Let us try a thought experiment? What if you could read people’s minds? Well you might want to do some cool party tricks. Astonish your friends by asking them to pick a number between one and a million. This is cool and might make you a lot of friends. After a while, you might want to put your talents to good use, making money. Okay so you can bet people that you will win guessing games. Besides the obvious, there is a lot of money to be made by reading people’s minds. Mind reading would give the ultimate leverage in a negotiation. You will be able to haggle any buyer or seller into the most advantageous price. Wielding this power as a corporation can help solve the problem of pricing your products.
Let us look at Coca-Cola and its classic product. Did you know that it costs less than $0.02 to manufacture a can of coke? This does not factor in all the other costs, but still they are selling a can at much more than it costs to make. For every dollar that Coca-Cola spends, they make about $0.18 in profit. Why not raise your prices even more and make a larger profit margin? The problem with this is that as you raise the price, less people will want to consume coke. Maybe the price is too high and you will get a lot more customers if you lower the price. Being able to find the right price inorder to maximize profit is a hard task for firms.
Since you can read minds, then you will be able to figure out how much people are willing to pay you for a can of coke. Then you can calculate the effect of different prices and see your projected profit. The only issue with this is that corporations often do a pretty okay job pricing. This is especially true for big corporations such as Coca-Cola. Instead of trying to do this better, we could cheat the system and make even more money. When someone walks into your store, just read their mind and then charge them the price they are most willing to give you. If you think about it for a second, this system really allows you to have the best of both worlds. For people who really love to drink a can of coke, you can charge them ridiculous prices. You could charge pepsi drinkers just the right price to get them to switch over. This is actually a very trivial and tedious example, in reality you would probably be used in large corporate negotiation. But the takeaway here is simple: The problem of pricing low or high is only a problem if you have one price.
While this may seem like a crazy hypothetical, companies are already using your data to charge you different prices. We can interpret this as a type of imperfect mind reading. Data is a history of past behavior which can predict future behavior. Collecting data about how the market would respond to price changes can help you set a price for a good or service. With the use of personalized data, companies are attempting to also offer individuals a personalized price. The technology behind data collection may be new, but the economic strategy of trying to charge people different prices has long existed and been studied. So this strategy might seem like a radical new scheme. I am going to try to open your eyes and show you what to look for. I am going to start with the obvious examples using modern technology. As we go, I will work in various strategies and limitations that are known about in existing markets.
Consider when you open your favorite free to play mobile game, it often will say it has a special offer for you. It is very likely the special items they are offering you at your special price are an educated guess based on your data. They don’t need to read your mind, they just use behavioral and statistical economics. What is more interesting is that for all you know they could offer your friend something very similar or maybe even the same thing but for a few dollars more. This is because they are pretty sure using the same methods, that they are much more willing to give the game money. You may be unaware of this, because there is very little transparency in special offers and discounts.
It is easy to worry about companies spying on us, but we often hand over the data quite transparently. Consider all the loyalty clubs you have memberships with for your local stores. Each household in the United States has about 29 such memberships. The corporation gives these out, so they can look at your shopping behavior in exchange for some member benefits. One of the goals is to be able to offer you special deals in order to get you to buy more products. When they send you special member coupons for certain products, they are doing the same thing as a mobile game special offer pop up. You unknowingly just call this a coupon and don’t pay it much thought. I mean if you are the type of person to spend a lot of time clipping coupons, you are probably the type of person that could need a lower price to entice you to shop more. All of this segmenting people based on data allows companies to figure out what prices they could offer you to most maximize their profits.
There was a comical example many years ago where a teen aged girl was sent coupons for things new mothers would need. Target’s system could monitor shopping behavior and anticipated in the future when a woman was likely to give birth and thus need to buy stuff for her new child. The father was outraged they would send a teenaged girl coupons for strollers and diapers. Were they trying to entice her to have a baby? It turns out Target’s system was right and the father was very wrong.
It might have been many years ago that they targeted specific groups manually with big data. Today we have much more advanced and general recommendation systems that are pretty good. A lot of new techniques can identify very strong trends in a set of data and identify groups to segment. This is what websites like YouTube and Amazon try to do. YouTube is trying to maximize watch time and Amazon is trying to show you things you are likely to buy. In both cases they are an attempt to maximize profit. They are just not using this to charge personalized prices. Not yet at least.
While it is easy to scare people about the power of big data to charge people different prices. Just as with the coupon clipper, there are many simple ways that we use information to segment people. If you are working in insurance sales, then your goal is to get customers to often switch over to your company. Now one trick they will have you use is to ask people what they are already paying. Just follow a simple formula to determine the price you will charge them. This price will usually be less than they are already paying, but still profitable for the company. It is not just internet surveillance, but often the information you provide in a conversation or application that can be used to customize your price. You might tell them, because you interpret it as a bit of harmless information they need to know so they can look up if you are going to save money by switching. When you apply for a job, you often tell your employers how much you made at your old job. In this context, it is more transparent that the employer wants leverage over you.
So far we have gone over how firms might go about personalizing your price for services. There exists reasons why this can’t actually work for every market. Let us say that we have a game such as RuneScape where we could try some of the same strategies with ingame gold. What problem might they encounter? Well if you could buy a million gold for $2 and your friend could buy a million gold for $4. Why not just act as the intermediary for your friend? You can charge your friend $3 for a million gold and you just pocket the difference. Once you both realize this, it will change your behavior and then the most you are both willing to pay will be $3. This scheme just doesn’t work here. People can trade and establish a price equilibrium in the grey market.
This does not mean that you can’t try to prevent trading goods that are considered easily tradable. As we have explored, it could be very profitable to figure out a method of doing this. There was hype not too long ago about Trump proposing to allow people to import pharmaceutical drugs from Canada and Mexico. The reason being that they are somehow cheaper in these countries. This seems perfectly logical and it begs the question. Like yeah, we manufacture stuff in China and then import it to America because it is cheaper. This is the whole point of international trade. Why would there exist laws making it illegal to trade something between countries?
In Utah, a few state employees are even getting trips to Mexico to refill their prescriptions. This is bizarre considering it is costly to travel every few months to Mexico. It is clearly inefficient to send an individual across the border with pharmaceutical drugs as opposed to a truck shipping them to a pharmacy. Still about 10 people so far are part of this program. How could this be happening?
This might seem like a big conspiracy to you and it might as well be. By having borders and making trade harder, they can charge two groups different prices. The data point is different countries and the profit maximizing price they are willing to pay. It is not that Canada or Mexico can manufacture drugs cheaper, but it is often the same drugs being sold at a different price. These countries have different markets and different prices they will be willing to pay.
One thing we have yet to talk about is resentment and morality. Is it immoral for you to be price gouged, because you are willing to pay more? The answer to this might seem obvious. It does not take much imagination to see a firm exploiting those who are loose with their credit cards to squeeze a few extra dollars out of them. There are numerous headlines about people spending thousands of dollars on microtransactions. Let us put this thought on hold and explore the economics of the third world.
AIDS is a disease which has had devastating effects when it was first introduced, but we can now treat it. This has not been a serious problem for many in the first world as they can afford the medication to stay healthy for years. The problem is for people who live in countries that lack economic development. Most people in these countries could hardly be expected to pay the same price. You could say that while it may be profitable to be able to sell to Africa at a different price, it would also be a humanitarian choice. Just because you have HIV and are stuck in a country that is poor, this doesn’t mean you should die from AIDS.
The drug combivir is an example of something used to treat HIV. In Europe it was being sold for $12.50 a pill and in Africa it was being sold for $0.50 a pill. This presented an opportunity to buy up millions of pills in Africa and sell them for an insane markup in Europe. People were in fact buying up the pills in Africa and smuggling them to sell for $12.00 a pill in Europe. The only problem is that this ruins the whole point of selling to Africa at a cheap price. The idea of selling at a price affordable and still profitable only works if those who can afford to pay more do in fact pay more. Even if we gave out the pills for free in Africa purely on philanthropy, people will still be incentivized to get them and smuggle them out of the country. This means that people in Africa would be incentivized to sell their medication so foreigners could get a discount. This also ruins the incentive to give them to African patients, because they take away business from wealthier Europeans. In many ways preventing smuggling over borders is important to making sure people receive their HIV treatment.
Corporations don’t actually price based on need, nor will they ever. If you need something, it will not necessarily make the price higher or lower. It is based on the most money you are willing to pay for it. This can work both ways. Poor people don’t need the drug more than rich westerners necessarily. The difference here is the amount of money we can pay for it. In this sense people can make a case for borders on both humanitarian and corporate profit grounds. Borders act to segment markets so they can be charged based on how much people in that group are willing to pay. Trying to put people in categories and price based on these categories is the name of the game here. While exploiting psychological weakness is one possibility. The lucrative and more definite predictor is income. It has consistently been the main motivation behind these massive price differences.
Is there a serious danger of corporations exploiting the vulnerable by using price dscrimination? In many ways, they will indeed do this, but this ignores that they only care about need in terms of how much people will be willing to pay for it. Consider a guy with $10 in his pocket and another guy with $1000 in his pocket. I would be willing to bet that it is much more worth your time to try and squeeze the guy with $1000 for more money. Even if rich people need or desire something less, they have much money at their disposal. As we have demonstrated corporations are very willing to sell to poor people at a reduced price, as long as it doesn’t mean their richer customers get that same price.
This is not to say that prices will always be cheaper for the poor. We can think about various examples where prices are higher for the poor. In the case of interest rates, richer people are usually less of a risk to lend to. Some goods are cheaper per unit if you can pay a larger up front price. It is often more costly to run stores in areas which have high crime rates. These effects often hurt the poor and I am not disputing their effects. I am simply referring to various market conditions that work the other way. Markets are incentivized to price higher for the rich people and it can happen given certain conditions. The increase of technology here and data collection helps enable this effect to make prices cheaper for the poor.
Let us visit an even more extreme example, the United States university system. Did you know that while the price of tuition is radically increasing, the price being paid on average for tuition is growing much slower or in some years decreasing. This seems nonsensical until you consider that tuition is being priced based on how much money people are willing to pay. The price that you see for tuition is just the maximum price that people could pay. The university simply puts out a ridiculously high price and asks you to fill out a form detailing your income and assets to receive a discount.
This would appear strange if you went to the store tomorrow and prices increased 10 fold. Before you panic, the people at the store told you to send them all your financial details and then they might give you a discount. If they could successfully do this, then it would probably save poorer people a boat load of money and really rake the rich over the coals.
Besides the outrage that would be generated if corporations try to do this, there would be a lucrative black market created for poorer people to make money on the side as personal shoppers. Just hire someone who is poorer to shop for you and then you can save a boatload of money.
This is harder to avoid if you are being surveilled without your knowledge. That website can just offer you less discounts if you are logging in from that expensive mac computer and have a history of being a big spender. I am somewhat safe as I own a ghetto laptop and am a computer nerd that has Brave browser installed. I am kidding, only if you really could magically hide who you are.
American Universities have successfully pulled this off. How? You can’t resell your education and they have convinced people that giving them your financial information is normal and probably moral. The latter is accomplished with the FAFSA, Free Application For Student Aid. Basically it is used to apply for student aid from the government and university. They charge a ridiculous price and then ask you to send them information detailing all of your income and assets to hopefully get a discount.
The curious thing about this arrangement is that we offer everyone the same service, but we charge the richer people even more. This trick to maximize output and squeeze more profit out of people reminds me of another principle; From each according to their ability to each according to their need. The richest among us are squeezed for a high price and the poor get it at closer to cost. This acts to reduce the benefits of having a high income. The plain irony of this arrangement is that it contradicts what you intuitively would think about such schemes and their impact. The intuition would be that companies using your data to change the price of something would lead to the rich robbing the poor. The fact is that in essentially all cases the richer always get the raw end of the deal. The market here is exploiting the idea of the rich paying more, because they can afford it.
The university system was in fact established by government intervention. This does not mean that if government intervention was pulled, then it would end the system. The issue here is that the university system is widely considered to be moral. Of course universities want to see your financial information! It is just to help you and poor people afford university. This might still occur even if the government stopped giving aid. The numbers would indeed shift and it would most certainly hurt the poor. Universities are still incentivized by profit and the market is trained so that people hand over their information.
A curious fact of the university system is that in many circumstances there is a disincentive. If you are a family that is well off and are paying for your child in university, then it is possible that it will make you better off than if you earned just a little bit less. They actually almost function like taxes. Universities have yet to properly squeeze the very rich and maybe that is not desirable. We might need million dollar tuition with massive million dollar student aid packages for everyone except the 1% of the 1% to successfully pull off this scheme. This system does have the one flaw that if your parents are well off and they refuse to help you, then you are expected to go into massive amounts of debt. There are questions about the effect of taxation on willingness to work, and the same arguments apply here.
Let us return to the moral issue of doing imperfect mind reading or as it is more technically called data collection and behavioral economics. A lot of the panic here is not entirely realistic. I believe that optimism is for cowards, but it is bad to be absurdly pessimistic. There are a lot of critiques here of this development, but I want to offer counter points. In terms of goods and services which are common and competitive, this development will not likely affect them. It is very hard to have a broad monopoly on water and food. For people who can already easily afford less competitive services, they would probably be gouged. Those who struggle to afford various services will be offered them at a cheaper price. All of this will lead to more profits and thus more money for research and development. New markets in providing people cutting edge services might be able to offer everyone access with the bulk of profits coming from those who can afford to pay the most.
Earlier, I made a tongue and cheek comparison to communism. While I am not using that word in a technically correct sense, I was trying to invoke the spirit of what people want. From each according to their ability to each according to their need. The idea that everyone can have something and people who can pay more contribute to paying for the fixed costs.
Consider that it costs a lot to build a police station, but it costs very little to protect more people. If we were to be charged equally for police, the price would need to compensate for these fixed startup costs. One argument for the government is its ability to come in and offer monopoly services to everyone at different prices. The poor can get the monopoly services at near marginal cost and the rich pay for the fixed costs.
The government does this by investigating people’s income and assets. Its business is data collection and price discrimination. Taxes are a type of discrimination against those who have more money. If you have a higher income, you pay a higher price for civilization. So far this business has largely been cornered by the public sector. Opening up this access to data can usher in a new era of private commons. Areas which are open for the public use, but are not public commons. They are “taxed” services which exist for profit.
The historical battle between efficiency and public access for monopolies could be solved by the data revolution. Instead of government expansion to meet the needs for all as new services become considered a necessity, private entities can act to build these commons and run them for profit. This could be a solution to halt the growth of government into various new sectors of the economy that come out of a unique private intervention.
Social media is a service that most of the public consumes and has equal access to, but it is not a public service. We can all come to Twitter, YouTube, and Facebook as the public. These are services which act as common grounds for the public. The question is always monetizing them and holding them accountable. These services are incentivized to pull in and have participation from the public. They are however not mandatory and can in theory be replaced. This is a problem with most government institutions. Even if we have a revolution, they would probably just occupy and only partially demolish the existing structure. Myspace collapses and is replaced by a new institution, facebook. What is next? I am not sure, but I at least don’t have to worry about it on a more foundational scale.
What is the potential of data to revolutionize the world? Will it be used as a tool of the powerful to exploit people in need? Hopefully, I have put some ideas in your head to think more positively and critically about the power and uses of big data. I do not possess the power to read minds, so I don’t know what you are thinking anyway.