19 May 2014 Research & Ideas

Companies Should Compete for Your Privacy

Consumers are sometimes willingto trade personal data for lowerprices. How should companiescompete for that valuableinformation? A discussion withRamon Casadesus-Masanell andAndrs Hervs-Drane.

by Dina Gerdeman

Consumers are increasingly waryabout sharing personal informationwith firms. Yet when they benefitfrom providing information inexchange for lower prices or betterservices, many consumers willgladly make the privacy trade-off.

But how does this disclosure ofpersonal information affectcompetition among firms?

In the working paper Competingwith Privacy, RamonCasadesus-Masanell and AndrsHervs-Drane "consider a marketwhere firms set prices anddisclosure levels for consumerinformation, and consumersobserve both before decidingwhich firm to patronize and howmuch personal information toprovide."

"Focusing on a singlerevenue source is the mostprofitable strategy whenfirms compete forconsumer information"

It's clear from their research thatthe marketplace has plenty of roomfor two types of Internet firms:those that ask consumers todisclose a large variety of personaldatain some cases in exchangefor free services or lowerpricesas well as firms thatpledge to keep a lid on people'sinformation, but often chargeconsumers higher prices.

Firms competing with privacy tendto benefit from engaging indifferent degrees of informationdisclosure as they cater to theneeds of different consumergroups. Casadesus-Masanell, theHerman C. Krannert Professor ofBusiness Administration atHarvard Business School, andHervs-Drane, assistant professorat Universitat Pompeu Fabra inBarcelona, found that competitionhas three main effects on themarketplace:

1. Competition drives the supply ofservices with a low level ofdisclosure, since some customerswill choose to pay more for a

service in exchange for keepingtheir personal information underwraps.

2. Competition ensures thatservices that disclose a lot ofpersonal information providesome benefit to customers, attimes in the form of subsidies.For example, Amazon providesdiscounts on its e-reader pricesfor customers who agree toreceive targeted ads fromAmazon and third-party sellerson their devices.

3. Higher intensity of competitionbetween firms increases thevolume of consumer informationdisclosed, reducing consumerprivacy. Consumers benefit fromintense competition, but oftenthrough lower prices orsubsidies, rather than throughreduced disclosure of theirinformation.

Consumers are more in tune thanever with corporate disclosurepractices, so firms need to makesure they are transparent in theirprivacy policies, the paper states.The researchers were quick topoint out that they were notrecommending a restriction ofdisclosure practices, since"high-disclosure services play animportant role in a competitivemarketplace and informedconsumers adjust their choicesaccordingly."

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Casadesus-Masanell andHervs-Drane provide additionaldetails about their research in theQ&A below. They collaborated inanswering the following questionsfor Working Knowledge via email.

Q: It appears that consumers areoften willing to provideinformation to firms, not onlybecause they may receive lowerprices in return but also because, insome cases,firms provide betterservice.

A: There are many examples ofhow firms exploit consumerpersonal information to improveonline services. Retailers and travelagencies, for instance, useinformation about consumers' likesand dislikes to improve theirautomated productrecommendations. Theserecommendations are oftenpresented as ''inspired by yourbrowsing history'' or''recommended for you,'' and helpconsumers discover new productsor holiday packages that matchtheir tastes. Similarly, onlineservices such as Microsoft's Office365 learn from consumer usagepatterns and documents,personalizing their user interfacesby selecting which quick-accessfunctions to display andincorporating new words andexpressions into their correctiondictionaries. Moreover, someonline services rely heavily on theexploitation of consumerinformation. Social networking onFacebook would be of little value ifusers provided no personalinformation, and digital assistantssuch as Apple's Siri require accessto consumers' location, contactlists, and calendar to be helpful.

However, not all forms of personalinformation exploitation arebeneficial to consumers. Firmssometimes exploit personalinformation to better estimatecustomers' willingness to pay andto engage in price discrimination,which may end up hurtingconsumers. Moreover, firms mayexploit personal information to tapinto complementary revenuestreams, such as advertising.Personal information can be usedto improve the targeting of ads,increasing advertisers' willingnessto pay. In addition, firms maydirectly share or sell consumerinformation to interested parties.

These practices can generatesubstantial revenues for firms, andwhile price discrimination, targetedads, and information sharing neednot be detrimental to welfare,consumers are generallyuncomfortable with them. When itwas discovered that DVD prices onAmazon.com varied with thecookies stored on consumers'browsers, resulting in higher pricesfor returning shoppers, consumerbacklash led the company to statethat such practice was a "mistake"and that it would refrain frompricing based on customerdemographics in the future.Similarly, when Amazonintroduced the Kindle Fire tabletwith targeted ads on the lockscreenand home screen, consumersclamored for an ad-free version.Amazon backtracked and extendedits Special Offers program to thetablet, allowing consumers to optout from the ads.

Q: You're expecting that morecompanies will come up withprograms similar to Amazon'sSpecial Offers program. Why are

these types of programs important?

A: Amazon's Special Offersprogram is significant because itexplicitly acknowledges thatcertain forms of informationexploitation are disliked byconsumers. The programsubsidizes the purchase of Kindletablets and e-readers with $15 and$20 discounts, respectively, inexchange for targetedadvertisements from Amazon andthird-party sellers on the device. Ifconsumers opt-out of the program,they skip both the ads and thesubsidy. The logical conclusion isthat Amazon is willing to subsidizeconsumers in order to exploit theirpersonal information because theadditional revenues generated inthe process exceed the consumerdisutility incurred. Clearly,personal consumer information is avaluable asset in the marketplace.

To better understand theimplications of consumerinformation for firms, we havebuilt a formal model to analyze theinformation exploitation dichotomyoutlined above. We take the viewthat there are two types ofexploitation: one which isbeneficial to consumers, and onewhich is not. The first type ofexploitation improves the qualityof the service and provides arationale for consumers to providetheir personal information to thefirm. The second type ofexploitation generates disutility forconsumers but enables the firm totap into additional revenue sources.We use the term disclosure todenote this second type ofexploitation since it frequentlyimplies participation ofthird-parties such as advertisers.Note that both forms of

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exploitation are compatible andmay coexist on the same service, asin the Amazon example.

The difference between the twotypes of information exploitation isstark, but it turns out to be quiteuseful to analyze the effects ofprivacy on competition. Consumersare the gatekeepers of theirpersonal information and choosewhether to sign up for the firm'sservice and how much personalinformation to provide. Theincentives of consumers and thoseof the firm are aligned with respectto the first type of informationexploitation, but not with respect tothe second. The firm's strategyconsists of choosing what level ofdisclosure to engage in and how toprice the service to consumers.These choices reflect the tworevenue sources available to thefirm, disclosure revenues and pricerevenues, and there is a strategictension between them: a higherlevel of disclosure revenuescommands lower prices, or evensubsidies, to ensure that consumersare willing to participate andprovide their personal information.

Q: It seems that the paperrecommends that firms would dowell to compete by focusing on asingle revenue source andforegoing another: A firm canengage in a high level ofdisclosure, but should keepconsumer prices lower; and a firmthat charges consumers higherprices needs to engage in a lowlevel of disclosure. Can youcomment on this need to focus on asingle revenue source?

A: The single-revenue-sourcefocus is one of the main findings ofour analysis. Firms focus on a

single revenue source when theytap exclusively into disclosurerevenues, or when they tapexclusively into price revenues.Our model reveals that focusing ona single revenue source is the mostprofitable strategy when firmscompete for consumer information.When two firms compete in themarket, the optimal strategies arefor one firm to set a high level ofdisclosure and subsidize consumersin exchange, and for the other firmto charge high prices but not toengage in information disclosure.The result can be understood as anatural consequence of the need fordifferentiation in this market.Firms benefit from differentiatingtheir services, and thus one firmhas incentives to set a high level ofdisclosure and the other firm to seta low level of disclosure. Becausedisclosure levels generate revenuesand affect consumer participationand information provision, pricesand disclosure levels are negativelycorrelated. The firm setting a highlevel of disclosure needs tosubsidize consumers in order toattract them to the service, and thefirm setting a low level ofdisclosure quotes high prices toremain profitable.

This asymmetry betweencompetitors has profoundimplications for their businessmodels and the logic with whichthey operate. An example thatillustrates our result is that ofGoogle and Microsoft. Both firmsoffer consumers online services tomanage e-mail, contacts, calendarevents, and documents. Googleoffers these services for free, butengages in disclosure by profilingconsumers and chargingadvertisers to target them. Incontrast, Microsoft charges a

subscription price for Office 365but does not disclose consumerinformation for advertisingpurposes. Microsoft's recentScroogled! campaign emphasizedthe difference as follows: "Googlegoes through every Gmail that'ssent or received, looking forkeywords so they can target Gmailusers with paid ads. And there's noway to opt out of this invasion ofyour privacy. Outlook.com isdifferentwe don't go throughyour email to sell ads."

At a deeper level, firms areessentially competing for consumerinformation through differentstrategies. When you look at thisproblem through the lens of ourmodel, you see that both firms arecarefully adjusting disclosurelevels and prices so as to remainattractive to consumers andaccumulate as much personalinformation as possible. Both firmsmonetize consumer information:Google exploits it to generatedisclosure revenues, and Microsoftexploits it to personalize its serviceand sustain high prices.

Of course, this affects whichconsumers they attract. In ourmodel, Google attracts consumerswith low valuations, those lesswilling to pay to avoid disclosure.Microsoft attracts high-valuationconsumers. Which of these twostrategies yields highest profitsdepends on how consumervaluations compare to disclosurerevenues, that is, on how consumerwillingness to pay compares to thatof advertisers, and on how firmsinteract in the marketplace. In thepaper we provide a detailedcharacterization of the performanceof both strategies.

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Q: Your work assumes there istransparency in the market withregard to the sharing of consumerinformation. Why is this key to aconsumer's decision about whichfirms to use?

A: Yes, this is a key ingredient ofour analysis. As is the case in anymarket, consumers need to beinformed about products to makethe right decisions. In the contextof consumer privacy, consumersneed to be informed about thedisclosure practices of firms inorder to choose which services topatronize and how muchinformation to provide them with.By focusing on the case of atransparent market, our analysisprovides a benchmark for how awell-functioning market forconsumer privacy should look like.

It is worth noting, however, thattransparency in the market does notyield better consumer privacy perse. It has often been suggested thattransparency, together withcompetition, will discipline theamount of consumer informationdisclosed in the marketplace. Thisview contends that lack ofconsumer privacy is a symptom oflack of transparency. Our analysisreveals that this need not be thecase; high-disclosure services playan important role in a transparentmarket and informed consumersadjust their choices accordingly.

Moreover, when disclosurerevenues exceed price revenues(i.e., when advertisers' willingnessto pay exceeds that of consumers'),higher intensity of competition can

lead firms to increase the amountof information disclosed(subsidizing consumers inexchange). In the market forconsumer privacy, transparency isbetter understood as discipliningthe share of the privacy profit piethat accrues to consumers ratherthan disciplining the level ofprivacy they enjoy. Our view isthat initiatives to make disclosurepractices salient andunderstandable to consumers areclearly desirable from a policyperspective, but our resultsrecommend caution on restrictingthe disclosure practices of firms.

Q: How guarded are consumerswith their personal informationtoday? Would you estimate thatthey have gotten more savvy andguarded over time?

A: Consumers are becomingincreasingly cautious with theirpersonal information. In Westerncountries, surveys of consumerattitudes towards privacy confirmthis trend. Several factors arecontributing to this. Consumerawareness of disclosure practicesand familiarity with theirimplications have increased overtime, leading consumers to weighmore carefully the pros and cons ofproviding their personalinformation. Consumers have alsolearned that the disclosurecommitments of firms change overtime and are not always credible.When Facebook acquired Moves,for example, Moves promisedcustomers that it would not"commingle data with Facebook."Ten days later, however, its user

agreement was updated to provideFacebook access to its customerinformation. Unsurprisingly,privacy advocates have metFacebook's recent acquisition ofWhatsApp, a service committednever to disclose consumerinformation, with substantialskepticism.

In addition, industry initiatives toself-regulate disclosure practiceshave largely failed. The "Do nottrack" initiative is a prominentexample. It simplifies the processfor consumers to inform onlineservices that they do not wish theiractivities to be tracked, yetcompliance is voluntary and majorindustry players have not adheredto the initiative or dropped out overtime. Online services thereforeoperate without standardizedprocedures for how disclosurepractices are presented and howconsumers may communicate theirpreferences.

The consequence has been achilling of the market for personalinformation, with consumers lesswilling to provide their informationin the first place. This is anundesirable outcome since it meansthat society loses out on some ofthe potential benefits thatinformation can provide, thosefrom which we all stand to profit.

About the author

Dina Gerdeman is a writer basedin Mansfield, Massachusetts.

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Companies Should Compete for Your PrivacyAbout the author