The Perils of Personalized Pricing with Network Effects

This research examines how network effects, a phenomenon whereby the larger the demand for a product or service, the higher the value of that product or service for each consumer, influence the impact of price personalization on firms and consumers. We study the impact of network effects on price personalization in terms of price, demand, profit, and consumer surplus. One belief commonly held by companies is that price personalization increases their profit by providing means for capturing heterogeneity in consumers’ willingness to pay and enticing demand from heterogeneous consumer segments. Using a game-theoretical model, we find conditions under which price personalization not only shrinks demand, but also decreases the profit of the firm and reduces surplus of all consumers. Specifically, our model shows, in markets with network effects, unless when the impact of expected consumer heterogeneity is higher than the impact of network effects, personalized pricing reduces demand, lowers profit, reduces surplus of all consumers, and thus causes a deficiency in the market.