Quality and pricing decisions under clustered targeting

With the increasing availability of consumer data, firms are well positioned to segment the market by targeting consumers with various discounts. We study clustered targeting, the practice of segmenting the market by targeting different clusters of consumers with cluster-specific discounts in a single as well as vertically differentiated product environments. Should the ability to approach consumers with different prices impact products’ quality, and if so, would they go up or down? We find that in the single product case, clustered targeting bears no impact on the product’s quality. However, when offering quality differentiated products, the impact depends on the firm’s targeting practice: extending discounts towards non-buyers leads to an increase in products’ qualities (up to 50%), while targeting existing buyers to upgrade leads to a drop in qualities (as much as 33%). Thus, in the vertically differentiated case, product design decisions require foresight by incorporating future targeting plans. Furthermore, we reveal the dynamics of the low quality product’s regular price as it changes from active to idle (such that no one purchases at this price). To support practitioners, who favor simplicity by maintaining a manageable number of segments to target, we provide guidelines how to efficiently allocate targeting efforts between non-buyers and existing buyers. We also shed light on the adverse effect of secondary market trading and the adjustments that firms can make to mitigate it.