The Charm of Behavior-Based Pricing: When Consumers’ Taste Is Diverse and the Consideration Set Is Limited

Abstract

Technology is making it easier for firms to track consumers’ purchase history and leverage the information when setting prices. This article explores the practice of behavior-based pricing (BBP) in a horizontally differentiated market where consumers’ taste is diverse and the consideration set is limited. The analysis identifies a novel mechanism that can help firms earn more profits with BBP than without it. Prior research shows that BBP intensifies price competition for new consumers. The authors show that if consumer valuation is low, the lower price can help expand sales to consumers for whom only the second preferred product is available, and the resulting increase in revenue more than offsets the loss in revenue because of the intensified price competition. The opposite result occurs if product valuation is high. Moreover, the difference in the price charged for old and new consumers under BBP decreases with the diversity in consumers’ taste if consumer valuation is low. The result, however, is reversed if consumer valuation is high.