On a project recently at a
retailer, we broached the idea of dynamic personalised pricing. The basic idea
is to identify each customer via facial recognition, using all relevant
activities of the customer both online and in bricks and mortar, determine a
price for specific items that we would like to offer the customer. The
operationalisation would involve informing the customer of this offer and range
from app notification, sms/instant messaging...
It’s not that difficult to pull-off,
but you need quite a bit of investment in hardware, and ideally some changes to
the bricks and mortar layout. The idea, of course, is to increase sales and
profits by selling stuff to customers at prices they are likely to accept.
However it also means you pay more for your quinoa than I do, since I am most
likely less health conscious than you are.
How does that make you feel, as a
customer?
Let me first start by explaining
how this is viewed in Economics.
Imagine you are on a hot beach,
and a financially savvy genie offers you ice-cream. How much are you willing to
pay for your first ice-cream? May be $3? How about your second? Well since you
would be less hot and thirsty, may be $2.50 since you enjoy the second
ice-cream less than the first. And $1.80 for the third since you are starting
to get sick of ice-cream...
Let’s say you feel greedy and
decide you’d like to buy 3 ice-creams. What price will you pay? In a normal
world, you will pay a flat price, and that’s would be $1.80 for each ice-cream.
You wouldn’t buy a 4th ice-cream at $1.80 because you’d be willing
to pay only say $1.2 for it. The total you pay for the ice-cream is
3x$1.80=$5.40.
But this is a genie world, and
the genie would prefer to sell you the first ice-cream at $3, the second at
$2.50 and the thirst at $1.80. Hence you
would pay $7.30. The key is that the genie has used his/her powers to
understand you r willingness to pay and exploited that. The genie can convince
you to buy a 4th ice-cream by selling it to you at $1.20 (as long as
the ice-cream costs less than $1.20 to produce the genie is still making higher
profits).
Let’s just focus on the 3 ice-creams;
in one case you pay $5.40, in the other $7.30. The difference, that is $1.90,
is called the consumer surplus in economics. It’s a monetary value of the
difference between how much you are willing to pay and how much you do pay. In
the normal case you, as consumer, enjoy the consumer surplus, in the genie
world he captures the consumer surplus and it becomes ‘genie surplus’.
Things become more interesting if
your calorie conscious friend is next to you on the beach. He is only willing
to pay $2.40 for the first ice-cream he consumes and $1.80 for the second,
$1.00 for the third.
In a normal world, at price of
$1.80, you would get 3 ice-creams with a surplus of $1.90 to you, and your
friend gets 2 ice-creams with a surplus of $0.60 (he pays $3.60 but would have
been willing to pay $4.20). The total surplus consumes enjoy is $2.50 ($1.90 to
you, $0.60 to your friend).
The greedy genie eats up your
entire surplus and that of your friend by personalising the prices, each one of
you pays a different price for each ice-cream.
In Economics, this is called
“price discrimination”, setting different prices for the same product to different
people/markets. The word “discrimination” has certain connotations and was
chosen accordingly.
Why should the genie stop there?
He/she is after all a greedy one.
There is no simply no reason for
the genie to charge both you and your friend $1.80. For example, he might
decide that the heat is a good reason to try and make your friend more
appreciative of the joys of ice-cream and sell a third ice-cream to your friend
at $1.00. The genie has a plan to nudge your friend away from the calorie
counting days to the more indulgent path. For you, the genie decides that you
will still buy ice-cream tomorrow anyway, so he shouldn’t decrease the price so
much.
Now, you and your friend are
paying very different prices. What do you feel? Does it matter? Is the price
you are willing to pay for something independent of how much your friend pays?
How about the dynamic piece would
you ask?
Now let’s say the temperature
goes up. A hot wind has started to blow.
The benefits you derive from the
ice-creams increase. It is hotter; you and your friend are now willing to pay
20 cents more for every ice cream.
In ‘old school’ where prices are
printed, there’s nothing much the seller can do. So you enjoy $0.60 more of
surplus and your friend enjoys $0.40 extra.
A programmatic system could tie
the price of ice-cream to temperature, and the price of ice-cream goes up by
$0.20, and the seller captures this increase in your (and your friend’s)
willingness to pay by taking advantage of dynamic pricing (think of the
supermarkets where prices are electronically set and can be easily changed). There
is no personalisation yet.
Every unit is sold at the same price;
it’s just that the increase in willingness to pay across the board has allowed
the seller to charge 20cents more for every unit. Only the surplus on the last
units is completely captured by the seller, the rest deliver the same amount of
surplus as previously (because we assumed an increase of $0.2 across the board
and the price rose by $0.2 too).
In the world of price
discrimination, the supplier can also easily absorb the increase in willingness
to pay. How about personalised dynamic pricing?
You can bet the genie will instantly
scoop up this extra $1.20 of surplus by selling you the ice-creams at $3.20,
$2.70, and $2.00 and your friend at $2.60, $2.00 and $1.20 since he still wants
to convert your friend).
The question is how far are we
from the genie’s world?
We are already there; as I
mentioned at the start, this was part of a discussion with a prospect. (no
worries, they didn’t bite. Yet.)
The article by the guardian (1)
that inspired this article mentions it is easier to implement dynamic
personalised pricing online; that is true, but it is actually not that
difficult in the bricks and mortar world too; all that is required is to invest
in cameras (security camera feeds can be used). The physical equivalent of
hovering your mouse over a product is you spending time looking at that product
on the shelves isn’t it? The only thing that needs to be determined is whether
the hover is because of the product or because of some distraction (and it is
easier from a camera feed).
Where the organisation really can
exploit the customer is when you combine online and bricks and mortar behaviour
(via customer identification and proper data integration/customer 360/scv...),
the organisation can even drive customers to different channels, all this then
ends up in the domain of personalised customer journeys.
Most organisations are not at
this stage of analytical maturity yet.
So what can you do as a consumer
if you do not agree to be exploited/discriminated?
One way out is arbitraging: get
your calories counting friend to buy the ice-cream and sell it to you, you’ll
both be better off. Another way is to play different providers against each
other; find a different genie and compare prices – at this moment price
comparison may be expensive, but more and more price aggregators are popping
up, making the cost of comparing lower. Store products and take advantage of
lower prices...
Hopefully there will still be alternatives to dynamic
personalised pricing, going “old school” isn’t a bad idea; in fact one of the
competitors to Uber for example is advertising the fact that its prices are
predetermined.
(1) https://www.theguardian.com/global/2017/nov/20/dynamic-personalised-pricing
