19 May 2014 Research & Ideas

Companies Should Compete for Your Privacy

Consumers are sometimes willing
to trade personal data for lower
prices. How should companies
compete for that valuable
information? A discussion with
Ramon Casadesus-Masanell and
Andrs Hervs-Drane.

by Dina Gerdeman
Consumers are increasingly wary
about sharing personal information
with firms. Yet when they benefit
from providing information in
exchange for lower prices or better
services, many consumers will
gladly make the privacy trade-off.
But how does this disclosure of
personal information affect
competition among firms?
In the working paper Competing
with Privacy, Ramon
Casadesus-Masanell and Andrs
Hervs-Drane "consider a market
where firms set prices and
disclosure levels for consumer
information, and consumers
observe both before deciding
which firm to patronize and how
much personal information to
provide."

"Focusing on a single
revenue source is the most
profitable strategy when
firms compete for
consumer information"
It's clear from their research that
the marketplace has plenty of room
for two types of Internet firms:
those that ask consumers to
disclose a large variety of personal
datain some cases in exchange
for free services or lower
pricesas well as firms that
pledge to keep a lid on people's
information, but often charge
consumers higher prices.
Firms competing with privacy tend
to benefit from engaging in
different degrees of information
disclosure as they cater to the
needs of different consumer
groups. Casadesus-Masanell, the
Herman C. Krannert Professor of
Business Administration at
Harvard Business School, and
Hervs-Drane, assistant professor
at Universitat Pompeu Fabra in
Barcelona, found that competition
has three main effects on the
marketplace:
1. Competition drives the supply of
services with a low level of
disclosure, since some customers
will choose to pay more for a

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service in exchange for keeping

their personal information under
wraps.
2. Competition ensures that
services that disclose a lot of
personal information provide
some benefit to customers, at
times in the form of subsidies.
For example, Amazon provides
discounts on its e-reader prices
for customers who agree to
receive targeted ads from
Amazon and third-party sellers
on their devices.
3. Higher intensity of competition
between firms increases the
volume of consumer information
disclosed, reducing consumer
privacy. Consumers benefit from
intense competition, but often
through lower prices or
subsidies, rather than through
reduced disclosure of their
information.
Consumers are more in tune than
ever with corporate disclosure
practices, so firms need to make
sure they are transparent in their
privacy policies, the paper states.
The researchers were quick to
point out that they were not
recommending a restriction of
disclosure practices, since
"high-disclosure services play an
important role in a competitive
marketplace and informed
consumers adjust their choices
accordingly."

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Casadesus-Masanell and
Hervs-Drane provide additional
details about their research in the
Q&A below. They collaborated in
answering the following questions
for Working Knowledge via email.
Q: It appears that consumers are
often willing to provide
information to firms, not only
because they may receive lower
prices in return but also because, in
some cases,firms provide better
service.
A: There are many examples of
how firms exploit consumer
personal information to improve
online services. Retailers and travel
agencies, for instance, use
information about consumers' likes
and dislikes to improve their
automated product
recommendations. These
recommendations are often
presented as ''inspired by your
browsing history'' or
''recommended for you,'' and help
consumers discover new products
or holiday packages that match
their tastes. Similarly, online
services such as Microsoft's Office
365 learn from consumer usage
patterns and documents,
personalizing their user interfaces
by selecting which quick-access
functions to display and
incorporating new words and
expressions into their correction
dictionaries. Moreover, some
online services rely heavily on the
exploitation of consumer
information. Social networking on
Facebook would be of little value if
users provided no personal
information, and digital assistants
such as Apple's Siri require access
to consumers' location, contact
lists, and calendar to be helpful.

However, not all forms of personal

information exploitation are
beneficial to consumers. Firms
sometimes exploit personal
information to better estimate
customers' willingness to pay and
to engage in price discrimination,
which may end up hurting
consumers. Moreover, firms may
exploit personal information to tap
into complementary revenue
streams, such as advertising.
Personal information can be used
to improve the targeting of ads,
increasing advertisers' willingness
to pay. In addition, firms may
directly share or sell consumer
information to interested parties.
These practices can generate
substantial revenues for firms, and
while price discrimination, targeted
ads, and information sharing need
not be detrimental to welfare,
consumers are generally
uncomfortable with them. When it
was discovered that DVD prices on
Amazon.com varied with the
cookies stored on consumers'
browsers, resulting in higher prices
for returning shoppers, consumer
backlash led the company to state
that such practice was a "mistake"
and that it would refrain from
pricing based on customer
demographics in the future.
Similarly, when Amazon
introduced the Kindle Fire tablet
with targeted ads on the lockscreen
and home screen, consumers
clamored for an ad-free version.
Amazon backtracked and extended
its Special Offers program to the
tablet, allowing consumers to opt
out from the ads.
Q: You're expecting that more
companies will come up with
programs similar to Amazon's
Special Offers program. Why are

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these types of programs important?

A: Amazon's Special Offers
program is significant because it
explicitly acknowledges that
certain forms of information
exploitation are disliked by
consumers. The program
subsidizes the purchase of Kindle
tablets and e-readers with $15 and
$20 discounts, respectively, in
exchange for targeted
advertisements from Amazon and
third-party sellers on the device. If
consumers opt-out of the program,
they skip both the ads and the
subsidy. The logical conclusion is
that Amazon is willing to subsidize
consumers in order to exploit their
personal information because the
additional revenues generated in
the process exceed the consumer
disutility incurred. Clearly,
personal consumer information is a
valuable asset in the marketplace.
To better understand the
implications of consumer
information for firms, we have
built a formal model to analyze the
information exploitation dichotomy
outlined above. We take the view
that there are two types of
exploitation: one which is
beneficial to consumers, and one
which is not. The first type of
exploitation improves the quality
of the service and provides a
rationale for consumers to provide
their personal information to the
firm. The second type of
exploitation generates disutility for
consumers but enables the firm to
tap into additional revenue sources.
We use the term disclosure to
denote this second type of
exploitation since it frequently
implies participation of
third-parties such as advertisers.
Note that both forms of

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exploitation are compatible and

may coexist on the same service, as
in the Amazon example.
The difference between the two
types of information exploitation is
stark, but it turns out to be quite
useful to analyze the effects of
privacy on competition. Consumers
are the gatekeepers of their
personal information and choose
whether to sign up for the firm's
service and how much personal
information to provide. The
incentives of consumers and those
of the firm are aligned with respect
to the first type of information
exploitation, but not with respect to
the second. The firm's strategy
consists of choosing what level of
disclosure to engage in and how to
price the service to consumers.
These choices reflect the two
revenue sources available to the
firm, disclosure revenues and price
revenues, and there is a strategic
tension between them: a higher
level of disclosure revenues
commands lower prices, or even
subsidies, to ensure that consumers
are willing to participate and
provide their personal information.
Q: It seems that the paper
recommends that firms would do
well to compete by focusing on a
single revenue source and
foregoing another: A firm can
engage in a high level of
disclosure, but should keep
consumer prices lower; and a firm
that charges consumers higher
prices needs to engage in a low
level of disclosure. Can you
comment on this need to focus on a
single revenue source?
A: The single-revenue-source
focus is one of the main findings of
our analysis. Firms focus on a

single revenue source when they

tap exclusively into disclosure
revenues, or when they tap
exclusively into price revenues.
Our model reveals that focusing on
a single revenue source is the most
profitable strategy when firms
compete for consumer information.
When two firms compete in the
market, the optimal strategies are
for one firm to set a high level of
disclosure and subsidize consumers
in exchange, and for the other firm
to charge high prices but not to
engage in information disclosure.
The result can be understood as a
natural consequence of the need for
differentiation in this market.
Firms benefit from differentiating
their services, and thus one firm
has incentives to set a high level of
disclosure and the other firm to set
a low level of disclosure. Because
disclosure levels generate revenues
and affect consumer participation
and information provision, prices
and disclosure levels are negatively
correlated. The firm setting a high
level of disclosure needs to
subsidize consumers in order to
attract them to the service, and the
firm setting a low level of
disclosure quotes high prices to
remain profitable.
This asymmetry between
competitors has profound
implications for their business
models and the logic with which
they operate. An example that
illustrates our result is that of
Google and Microsoft. Both firms
offer consumers online services to
manage e-mail, contacts, calendar
events, and documents. Google
offers these services for free, but
engages in disclosure by profiling
consumers and charging
advertisers to target them. In
contrast, Microsoft charges a

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subscription price for Office 365

but does not disclose consumer
information for advertising
purposes. Microsoft's recent
Scroogled! campaign emphasized
the difference as follows: "Google
goes through every Gmail that's
sent or received, looking for
keywords so they can target Gmail
users with paid ads. And there's no
way to opt out of this invasion of
your privacy. Outlook.com is
differentwe don't go through
your email to sell ads."
At a deeper level, firms are
essentially competing for consumer
information through different
strategies. When you look at this
problem through the lens of our
model, you see that both firms are
carefully adjusting disclosure
levels and prices so as to remain
attractive to consumers and
accumulate as much personal
information as possible. Both firms
monetize consumer information:
Google exploits it to generate
disclosure revenues, and Microsoft
exploits it to personalize its service
and sustain high prices.
Of course, this affects which
consumers they attract. In our
model, Google attracts consumers
with low valuations, those less
willing to pay to avoid disclosure.
Microsoft attracts high-valuation
consumers. Which of these two
strategies yields highest profits
depends on how consumer
valuations compare to disclosure
revenues, that is, on how consumer
willingness to pay compares to that
of advertisers, and on how firms
interact in the marketplace. In the
paper we provide a detailed
characterization of the performance
of both strategies.

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Q: Your work assumes there is

transparency in the market with
regard to the sharing of consumer
information. Why is this key to a
consumer's decision about which
firms to use?
A: Yes, this is a key ingredient of
our analysis. As is the case in any
market, consumers need to be
informed about products to make
the right decisions. In the context
of consumer privacy, consumers
need to be informed about the
disclosure practices of firms in
order to choose which services to
patronize and how much
information to provide them with.
By focusing on the case of a
transparent market, our analysis
provides a benchmark for how a
well-functioning market for
consumer privacy should look like.
It is worth noting, however, that
transparency in the market does not
yield better consumer privacy per
se. It has often been suggested that
transparency, together with
competition, will discipline the
amount of consumer information
disclosed in the marketplace. This
view contends that lack of
consumer privacy is a symptom of
lack of transparency. Our analysis
reveals that this need not be the
case; high-disclosure services play
an important role in a transparent
market and informed consumers
adjust their choices accordingly.
Moreover, when disclosure
revenues exceed price revenues
(i.e., when advertisers' willingness
to pay exceeds that of consumers'),
higher intensity of competition can

lead firms to increase the amount

of information disclosed
(subsidizing consumers in
exchange). In the market for
consumer privacy, transparency is
better understood as disciplining
the share of the privacy profit pie
that accrues to consumers rather
than disciplining the level of
privacy they enjoy. Our view is
that initiatives to make disclosure
practices salient and
understandable to consumers are
clearly desirable from a policy
perspective, but our results
recommend caution on restricting
the disclosure practices of firms.
Q: How guarded are consumers
with their personal information
today? Would you estimate that
they have gotten more savvy and
guarded over time?
A: Consumers are becoming
increasingly cautious with their
personal information. In Western
countries, surveys of consumer
attitudes towards privacy confirm
this trend. Several factors are
contributing to this. Consumer
awareness of disclosure practices
and familiarity with their
implications have increased over
time, leading consumers to weigh
more carefully the pros and cons of
providing their personal
information. Consumers have also
learned that the disclosure
commitments of firms change over
time and are not always credible.
When Facebook acquired Moves,
for example, Moves promised
customers that it would not
"commingle data with Facebook."
Ten days later, however, its user

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agreement was updated to provide

Facebook access to its customer
information. Unsurprisingly,
privacy advocates have met
Facebook's recent acquisition of
WhatsApp, a service committed
never to disclose consumer
information, with substantial
skepticism.
In addition, industry initiatives to
self-regulate disclosure practices
have largely failed. The "Do not
track" initiative is a prominent
example. It simplifies the process
for consumers to inform online
services that they do not wish their
activities to be tracked, yet
compliance is voluntary and major
industry players have not adhered
to the initiative or dropped out over
time. Online services therefore
operate without standardized
procedures for how disclosure
practices are presented and how
consumers may communicate their
preferences.
The consequence has been a
chilling of the market for personal
information, with consumers less
willing to provide their information
in the first place. This is an
undesirable outcome since it means
that society loses out on some of
the potential benefits that
information can provide, those
from which we all stand to profit.

About the author

Dina Gerdeman is a writer based
in Mansfield, Massachusetts.