Price Discrimination is a Violation of an Equal Treatment Norm
We should not ignore the common ‘gut reaction’ that two people paying different prices for the same thing is unjust, which was described in the opening of this paper. Although this reaction is common among laypeople as previously described, and although some academics assert, “From an ethical point of view, charging different prices for the same product is a violation of the equal treatment norm that underlies market exchanges” (Ayadi et al. 2017), Elegido (2011, p. 641) correctly summarizes the state of ethical inquiry into a supposed equal treatment norm in pricing: “…no good arguments have been provided in the literature on equality to support the position that an equal treatment norm applies to commercial transactions, and, more specifically, to pricing issues, and…there are important considerations that urge against such a norm in this context.” In other words, this common lay reaction has never been successfully defended as a rigorous philosophical principle.
Even if someone were to successfully argue that there is an equal treatment norm that applies to commercial transactions or pricing issues, it is not clear that such equal treatment would require equal pricing. Indeed, as we (and Marcoux (2006) before us) have argued, if one grants that the currency of egalitarian justice is utility (priority-weighted or otherwise), an equal treatment norm would more plausibly apply to utility (e.g., the rule ‘equalize utility’) than prices themselves (e.g., the rule ‘equalize prices’).
The Just Price as the Price in an Open Market
Elegido (2011, 2015) argues the case that a just price is that which is obtainable in an open market, by which he does not mean a competitive market, but rather one devoid of a legal or natural monopoly. His argument is roughly that when there are enough buyers to sustain a particular business at a particular price, then the prevailing market price (or a lower price) is a just one. Since the market can clearly bear that price, Elegido argues that is a strong sign of the inherent value of the product or service. He is careful to distinguish value from utility; in other words, while every individual may gain a different level of utility, there is one level of value, as demonstrated by the market price. Elegido (2011) gives us an example where his standard allows for price discrimination (p. 653):
You arrive in a city late at night and check into a hotel, at which time you are informed that the rate per night is $300. You find it steep, but it is late, you are tired, and outside it is raining heavily, so you accept and move into your room. The following morning, while having breakfast, you strike up a casual conversation with a fellow guest and learn that she had made her reservation online and is only paying $80 per night.
His argument is that if a ‘substantial portion’ of guests are paying the $300 price, that is a good signal of its value and therefore it is a just price to charge, regardless of whether or not some other guests are paying a lower price. On the other hand, if some guest were to be charged, say, $500, when the accepted open market price being paid by a substantial portion of guests is $300, this would be morally suspect.
The issue we take with the ‘substantial portion’ criterion is that, under our Progressive Pricing model, it is possible and perhaps even likely that applying the same rule of, for example, ‘price equal to 50% of an individual’s WTP’ could easily lead to a continuum of prices on which no two individuals pay the same price (e.g., if there is complete heterogeneity of individual WTP). Our view is of course that a ‘50% of WTP’ rule for pricing is superior to one in which there is one price or even a few discrete ‘buckets’ of consumers, with the same price within a bucket (what economists would call ‘third degree’ price discrimination). However, only in the latter scenario of third-degree price discrimination would a demand curve with highly heterogeneous WTP allow for price discrimination while also allowing for ‘substantial portions’ of consumers to pay the same price. Therefore, we conclude the ‘substantial portion’ rule to be overly-restricting: it could be the case that no two people pay the same price, and therefore there is no ‘substantial portion’ paying the price, and yet, within our framework, it could be perfectly acceptable.
In other words, this standard would not allow for Progressive Pricing as we have defined it. To illustrate, imagine a demand curve with 100 consumers, each with a distinct WTP ranging from 1 to 100, in one-unit increments. Imagine the pricing rule is ‘50% of WTP.’ The ‘substantial portion’ standard would not allow the consumer with WTP 100 to pay a price of 50, because no one else (and therefore no ‘substantial portion’ of consumers) would be paying such a high price. Therefore, their price would need to be reduced, let’s say to match the next-highest price, 49.5 (50% of the next-highest-WTP consumer’s WTP of 99). Although there is no explicit rule to identify what constitutes a ‘substantial portion,’ let’s presume 2 individuals each paying 49.5, when everyone else pays a lower price, is insufficient to meet that standard, and so those two must now have their prices reduced to 49 each, so now there are three consumers with the price 49, and so on until a ‘substantial portion’ is reached. We would submit this is an unnecessary reduction of price for the highest-WTP consumers; indeed, we have argued that a Progressive Pricing rule of ‘pay 50% of WTP,’ which would have the highest-WTP consumer pay 50 (more than any other consumer) is perfectly morally justifiable, regardless of the existence of other consumers paying such a high price or not. Indeed, with that rule, the highest-priced customers are also precisely the highest-surplus customers. In our example, the person with WTP of 100 pays 50, but keeps 50 surplus, meaning that, although she pays the highest price, she also achieves the highest (monetary) surplus.
Why is the Willingness-to-Pay Higher for Some?
Another potential objection to a Progressive Pricing regime is that it does not question why one individual’s utility is higher than another’s for a given good or service. We return to our WTP decomposition framework to tackle this objection in two parts. Recall that the two components of WTP are utility lost from the money spent (which we argue can be proxied by income: the higher one’s income, the lower the loss of utility from a given amount of money spent) and the utility gained from the product or service. We begin with income.
If a person’s WTP is higher because their income is higher, our argument is this should be presumed a just basis upon which to price discriminate. In other words, if two people derive the same level of utility from a product or service, but one has a higher income than the other, it need not be questioned that the person with the higher income pay a higher price, since there is a strong presumption they would lose less utility from an equivalent price paid and hence Unitary Pricing would result in differential surplus (which we have shown ought not be preferred under any plausible SWF). Of course, this does not mean that any higher price can be justified on the basis of higher income (using the prior reasoning, there is of course some higher price that will be too high so as to leave the higher income consumer with a lower utility surplus), but rather that the mere existence of some higher price for a consumer with higher income is not intrinsically suspect. However, we will argue that more scrutiny may be required when WTP is higher due to a higher utility derived from the product or service.
There is a long ethical literature and corresponding legal history concerning the immorality and illegality of price gouging, exploitation, and false advertising. For example, during a natural disaster there is often a surge in demand for water, gasoline, fuel, flashlights, etc., which would cause prices to rise in a free market. However, it should be clear that such price increases are exploitative and immoral (e.g., Snyder 2009a)—although there is some debate among philosophers (Zwolinski 2008; Snyder 2009b). A broader theory of exploitation (of which price gouging is arguably a form) has also been utilized to evaluate the wrongness of (some forms of) price discrimination, from St. Thomas Aquinas to Locke to today (Zwolinski and Wertheimer 2017). A famous example from Locke examines the case of two ships, one of which has lost all its anchors (and therefore cannot safely come to a stop or weather a storm). The ship comes upon another ship, which has an anchor to spare. Of course, the question becomes, at what price ought the captain of the extra-anchored ship offer her surplus anchor to the captain of the distressed ship? Locke’s answer: “[T]he same price that she would sell the same anchor to a ship that was not in that distress. For that is still the market rate for which one would part with anything to anybody who was not in distress and absolute want of it” (1661/2004, p. 446).
On a related note, in discussing pricing based on a consumer’s maximum WTP (as we have argued ought to be done), Elegido (2011, p. 640) states, “…it seems fundamentally wrong to make an argument about fairness in pricing depend on the buyer’s reservation price. Along those lines, the more desperate the buyer happens to be, the higher the price the seller is justified in charging. In fact, perversely, it would follow that by not charging a very high price to a customer who finds himself in a situation of very special need, the seller would be behaving unfairly.”
We agree with the conclusions above, and in light of them argue it is not always the case that those with higher WTP should pay more, for example when such pricing would be an instance of price gouging specifically or exploitation more broadly. However, these considerations should be considered ‘side constraints,’ leaving the core thrust of our argument unscathed. In other words, it is not immoral to charge those with higher WTP higher prices in and of itself, but of course when such pricing would entail price gouging, exploitation, or any other condition that would make a price unjust between two individuals, one ought not implement it. However, these side constraints do the ‘moral work,’ not a prohibition on price personalization.
To summarize, why someone’s WTP is higher than another’s is indeed an important normative consideration. When it is because of a higher income, we argue it is not morally suspect. However, when it is because of a higher (expected) utility, one must investigate whether pricing in accordance with that higher (expected) utility would violate a moral side constraint such as avoiding price gouging, exploitation, or any other condition that would make the price of a transaction between two parties unjust. Our argument instead is that, given that the interparty dynamics of a transaction are just, Progressive Pricing increases social welfare, and as such it would be erroneous to limit its application absent these side constraints.
How do Firms Know About Differential Willingness-to-Pay?
Another set of ‘side constraints’ will likely apply to how firms come to estimate differential WTP for different customers, with some methods being clearly permissible (e.g., customers who willingly and knowingly sign up for loyalty programs) and others being clearly impermissible (e.g., installing a keystroke logger on their computer without their consent). In the digital age, we expect the impermissible methods of most concern will correspond to invasions of reasonable expectations of privacy on the Internet.
Indeed, in 2016 Europe passed the sweeping General Data Protection Regulation (GDPR); California followed in 2018 by passing the California Consumer Privacy Act, with more US states following thereafter. These regulations are designed to protect consumer data and privacy on the Internet, including the establishment of new rights such as ‘data portability’ (you must be allowed to export your personal data from one social media site or online retailer to another, e.g.) and ‘the right to be forgotten’ (they must delete your data if you request), among others. Given the recency of such laws, little academic work has been done on the practical implications of GDPR on price personalization, although the scholarship to date concludes GDPR “generally applies to personalized pricing” and “[i]f enforced…could thereby play a significant role in mitigating any adverse effects of personalized pricing” (Zuiderveen Borgesius and Poort 2017). We will not take a stance in appraisal of these laws, but will instead argue that insofar as there are rights to privacy on the Internet, firms ought to respect those rights when algorithmically estimating WTP.
More work needs to be done to clearly define under which circumstances and how customer data can be collected, stored, and used ethically and legally, whether for use in pricing or otherwise. In the meantime, clearly there will be many instances in which a firm could more progressively price, if only they knew their customers’ WTP more accurately, and yet a more accurate estimate of WTP would require an unethical invasion of privacy; in these cases, firms clearly must abide by such privacy-related moral side constraints and laws.
Second-Order Effects of Unequal Pricing
As was discussed in the introduction, some consumers have strong negative reactions to being treated in ways they perceive as unfair vis-à-vis pricing. These negative reactions are likely associated with negative utility, and yet our Progressive Pricing discussion thus far has not included an endogenous consideration of the likely negative utility some consumers would experience when they learn they are paying more than others. More concretely, in calculating Alice’s utility surplus, we only included her utility gained from the subscription to the Journal and her utility lost from the money she spent on it when comparing a Unitary Pricing regime to a Progressive Pricing regime, when it could be argued we should have included some disutility from her perception of being treated unfairly (assuming the Journal were transparent about the discrepancy or she found out some other way). In other words, her net utility equation could have been net utility = [(utility gained from subscription) − (utility lost from spending $X) − (utility lost from unfairness perception)]. This last variable would be zero in the Unitary Pricing regime and (arguably) nonzero in the Progressive regime (at least for some consumers).
This disutility should be factored in, implying that sometimes differences in price levels may need to be attenuated to be less extreme than would otherwise be required were it not for these consumer reactions. In other words, if WTP differs by 10 × , Progressive Pricing would recommend prices that differ by 10 ×—however, after factoring in the disutility from differential pricing some would experience, this 10 × may need to be reduced to, say, 5 ×.
However, firms are in a position to influence these perceptions. For one, given that Progressive Pricing is superior in the ways we have shown, firms can appeal to this fact in assuaging consumers, since consumers already widely support price discrimination they view as fair (e.g., senior and student discounts). Firms can also appeal to the fact that, for any individual consumer, while there are likely lower-WTP consumers who are paying less than them, there are also likely higher-WTP consumers who are paying more than them. Given that all consumers are charged (let’s presume) with the same rule, e.g., 50% of maximum WTP, they are being treated the same in the way that matters. Additionally, we know that as a form of price discrimination becomes more familiar, it is perceived as less unfair. For example, airlines massively price discriminate, Uber has ‘surge pricing’ that was originally decried by riders, hotels charge based on a ‘yield management’ practice, etc.—and yet these practices are widely accepted (if grumbled about), unlike the reactions to Amazon and Staples mentioned above, which consumers do not (yet) find fair. As Progressive Pricing becomes more common, its lay fairness perception will likely increase as well.
Why Would Firms Choose Progressive Pricing?
As we briefly alluded to earlier, our view is that even if firms could estimate an individual consumer’s WTP, they should not then set that individual’s price equal to their WTP. Indeed, throughout the paper, we have argued that Progressive Pricing should entail pricing as some fraction of an individual consumer’s WTP (e.g., 50%). There are (at least) two reasons why firms should opt to do this.
First, even the most sophisticated algorithms will not be able to estimate an individual’s WTP with complete accuracy. A consumer’s WTP is dependent on a number of constantly varying, context-specific variables (e.g., time of day, psychological disposition, awareness of certain facts in the world, etc.), and so any pricing algorithm will necessarily be tracking a moving target. Furthermore, even if WTP were a static variable, it would still be difficult to measure algorithmically as individuals themselves are often unaware of their own WTP. This means that any estimate of a consumer’s WTP will necessarily have some confidence interval around it that takes into account not only the algorithm’s uncertainty about its own internal estimate, but also the consumer’s uncertainty regarding their own WTP. For example, imagine Firm X’s 95% confidence interval for its estimate of Bob’s maximum WTP for their widget is between 80 and 120. Importantly, there is asymmetric risk to overpricing versus underpricing. Imagine Bob’s actual maximum WTP at the time of sale is 90; if the firm were to set a price of 100 (the middle of their confidence interval), they lose out on the sale completely. Instead, if they had charged at the bottom of their 95% confidence interval, 80, they would have made the sale and only left 10 on the table.
The second reason firms should not seek to price equal to 100% of each consumer’s estimated WTP is simply that it is not the right thing to do. That is, when all the consumer surplus is extracted by the producer, the benefits to Progressive Pricing we have argued for across the four consequentialist SWFs are significantly dampened (if not completely eliminated), as total consumer utility surplus goes to 0.
Indeed, in a recent paper, Steinberg (2020) argues that while personalized pricing may lead ‘to better overall social welfare…these advantages…are undermined when [it] does not contribute to any socially desired end (other than improved market efficiency in an imperfect market).’ He uses a market failures approach, under which ‘managers are morally constrained by the point of having competitive markets’ (p. 109). He further convincingly argues that when personalized pricing extracts all of the consumer surplus in the market (by charging each consumer their individual maximum WTP), this, ‘in a somewhat deontic spirit,’ undermines the point of having a market (p. 113). That is, one of the purposes of markets is to compete for consumer surplus, and when firms instead extract all of it for themselves, they deprive the market of a core component of what makes markets beneficial.
However, it is important to underscore that his main argument against price discrimination (although not the only argument he presents) depends upon the premise that ‘[i]n personalized pricing, each consumer is charged according to their individual reservation price. Personalized pricing extracts all of one’s consumer surplus’ (p. 98). As we have argued throughout the paper and are emphasizing in this section, however, firms should not set each consumer’s price equal to their exact maximum WTP. Indeed, his paper helps emphasize the moral (as opposed to just the practical) limitations on price personalization: even if firms could estimate WTP perfectly, charging a price equivalent to 100% of that WTP would be worse than charging as a fraction of that WTP, partly because it eliminates the benefits of Progressive Pricing we espoused previously, but also as it critically undermines a fundamental reason for having markets in the first place, which is to provide consumers with surplus. This ‘deontic’ reasoning is not meant to override the fundamentally consequentialist framework we have been using, but instead to provide yet another argument against charging 100% of consumers’ WTP; that is, it fails both the consequentialist test we have been using with our four SWFs, but also a deontological approach that is encapsulated in the market failures approach Steinberg uses.