Personalized pricing with consumers’ quality uncertainty

Abstract

We examine a firm’s personalized pricing (PP) strategies in markets where consumers are uncertain about product quality. In such markets, prices serve not only as a tool for price discrimination but also as a means of conveying quality information to consumers. We reveal that a firm faces a tradeoff between adopting PP to better price discriminate among consumers and not adopting it to signal its high quality. We find that a high-quality firm should adopt PP only when its product quality is known to either a very small or a very large fraction of consumers, and when its high-quality product, on average, offers either very low or very high additional value to consumers relative to a low-quality product. Moreover, the high-quality firm may charge consumers personalized prices less than their willingness to pay to signal its quality in equilibrium, deviating from first-degree price discrimination when consumers are informed about quality. Counterintuitively, when more consumers know product quality or when the high-quality product provides higher average value to consumers, consumer surplus and social welfare may decrease, but a low-quality firm’s profit may increase. Furthermore, the firm’s profit can be lower when its personalized pricing leverages more information about consumer characteristics. Randomized experiments provide evidence that a personalized price is a weaker signal of objective product quality than a uniform price.