22 Apr 2013Working Paper Summaries

Competing with Privacy

by Ramon Casadesus-Masanell and Andres Hervas-Drane

Personal consumer information has become a valuable asset in the marketplace and an important element of firm strategy. While consumers are unable to control the disclosure practices of services that collect their personal information, they can decide which services to trust and how much information to provide. How do these choices shape competition? The analysis in this paper explains how firms engaging in disclosure choose to share the benefits with consumers by subsidizing them, and firms charging positive prices choose not to engage in disclosure. Competition is likely to increase the supply of both subsidized and no-disclosure services. Moreover, subsidized services have the potential to remain highly profitable under competition despite the fact that disclosure generates consumer disutility. Overall, these findings are particularly relevant to the business models of Internet firms. Findings also contribute to inform the regulatory debate on consumer privacy. Key concepts include:

High-disclosure services should be expected to play an important role in a competitive marketplace. Therefore, efforts to make disclosure practices salient and understandable for consumers are clearly desirable.
High-disclosure services can outperform their no-disclosure counterparts in generating consumer surplus, ensuring that lower valuation consumers participate in the market.
Initiatives to subsidize consumers in order to sustain disclosure revenues, such as Amazon's Special Offers program, are likely to become more widespread.
There is scope for no-disclosure services to compete. Such services may attract consumers with larger stocks of personal information or those whose information is more sensitive to disclosure.
Tensions surrounding consumer information provision and disclosure will remain for the foreseeable future.

Author Abstract

We analyze the implications of consumer privacy for competition in the marketplace. We 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 information to provide it with. The provision and disclosure of information presents tradeoffs for all market participants. Consumers benefit from providing information to the firm, as this increases the utility they derive from the service, but they incur disutility from information disclosure. This, in turn, benefits the firm providing an additional source of revenue but reduces consumer demand for the service. We characterize equilibrium information provision, disclosure levels, and prices as a function of the consumer population's valuation for the service and show that competition has three main effects on the marketplace. First, competition drives the provision of services with a low level of disclosure. Second, competition ensures that services with a high level of disclosure subsidize consumers. And third, higher competition intensity tends to increase the volume of consumer information disclosed by firms. Our findings are particularly relevant to the business models of Internet firms and contribute to inform the regulatory debate on consumer privacy.