19 May 2014  Research & Ideas

Why Companies Should Compete for Your Privacy

Consumers are sometimes willing to trade personal data for lower prices. How should companies compete for that valuable information? A discussion with Ramon Casadesus-Masanell and Andrés Hervás-Drane.

 

Consumers are increasingly wary about sharing personal information with firms. Yet when they benefit from providing information in exchange for lower prices or better services, many consumers will gladly make the privacy trade-off.

But how does this disclosure of personal information affect competition among firms?

In the working paper Competing with Privacy, Ramon Casadesus-Masanell and Andrés Hervás-Drane "consider a market where firms set prices and disclosure levels for consumer information, and consumers observe both before deciding which firm to patronize and how much personal information to provide."

"Focusing on a single revenue source is the most profitable strategy when firms compete for consumer information"

It's clear from their research that the marketplace has plenty of room for two types of Internet firms: those that ask consumers to disclose a large variety of personal data—in some cases in exchange for free services or lower prices—as well as firms that pledge to keep a lid on people's information, but often charge consumers higher prices.

Firms competing with privacy tend to benefit from engaging in different degrees of information disclosure as they cater to the needs of different consumer groups. Casadesus-Masanell, the Herman C. Krannert Professor of Business Administration at Harvard Business School, and Hervás-Drane, assistant professor at Universitat Pompeu Fabra in Barcelona, found that competition has three main effects on the marketplace:

  1. Competition drives the supply of services with a low level of disclosure, since some customers will choose to pay more for a service in exchange for keeping their personal information under wraps.
  2. Competition ensures that services that disclose a lot of personal information provide some benefit to customers, at times in the form of subsidies. For example, Amazon provides discounts on its e-reader prices for customers who agree to receive targeted ads from Amazon and third-party sellers on their devices.
  3. Higher intensity of competition between firms increases the volume of consumer information disclosed, reducing consumer privacy. Consumers benefit from intense competition, but often through lower prices or subsidies, rather than through reduced disclosure of their information.

Consumers are more in tune than ever with corporate disclosure practices, so firms need to make sure they are transparent in their privacy policies, the paper states. The researchers were quick to point out that they were not recommending a restriction of disclosure practices, since "high-disclosure services play an important role in a competitive marketplace and informed consumers adjust their choices accordingly."

Casadesus-Masanell and Hervás-Drane provide additional details about their research in the Q&A below. They collaborated in answering the following questions for Working Knowledge via email.

Q: It appears that consumers are often willing to provide information to firms, not only because they may receive lower prices in return but also because, in some cases,firms provide better service.

A: There are many examples of how firms exploit consumer personal information to improve online services. Retailers and travel agencies, for instance, use information about consumers' likes and dislikes to improve their automated product recommendations. These recommendations are often presented as ''inspired by your browsing history'' or ''recommended for you,'' and help consumers discover new products or holiday packages that match their tastes. Similarly, online services such as Microsoft's Office 365 learn from consumer usage patterns and documents, personalizing their user interfaces by selecting which quick-access functions to display and incorporating new words and expressions into their correction dictionaries. Moreover, some online services rely heavily on the exploitation of consumer information. Social networking on Facebook would be of little value if users provided no personal information, and digital assistants such as Apple's Siri require access to consumers' location, contact lists, and calendar to be helpful.

A consumer's shopping data is a valuable asset that carries monetary value.
Photo: iStockPhoto

However, not all forms of personal information exploitation are beneficial to consumers. Firms sometimes exploit personal information to better estimate customers' willingness to pay and to engage in price discrimination, which may end up hurting consumers. Moreover, firms may exploit personal information to tap into complementary revenue streams, such as advertising. Personal information can be used to improve the targeting of ads, increasing advertisers' willingness to pay. In addition, firms may directly share or sell consumer information to interested parties.

These practices can generate substantial revenues for firms, and while price discrimination, targeted ads, and information sharing need not be detrimental to welfare, consumers are generally uncomfortable with them. When it was discovered that DVD prices on Amazon.com varied with the cookies stored on consumers' browsers, resulting in higher prices for returning shoppers, consumer backlash led the company to state that such practice was a "mistake" and that it would refrain from pricing based on customer demographics in the future. Similarly, when Amazon introduced the Kindle Fire tablet with targeted ads on the lockscreen and home screen, consumers clamored for an ad-free version. Amazon backtracked and extended its Special Offers program to the tablet, allowing consumers to opt out from the ads.

Q: You're expecting that more companies will come up with programs similar to Amazon's Special Offers program. Why are these types of programs important?

A: Amazon's Special Offers program is significant because it explicitly acknowledges that certain forms of information exploitation are disliked by consumers. The program subsidizes the purchase of Kindle tablets and e-readers with $15 and $20 discounts, respectively, in exchange for targeted advertisements from Amazon and third-party sellers on the device. If consumers opt-out of the program, they skip both the ads and the subsidy. The logical conclusion is that Amazon is willing to subsidize consumers in order to exploit their personal information because the additional revenues generated in the process exceed the consumer disutility incurred. Clearly, personal consumer information is a valuable asset in the marketplace.

To better understand the implications of consumer information for firms, we have built a formal model to analyze the information exploitation dichotomy outlined above. We take the view that there are two types of exploitation: one which is beneficial to consumers, and one which is not. The first type of exploitation improves the quality of the service and provides a rationale for consumers to provide their personal information to the firm. The second type of exploitation generates disutility for consumers but enables the firm to tap into additional revenue sources. We use the term disclosure to denote this second type of exploitation since it frequently implies participation of third-parties such as advertisers. Note that both forms of exploitation are compatible and may coexist on the same service, as in the Amazon example.

The difference between the two types of information exploitation is stark, but it turns out to be quite useful to analyze the effects of privacy on competition. Consumers are the gatekeepers of their personal information and choose whether to sign up for the firm's service and how much personal information to provide. The incentives of consumers and those of the firm are aligned with respect to the first type of information exploitation, but not with respect to the second. The firm's strategy consists of choosing what level of disclosure to engage in and how to price the service to consumers. These choices reflect the two revenue sources available to the firm, disclosure revenues and price revenues, and there is a strategic tension between them: a higher level of disclosure revenues commands lower prices, or even subsidies, to ensure that consumers are willing to participate and provide their personal information.

Q: It seems that the paper recommends that firms would do well to compete by focusing on a single revenue source and foregoing another: A firm can engage in a high level of disclosure, but should keep consumer prices lower; and a firm that charges consumers higher prices needs to engage in a low level of disclosure. Can you comment on this need to focus on a single revenue source?

A: The single-revenue-source focus is one of the main findings of our analysis. Firms focus on a single revenue source when they tap exclusively into disclosure revenues, or when they tap exclusively into price revenues. Our model reveals that focusing on a single revenue source is the most profitable strategy when firms compete for consumer information. When two firms compete in the market, the optimal strategies are for one firm to set a high level of disclosure and subsidize consumers in exchange, and for the other firm to charge high prices but not to engage in information disclosure. The result can be understood as a natural consequence of the need for differentiation in this market. Firms benefit from differentiating their services, and thus one firm has incentives to set a high level of disclosure and the other firm to set a low level of disclosure. Because disclosure levels generate revenues and affect consumer participation and information provision, prices and disclosure levels are negatively correlated. The firm setting a high level of disclosure needs to subsidize consumers in order to attract them to the service, and the firm setting a low level of disclosure quotes high prices to remain profitable.

This asymmetry between competitors has profound implications for their business models and the logic with which they operate. An example that illustrates our result is that of Google and Microsoft. Both firms offer consumers online services to manage e-mail, contacts, calendar events, and documents. Google offers these services for free, but engages in disclosure by profiling consumers and charging advertisers to target them. In contrast, Microsoft charges a subscription price for Office 365 but does not disclose consumer information for advertising purposes. Microsoft's recent Scroogled! campaign emphasized the difference as follows: "Google goes through every Gmail that's sent or received, looking for keywords so they can target Gmail users with paid ads. And there's no way to opt out of this invasion of your privacy. Outlook.com is different—we don't go through your email to sell ads."

At a deeper level, firms are essentially competing for consumer information through different strategies. When you look at this problem through the lens of our model, you see that both firms are carefully adjusting disclosure levels and prices so as to remain attractive to consumers and accumulate as much personal information as possible. Both firms monetize consumer information: Google exploits it to generate disclosure revenues, and Microsoft exploits it to personalize its service and sustain high prices.

Of course, this affects which consumers they attract. In our model, Google attracts consumers with low valuations, those less willing to pay to avoid disclosure. Microsoft attracts high-valuation consumers. Which of these two strategies yields highest profits depends on how consumer valuations compare to disclosure revenues, that is, on how consumer willingness to pay compares to that of advertisers, and on how firms interact in the marketplace. In the paper we provide a detailed characterization of the performance of both strategies.

Q: Your work assumes there is transparency in the market with regard to the sharing of consumer information. Why is this key to a consumer's decision about which firms to use?

A: Yes, this is a key ingredient of our analysis. As is the case in any market, consumers need to be informed about products to make the right decisions. In the context of consumer privacy, consumers need to be informed about the disclosure practices of firms in order to choose which services to patronize and how much information to provide them with. By focusing on the case of a transparent market, our analysis provides a benchmark for how a well-functioning market for consumer privacy should look like.

It is worth noting, however, that transparency in the market does not yield better consumer privacy per se. It has often been suggested that transparency, together with competition, will discipline the amount of consumer information disclosed in the marketplace. This view contends that lack of consumer privacy is a symptom of lack of transparency. Our analysis reveals that this need not be the case; high-disclosure services play an important role in a transparent market and informed consumers adjust their choices accordingly.

Moreover, when disclosure revenues exceed price revenues (i.e., when advertisers' willingness to pay exceeds that of consumers'), higher intensity of competition can lead firms to increase the amount of information disclosed (subsidizing consumers in exchange). In the market for consumer privacy, transparency is better understood as disciplining the share of the privacy profit pie that accrues to consumers rather than disciplining the level of privacy they enjoy. Our view is that initiatives to make disclosure practices salient and understandable to consumers are clearly desirable from a policy perspective, but our results recommend caution on restricting the disclosure practices of firms.

Q: How guarded are consumers with their personal information today? Would you estimate that they have gotten more savvy and guarded over time?

A: Consumers are becoming increasingly cautious with their personal information. In Western countries, surveys of consumer attitudes towards privacy confirm this trend. Several factors are contributing to this. Consumer awareness of disclosure practices and familiarity with their implications have increased over time, leading consumers to weigh more carefully the pros and cons of providing their personal information. Consumers have also learned that the disclosure commitments of firms change over time and are not always credible. When Facebook acquired Moves, for example, Moves promised customers that it would not "commingle data with Facebook." Ten days later, however, its user agreement was updated to provide Facebook access to its customer information. Unsurprisingly, privacy advocates have met Facebook's recent acquisition of WhatsApp, a service committed never to disclose consumer information, with substantial skepticism.

In addition, industry initiatives to self-regulate disclosure practices have largely failed. The "Do not track" initiative is a prominent example. It simplifies the process for consumers to inform online services that they do not wish their activities to be tracked, yet compliance is voluntary and major industry players have not adhered to the initiative or dropped out over time. Online services therefore operate without standardized procedures for how disclosure practices are presented and how consumers may communicate their preferences.

The consequence has been a chilling of the market for personal information, with consumers less willing to provide their information in the first place. This is an undesirable outcome since it means that society loses out on some of the potential benefits that information can provide, those from which we all stand to profit.

About the author

Dina Gerdeman is a writer based in Mansfield, Massachusetts.

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Comments

    • Kapil Kumar Sopory
    • Company Secretary, SMEC(India) Private Limited

    This is a good strategy to keep the consumers engaged by offering goods and (probably) services also at discounted prices. However, I am wary of the likelihood of personal data and/or information being misused. There must not be any compromise on such information/ data without the consumer's approval. In India, we do not generally come across marketing that way. Offers are made to sell items at reduced costs but there is no direct relationship to first extracting detailed information as is being done in US and could be in some other countries too.