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Salmon: Why the Internet Is Perfect for Price Discrimination

NEW YORK ( Reuters Blogs) -- Price discrimination is one of those concepts that only an economist could love. But the theory is clear: The more that a vendor can discriminate according to willingness to pay, the more value that vendor can add. Rory Sutherland uses air travel as an example: Having a mix of classes allows price-sensitive people to pay low fares, while the rich have a large number of flights to choose from. On top of that, he could have added, airlines are extremely good at exercising price discrimination within classes, so that two people receiving identical service might be thousands of dollars apart in the amount they paid for their tickets.

Airlines have always used a multitude of proxies to determine customers' willingness to pay: how far in advance people are booking, whether they're going one-way or return, whether they're staying a Saturday night, and so on and so forth. But nowadays, online, the amount of information that companies have about their customers has never been higher. And the obvious way to monetize that information is through price discrimination: charge the people with high willingness to pay more money than those who will only buy if the price is low. Adam Ozimek explains:

The more information we have, the more profitable first degree price discrimination will be. As big data and online buying increases the information that business have on us, the ease and profitability of first degree price discrimination will become difficult to resist.

Ozimek says that this kind of price discrimination will be "creepy, invasive, and unfair" -- but it will at the same time result in superior products. He doesn't mention this, but the obvious place for this kind of price discrimination is newspaper paywalls. The Financial Times already does it: There's no real list price for an FT subscription, and the paper basically just charges whatever it thinks it can get away with, given what it knows about you.

For newspapers with more price-sensitive readers, smart price discrimination is even more important. Ideally, you'd charge every reader just a little bit less than they were willing to pay -- and you'd give your content away to the people who were willing to pay nothing. And here's the thing: Newspapers know a lot about their readers -- and especially the regular readers who come back often enough to hit paywalls. To take a simple example, they know if those readers are looking at local sports reports, or whether they're looking at general entertainment news. The former group will be much more willing to pay than the latter. But they're also quite likely to know a lot more about you than that, including -- if you're someone who's ever had a print subscription -- exactly where you live.

The New York Times will shortly roll out a new, lower-priced product, giving some subset of its news to people who don't want to pay for the whole thing. But that's just going further in the wrong direction. Already the pricing is sending all manner of bad messages: access to nytimes.com plus a phone app is $15 every four weeks, access to the Web site plus the tablet app is $20, and access to the Web site plus both phone and tablet apps is $35. Which logically means that access to the website itself is worthless. (If A+B=15, and A+C=20, and A+B+C=35, then A=0.)

The NYT is in the process of building new products, for which it can then charge varying amounts of money. This is a lot of work, and has reportedly created tensions between the CEO and the editor when some of the new products report up to the former rather than the latter, even when they're being built by journalists. Instead of thinking in terms of creating a wide range of different products, then, maybe the NYT should just try to do the best journalism it can, and then sell that journalism at a wide range of different prices.

That would be a very tough decision to make: Consumers, as a rule, viscerally dislike price discrimination. If you know that your friends and neighbors are getting exactly the same product that you are, but are paying a different price for it, then someone is going to feel ripped off. Still, at the margin, the NYT can start to implement something like this without having to charge different prices. For instance, it can hold off on the paywall for certain readers -- the ones with the lowest willingness to pay -- while putting it up quite aggressively for others, such as perhaps the ones who spend a lot of time on the business pages. And if you price discriminate by giving away discount codes, few people object at all.

For companies that aren't as high-profile as the NYT, price discrimination is a no-brainer. Amazon was doing it as long ago as 2000, and Uber does it every day, by charging extremely high headline fees, and then giving away various discount coupons like confetti, to carefully-targeted audiences.

The Internet is a zone where companies sell products with zero marginal cost, and with a lot of information about exactly who their audiences are. In that world, it would be weird if they didn't try to charge different prices to different customers. We're used to the freemium model, which is very basic price discrimination. In future, expect that model to become a lot more sophisticated.

-- Written by Felix Salmon in New York.

Read more of Felix's blogs at Reuters.

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