Personalized coupons as a vehicle for perfect price discrimination

June 25, 2013 at 7:09 am 8 comments

Given the pervasive tracking and profiling of our shopping and browsing habits, one would expect that retailers would be very good at individualized price discrimination —  figuring out what you or I would be willing to pay for an item using data mining, and tailoring prices accordingly. But this doesn’t seem to be happening. Why not?

This mystery isn’t new. Mathematician Andrew Odlyzko predicted a decade ago that data-driven price discrimination would become much more common and effective (paper, interview). Back then, he was far ahead of his time. But today, behavioral advertising at least has gotten good enough that it’s often creepy. The technology works; the impediment to price discrimination lies elsewhere. [1]

It looks like consumers’ perception of unfairness of price discrimination is surprisingly strong, which is why firms balk at overt price discrimination, even though covert price discrimination is all too common. But the covert form of price discrimination is not only less efficient, it also (ironically) has significant social costs — see #3 below for an example. Is there a form of pricing that allows for perfect discrimination (i.e., complete tailoring to individuals), in a way that consumers find acceptable? That would be the holy grail.

In this post, I will argue that the humble coupon, reborn in a high-tech form, could be the solution. Here’s why.

1. Coupons tap into shopper psychology. Customers love them.

Coupons, like sales, introduce unpredictability and rewards into shopping, which provides a tiny dopamine spike that gets us hooked. JC Penney’s recent misadventure in trying to eliminate sales and coupons provides an object lesson:

“It may be a decent deal to buy that item for $5. But for someone like me, who’s always looking for a sale or a coupon — seeing that something is marked down 20 percent off, then being able to hand over the coupon to save, it just entices me. It’s a rush.”

Some startups have exploited this to the hilt, introducing “gamification” into commerce. Shopkick is a prime example. I see this as a very important trend.

2. Coupons aren’t perceived as unfair.

Given the above, shoppers have at best a dim perception of coupons as a price discrimination mechanism. Even when they do, however, coupons aren’t perceived as unfair to nearly the same degree as listing different prices for different consumers, even if the result in either case is identical. [2]

3. Traditional coupons are not personalized.

While customers may have different reasons for liking coupons, from firms’ perspective the way in which traditional coupons aid price discrimination is pretty simple: by forcing customers to waste their time. Econ texts tend to lay it out bluntly. For example, R. Preston McAfee:

Individuals generally value their time at approximately their wages, so that people with low wages, who tend to be the most price-sensitive, also have the lowest value of time. … A thrifty shopper may be able to spend an hour sorting through the coupons in the newspaper and save $20 on a $200 shopping expedition … This is a good deal for a consumer who values time at less than $20 per hour, and a bad deal for the consumer that values time in excess of $20 per hour. Thus, relatively poor consumers choose to use coupons, which permits the seller to have a price cut that is approximately targeted at the more price-sensitive group.

Clearly, for this to be effective, coupon redemption must be deliberately made time-consuming.

To the extent that there is coupon personalization, it seems to be for changing shopper behavior (e.g., getting them to try out a new product) rather than a pricing mechanism. The NYT story from last year about Target targeting pregnant women falls into this category. That said, these different forms of personalization aren’t entirely distinct, which is a point I will return to in a later article.

4. The traditional model doesn’t work well any more.

Paper coupons have a limited future. As for digital coupons, there is a natural progression toward interfaces that make it easier to acquire and redeem them. In particular, as more shoppers start to pay using their phones in stores, I anticipate coupon redemption being integrated into payment apps, thus becoming almost frictionless.

An interesting side-effect of smartphone-based coupon redemption is that it gives the shopper more privacy, avoiding the awkwardness of pulling out coupons from a purse or wallet. This will further open up coupons to a wealthier demographic, making them even less effective at discriminating between wealthier shoppers and less affluent ones.

5. The coupon is being reborn in a data-driven, personalized form.

With behavioral profiling, companies can determine how much a consumer will pay for a product, and deliver coupons selectively so that each customer’s discount reflects what they are willing to pay. They key difference is what while in the past, customers decided whether or not to look for, collect, and use a coupon, in the new model companies will determine who gets which coupons.

In the extreme, coupons will be available for all purchases, and smart shopping software on our phones or browsers will automatically search, aggregate, manage, and redeem these coupons, showing coupon-adjusted prices when browsing for products. More realistically, the process won’t be completely frictionless, since that would lose the psychological benefit. Coupons will probably also merge with “rewards,” “points,” discounts, and various other incentives.

There have been rumblings of this shift here and there for a few years now, and it seems to be happening gradually. Google’s acquisition of Incentive Targeting a few months ago seems significant, and at the very least demonstrates that tech companies are eyeing this space as well, and not just retailers. As digital feudalism takes root, it could accelerate the trend of individualized shopping experiences.

In summary, personalized coupons offer a vehicle for realizing the full potential of data mining for commerce by tailoring prices in a way that consumers seem to find acceptable. Neither coupons nor price discrimination should be viewed in isolation — together with rewards and various other incentive schemes, they are part of the trend of individualized, data mining-driven commerce that’s here to stay.

Footnotes

[1] Since I’m eschewing some academic terminology in this post, here are a few references and points of clarification. My interest is in first-degree price discrimination. Any price discrimination requires market power; my assumption is that is the case in practice because competition is always imperfect, and we should expect quite a bit of first-degree price discrimination. The observed level is puzzlingly low.

The impact of technology on the ability to personalize prices is complex, and behavioral profiling is only one aspect. Technology also makes competition less perfect by allowing firms to customize products to a greater degree, so that there are no exact substitutes. Finally, technology hinders first-degree price discrimination to an extent by allowing consumers to compare prices between different retailers more easily. The interaction between these effects is analyzed in this paper.

Technology also increases the incentive to price discriminate. As production becomes more and more automated, marginal costs drop relative to fixed costs. In the extreme, digital goods have essentially zero marginal cost. When marginal production costs are low, firms will try to tailor prices since any sale above marginal cost increases profits.

My use of the terms overt and covert is rooted in the theory of price fairness in psychology and behavioral economics, and relates to the presentation of the transaction. While it is somewhat related to first- vs. second/third-degree price discrimination, it is better understood as a separate axis, one that is not captured by theories of rational firms and consumers.

[2] An exception is when non-coupon customers are made aware that others are getting a better deal. This happens, for example, when there is a prominent coupon-code form field in an online shopping checkout flow. See here for a study.

Thanks to Sebastian Gold for reviewing a draft, and to Justin Brickell for interesting conversations that led me to this line of thinking.

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8 Comments Add your own

  • 1. Zack  |  June 25, 2013 at 9:32 am

    I take exception to “customers love coupons” and “coupons are not perceived as unfair”: I think you will find that at least a substantial minority of customers hate coupons, and that while this is principally because of the time cost of finding and redeeming them, it is also because coupons are perceived as unfair.

    I would go so far as to say that price discrimination of any kind will always be perceived as unfair by all customers who are aware that it is, in fact, price discrimination.

    Reply
    • 2. Arvind Narayanan  |  June 25, 2013 at 10:31 am

      “I think you will find that at least a substantial minority of customers hate coupons”

      I suppose we disagree on just how substantial that minority is.

      “I would go so far as to say that price discrimination of any kind will always be perceived as unfair by all customers who are aware that it is, in fact, price discrimination.”

      Quite possibly, but that doesn’t say much from my perspective. People hate anything with the dreaded d-word in it, justified or not, so of course if they see it as price discrimination they’ll hate it. As a corollary, take an example of price discrimination that’s seen as socially just — say need-based educational scholarships — and try convincing people that it is, in fact, price discrimination.

      More to the point, I have a rather dim view of what it is that consumers do perceive. I went into this in some detail in my previous post — price fairness perceptions are highly susceptible to the way the transaction is framed.

      Reply
  • 3. Zack  |  June 25, 2013 at 9:34 am

    I take exception to “customers love coupons” and “coupons are not perceived as unfair”: I think you will find that at least a substantial minority of customers hate coupons, and that while this is principally because of the time cost of finding and redeeming them, it is also because coupons are perceived as unfair.

    I would go so far as to say that price discrimination of any kind is always perceived as unfair by customers who are aware that it is, in fact, price discrimination.

    Reply
  • 4. Suresh Venkat (@geomblog)  |  June 25, 2013 at 9:53 am

    There are some kinds of traditional personalized coupons (if only in a weak personalized way): when you check out at a grocery store you get coupons related to what you just purchased. It’s not full profile-based personalization, but it is different for different people.

    Reply
    • 5. Arvind Narayanan  |  June 25, 2013 at 10:20 am

      Good point. I’d be curious to know if those are seen by retailers as a way to push new products or a way to price discriminate (or both).

      Reply
      • 6. dewimorgan  |  April 22, 2014 at 11:56 am

        It seems to me that complex data mining simply isn’t needed for this purpose, and that to claim otherwise is an instance of “if you have a hammer”ism – if you’re a data miner, everything looks like it could be improved with data mining.

        A concrete example: my local store, HEB, gives me a coupon for money off five Hot Poockets, when I buy four. When I buy eight, it suggests I buy ten. And so forth. It encourages me to scale up by about 20-25% on one or more products in my cart, each shopping trip. They don’t always offer coupons on hot pockets – it can be other items. they don’t always offer coupons on things I specifically bought, but rather on things that are often bought with them: if I buy hot dogs, they might offer me a coupon on hot dog buns even if I didn’t buy them. So while, this week, I might’ve bought my buns elsewhere, next week, I might buy them in HEB, too, making me more loyal.

        They don’t need complex profiling: they just need to know that “you bought a few of X on this shopping trip, so are likely to buy it again, and with some money off, can probably encouraged to stretch your spending on that item a little further, and buy 25% more. Further, by giving you coupons you can actually use, for products you actually buy, we can make you more loyal.”

        They don’t even need a store card system. A store card and rewards point system would get, I would argue, negligible benefit over and above this *delightfully anonymous*, point-of-sale coupon system.

        Anonymity is nice, and I appreciate it as a consumer: tracking-by-store-card is a whole less nice, so please don’t encourage it, even if that is what your research pertains to.

        Reply
  • 7. Peter Honeyman  |  June 25, 2013 at 12:38 pm

    My local supermarket —Krogers — sends me personalized coupons monthly. I love them. Who wouldn’t love FREE Häagen-Dazs (limit one, alas), or a “$3 off anything” coupon? This is included in a pack of about 20 they send each month.

    Krogers “gets” me: nearly every coupon they send is for a product I like and buy regularly. Krogers also knows how disorganized I am, and attaches coupons directly to my scan tag.

    On the other hand, Krogers knows more about me than even Google or Facebook in a lot of ways … a little scary.

    Reply
  • 8. Daniel Neely  |  June 26, 2013 at 7:16 pm

    My local grocery chain, Giant Eagle, has been experimenting with printed personalized coupons for the last few years. At present what they’re doing is more about nagging me to start buying stuff again. A few times a year they send a mailing with a half dozen coupons for items I buy semi-regularly; but haven’t purchased recently.

    Reply

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About 33bits.org

I'm an assistant professor of computer science at Princeton. I research (and teach) information privacy and security, and moonlight in technology policy.

This is a blog about my research on breaking data anonymization, and more broadly about information privacy, law and policy.

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