Price discrimination watch (10 Feb 2010)

In the world of economic abstraction, prices are believed to find their "true" level, a real-time approximation of a good's actual value (if there is such a thing), by balancing supply and demand. This process of price discovery is a central pillar of free-market ideology; drawing on Hayek, free marketeers read into prices the decentralized distribution of information vital to the development of the economy. Prices let the people on the ground, knowingly or not, translate local conditions into incentives that can be communicated far and wide.

But lots of things jam up the signal, as when prices are "sticky" and can't quickly adjust to shifts in the sovereign consumer's whims. Then, the discussion shifts to price elasticity of demand -- what sort of range of prices are possible for a good. Demand is "inelastic" if it's not much affected by price.

That brings us closer to what retailers' practical experience with prices seems to be: Their primary concern is to figure out how to charge as much as they can from a given customer for a given good. That is, they need to divide their customers into segments that see different menus of prices -- as when Americans in Prague get one menu from restaurateurs, Czechs another. Customers don't like this. It immediately seems unfair once we realize such discrimination is happening. Everybody wants to have the illusion that they are getting the best deal, or if not that, at least the same deal everyone else is getting.

Online retail -- as this CNN piece and this WashPost article by Joseph Turow, both from 2005, detail -- seems like it would be the perfect place to perfect techniques of price discrimination. We create a concrete demographic profile through our trackable online behavior (the sites we visit, the sort of goods we click through to have a closer look at, who we know on Facebook, that sort of thing), which can be used to make assumptions about the prices we can afford to pay. And in the absence of printed price tags or other customers at the scene of exchange (the point of sale), the discriminatory price can be generated on the spot. Think of it as automated haggling that has taken place without your having to go through all the awkward trouble and conflict. You are adequately sized up and the appropriate line in the sand (for retailers, at any rate) is drawn.

Amazon famously and clumsily tried this back in 2000, but users quickly discovered it and protested. Paul Krugman wondered if it might be illegal under the Robinson-Patman Act. Still, there was little reason to expect the issue to disappear. It's too potent a weapon in the retail arsenal, and it seems such a ideal application for all the data now being gathered in our new Web 2.0-powered knowledge economy.

But apparently there is some intramural strife among businesses: This recent NYT article looks at the battle between online retailers and manufacturers over who gets to set prices. The conflict, the article reports, stems from a 2007 Supreme Court ruling that gave manufacturers more power to dictate how prices can be advertised -- in sheer defiance of Hayek. Manufacturers want to stop online retailers from using their goods as loss leaders, tarnishing the brand with cheapness and presumably undermining their ability to price discriminate elsewhere.

[Manufacturers] say the competitiveness of the Internet has unlocked a race to the bottom -- with everyone from large corporations to garage-based sellers ravenously discounting products, and even selling them at a loss, in an effort to capture market share and attention from search engines and comparison shopping sites. They also worry that their largest retail partners may be unwilling to match the online price cuts and could stop carrying their products altogether.
“If there isn’t that back-and-forth between manufacturer and retailer, it’s just a natural tendency to drive the price down to nothing,” said Wes Shepherd, chief of Channel Velocity, which sells software that allows companies to scour the Web looking for violations of pricing agreements.

I've been thinking about that less quote all day, and I still can't make any sense of it. The online retailers don't exist to give products away to thwart manufacturers. What I am missing here?