Consumer Addressability and Customized Pricing∗

The increasing availability of customer information is giving many Þrms the ability to reach and customize price and other marketing efforts to the tastes of the individual consumer. This ability is labeled as consumer addressability. Consumer addressability through sophisticated databases is particularly important for direct marketing Þrms, catalog retailers such as L.L Bean and Land’s End, credit card issuing banks, and Þrms in the long-distance telephone market. We examine the strategic implications of consumer addressability on competition between database/direct marketing Þrms). We address questions such as: In a competitive environment, how should Þrms invest in addressability? Will future improvements in the degree of addressability increase or mitigate the intensity of competition between the Þrms? Will greater addressability always be beneÞcial for Þrms? We model competition between two Þrms in a market where consumers differ on a horizontal attribute of product differentiation. The market comprises of consumers located on a linear attribute space and Þrms located at the ends of the line. We represent the degree of addressability (or the reach of a Þrm’s database) as the proportion of consumers at each point in the market who are in the Þrm’s database. Consequently, the Þrm can offer these consumers customized prices. Consumer addressability creates two effects that govern the competition between Þrms: a “surplus extraction” effect due to the fact that a Þrm might address a consumer who is not reached by its competitor and a “competitive” effect that is created by the set of consumers who can be addressed by both Þrms. The key results of the paper pertain to when the addressability decision is endogenous. When the extent of market differentiation (or consumer heterogeneity in preferences for a product/brand attribute) as well as the incremental cost of addressability are sufficiently large Þrms make symmetric investments in equilibrium. Given high costs Þrms choose sufficiently low levels of addressability. Low addressability and high levels of market differentiation both help reduce price competition, which facilitates symmetric choice of addressability by the Þrms in equilibrium. However, when market differentiation and the cost of incremental addressability become small, Þrms face the prospect of destructive competition. As a result, they strategically differentiate in their choice of addressability to mitigate this competition. Interestingly, even in the extreme case when incremental addressability is costless, not every Þrm chooses full addressability in equilibrium. This has useful implications for direct marketing: Given that the advances in information technology should improve the ability of Þrms to address their consumers, it might indeed not be desirable for all direct marketing Þrms to indeÞnitely pursue greater addressability as costs of doing so decline.