Behavior-Based Quality Discrimination

Problem definition: New technology enables firms to recognize customers from their purchase histories and then provide different quality levels of product features or services for repeat and new customers. Extant research has examined behavior-based price discrimination (BBP)-that is, how firms set different prices for repeat and new customers. This research extends the literature by investigating behavior-based quality discrimination to reveal the unique effects of quality discrimination beyond the effects of BBP. Academic/practical relevance: This research is relevant to the marketing-OM research/practice community because product feature or service provision is critical for firms. As technology advances, firms could offer product features or services with different quality levels and prices based on consumers' purchase histories. Researchers need to understand whether, how, and why behavior-based quality discrimination differs from BBP. Managers need to know whether they should reward repeat or new customers with higher quality (product features or services) or lower prices. Methodology: We use a two-period dynamic game-theoretic model. In the first period, firms collect consumers' purchase history data. In the second period, they use these data for quality and price discrimination. Results: We find that behavior-based quality discrimination is fundamentally different from BBP. BBP intensifies competition in the second period but softens competition in the first period. By contrast, we find that behavior-based quality discrimination reduces competition in the second period but intensifies competition in the first period. We show two new mechanisms: First, firms use quality discrimination to soften second-period price competition by making competitive poaching more costly. Second, quality discrimination increases repeat purchase and customer retention. Anticipating this effect, firms reduce prices in the first period to attract more customers. Managerial implications: We show that managers should reward new customers on the price dimension by offering them a discount and reward repeat customers on the quality dimension by providing them with higher-quality product features or services. Managers should also understand that customer retention will increase with quality discrimination. Therefore, they need to reduce first-period prices to acquire customers and build up their customer base.