only some costs for some media and often limit rather than enhance consumer choice. The author presents new public policy recommendations to improve efficiency and consumer choice.
Submitted for presentation at the first QME conference This paper explores the demand for privacy that arises from the loss of consumer surplus when firms gain the ability to treat different consumers differently. It is shown that firms in quest of a competitive advantage may have an incentive to acquire consumer information and use it to gain exclusive access to finer consumer segments, even when the costs of customized marketing are exceedingly high. When such is the case, the opportunity arises for an intermediary to coarsen market access in order to protect consumer surplus and to bar firms from exercising price discrimination. This intermediary could be a mass retailer, a mass media or a diverse community. Formally, the paper analyzes the situation of an intermediary who owns a finer market access system, i.e., the capability to separately access two types of consumers who previously remained undistinguishable. The system could be made available to one firm in exclusivity, or to several firms (two instances of "exposure"), or to no firm at all ("privacy"). The best-bidding agent (from among firms, marginal-type consumers, and mainstream-type consumers) is buying the right to command the equilibrium access allocation. The solution involves either privacy (commanded by mainstream consumers) or exclusive exposure (commanded by a firm), depending intuitively on factors such as consumer involvement, homogeneity and adaptability, as well as the size of returns to scale in marketing and the extent of competition.
Consumer privacy is at the center of an ongoing debate among business leaders, privacy activists, and government officials. Although corporations face competitive pressures to collect and use personal information about their customers, many consumers find some methods of collection and use of their personal information unfair. We present a justice theory framework that illustrates how consumer privacy concerns are shaped by the perceived fairness of corporate information practices. We describe a set of global principles, fair information practices, which were developed to balance consumer privacy concerns with an organization's need to use personal information. We conclude by discussing three alternatives for implementing fair information practices with particular attention to the Internet: government regulation, industry self-regulation, and technological solutions.
Internet Shopping Agents (ISAs) allow consumers to costlessly search many online retailers and buy at the lowest price. One would expect these ISAs to subject sellers to intense price competition that results in uniform low prices. Yet, Internet retailers have joined these ISAs. Furthermore, the prices charged by inside retailers can vary substantially. We examine the impact of ISAs on market competition. An ISA creates differentiation in the pricing strategies of ex-ante identical retailers: Some retailers join the ISA due to mass of consumers that they can potentially win, while others stay out and extract surplus from their loyal consumers, while others stay our and extract surplus from their loyal consumers. The equilibrium inside pricing is such that the average price charged can increase or decrease when more retailers join, depending on whether or not the reach of the ISA is independent of the number of joining retailers. When the reach is endogenous, there exist a unique number of inside retailers.
Internet privacy concern has also prompted the U.S. government to threaten regulation if the Internet industry is unsuccessful in regulating itself. In several well-publicized events in 1998, the U.S. Federal Trade Commission (FTC) made it clear that its patience is running out with industry efforts to self-regulate privacy practices. TRUSTe is a non-profit, privacy seal program for Web sites dedicated to building consumers' trust and confidence on the Internet, and in so doing, accelerating the growth of the Internet. In displaying the TRUSTe trustmark, Web sites send a clear signal to users that they've openly agreed to disclose their information gathering and dissemination practices, and that their disclosure is backed by credible third-party assurance. In summary, TRUSTe's goal is to have a program that addresses both user and government privacy concerns by providing a cost-effective privacy solution to Web publishers.
We examine the equilibrium interaction between a market for price information (controlled by a gatekeeper) and the homogenous product market it serves. The gatekeeper charges fees to firms that advertise prices on its Internet site and to consumers who access the list of advertised prices. Gatekeeper profits are maximized in an equilibrium where (a) the product market exhibits price dispersion; (b) access fees are sufficiently low that all consumers subscribe; (c) advertising fees exceed socially optimal levels, thus inducing partial firm participation; and (d) advertised prices are below unadvertised prices. Introducing the market for information has ambiguous social welfare effects.
Consumer privacy and the market for customer information in electronic retailing are investigated. The value of customer information derives from the ability of firms to identify individual consumers and charge them personalized prices. Two settings are studied, a closed privacy regime in which sale of customer information is forbidden and an open privacy regime in which it is permitted. Consumers fare poorly and firms fare well under an open privacy regime when consumers are myopic. In such settings the opportunity to sell information often gives firms incentives to charge 'experimental' prices. When consumers are farsighted relative to firms, however, they may undermine the market for customer information by strategically rejecting offers. In this case, firms are always better off committing to keep customer information private.
Online Personalization and Privacy: Bargaining for Customer Information
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- Alan F Westin
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and hence, by Proposition 3, higher than with monopoly, i.e.,
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