The question is what do online advertisers get for their money? No doubt, user profiling helps advertisers more effectively identify the customers most likely to be interested in their products. However, the darker explanation is that such profiling also facilitates tailoring prices to individual consumers in ways that maximize revenue extracted from each transaction.
This ability to charge different prices to different customers for the same good or service, what economists call “price discrimination”, is based on the reality that people have different maximum prices they are willing to pay. And profiling consumers helps advertisers identify this “pain point” for each customer and offer a different price to each customer matching that maximum price they are willing to pay without them knowing that other deals are available.[i] Some economists argue that where consumers know all pricing options, they can potentially benefit from price discrimination, as when airline passengers choose between a cheap price at an inconvenient time to save money, which can fill seats, increase revenues for airlines and increase options for different customers.[ii] But when people either don’t know about better deals or don’t easily have the ability to access them, such price discrimination is far more likely to hurt consumers.
For example, a 2012 Wall Street Journal report found that major companies, including Staples, Home Depot, Discover Financial Services and Rosetta Stone, were systematically using information on user physical locations to display different online prices to different customers.[iii] More disturbingly, contrary to any hope this might benefit low-income bargain hunters, the paper found that higher-income locations were offered better deals than low-income communities, because those poorer areas had fewer local retail outlets competing with the online stores. Credit card companies like Capitol One show different offers with different credit card deals based on view locations and guesses by the company about their income.[iv]
In search advertising, this differential pricing overwhelmingly takes the form of web coupons offered to some people but not others based on their behavior and demographic data. As Ed Mierzwinski, consumer program director for the United States Public Interest Research Group (USPIRG) noted in an interview, companies “offer you, perhaps, less desirable products than they offer me, or offer you the same product as they offer me but at a higher price.”[v]
Economists like Nobel Prize Winner Joseph Stiglitz, who pioneered what has been called “information economics”, detail the economic harm to consumers from such differential pricing. When consumers don’t know all their price options, it creates “market power in product markets” which firms exploit through sales and “other ways of differentiating among individuals who have different search costs” in identifying different price options.[vi]
[i] See Ian Ayres, Super Crunchers, p. 173 (2007) (“[Firms] are becoming more adept at figuring out how much pricing pain individual consumers are willing to endure and still come back for more.”)
[ii] John Lazarev, The Welfare Effects of Intertemporal Price Discrimination: An Empirical Analysis of Airline Pricing in U.S. Monopoly Markets (Working Paper), January 7, 2013; https://files.nyu.edu/jl5214/public/Lazarev_JMP.pdf
[iv] Angwin (2014).
[v] Stephanie Clifford, “Web Coupons Know Lots About You, and They Tell,” New York Times, April 16, 2010; http://www.nytimes.com/2010/04/17/business/media/17coupon.html
[vi] Joseph Stiglitz, Information And The Change In The Paradigm In Economics: Nobel Prize Lecture, December 8, 2001, http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/2001/... see also Steven Salop and Joseph Stiglitz, “Bargains and Ripoffs: A Model of Monopolistically Competitive Price Dispersions,” Review of Economic Studies, October 1977, 44(3), pp. 493-510; S. A. Lippmana nd D. K. Levine, eds., The economics of information; Steven Salop; “The Noisy Monopolist: Information, Price Dispersion and Price Discrimination,” Review of Economic Studies, October 1977, 44(3), pp. 393-406, Stiglitz, “Monopoly, Non-linear Pricing and Imperfect Information: The Insurance Market,” Review of Economic Studies, October 1977, 44(3), pp. 407-30.