Behavior-Based Discrimination: Is It a Winning Play, and If So, When?

With advances in technology, the collection of information from consumers at the time of purchase is common in many categories. This information allows a firm to straightforwardly classify consumers as either “new” or “past” consumers. This opens the door for firms to implement marketing that (a) discriminates between new and past consumers and (b) entails making offers to them that are significantly different. Our objective is to examine the competitive effects of marketing that tailors offers to consumers based on their past buying behavior. In a two-period model with two competing firms, we assume that each firm is able to commit about whether or not to implement behavior-based discrimination (BBD), i.e., to add benefits to its offer for past consumers in the second period. When the firms are identical in their ability to add value to the second-period offer, BBD generally leads to lower profits for both firms. Past customers are so valuable in the second period that BBD leads to cutthroat competition in the first period. As a result, the payoffs associated with the implementation of BBD form a prisoner's dilemma. Interestingly, when a firm has a significant advantage over its competitor (one firm has the capability to add more benefits for its past customers than the other), it can increase its profit versus the base case even when there is significant competition in the second period. Moreover, the firm at a disadvantage sometimes finds that the best response to BBD by a strong competitor is to respond with a uniform price and avoid the practice completely.