Financial Stability Note - Differential Pricing: The Economics and International Evidence

• With enhanced technology and digitalisation, the potential for more sophisticated forms of differential pricing has increased
• From a policy perspective, price differentiation can be associated with benefits and costs for consumers, which may require a trade-off between different policy goals 
• International evidence of policy responses suggests appropriate consideration of potential competition and consumer price effects is warranted, as well as the impact on vulnerable consumers.

Today the Central Bank of Ireland has published a Financial Stability Note, written by Shane Byrne and Yvonne McCarthy entitled “Differential Pricing: The Economics and International Evidence”. Differential pricing refers to the practice of charging individual customers, or groups of customers, different prices for access to similar goods or services and is a practice widely used across a range of markets globally. In examining differential pricing, it is necessary to understand its economic underpinnings and wider market application. The Central Bank is continuing its supervisory review of differential pricing in the motor and home insurance markets, where an interim report is due to be completed by year end.

In this FSN, the authors describe how enhanced technology and digitalisation have increased the potential for more sophisticated forms of differential pricing, with the possibility for prices to be tailored to each individual. In this case, firms can price a good or service for a customer based on their personal characteristics and patterns of engagement.

The authors report that, from a policy perspective, price differentiation can be associated with both benefits and costs for consumers, which may require a trade-off between different policy goals. For example, it can encourage customers to try new products or providers to avail of lower prices and can promote new business growth and competition as firms attract customers away from existing providers. On the other hand, differential pricing can have a detrimental effect on distributional equity.

The authors outline that, in practice, customers may not always be aware of price differentiation or, even where they are aware of it, may not engage in sufficient search and negotiation to avoid it. This can result in adverse effects for consumers, particularly if the propensity to engage in effective search and negotiation is correlated with characteristics of vulnerability (e.g. age, income or financial capability) or with behavioural biases that create barriers to customer engagement.

Based on the review of international experience, the authors find that in responding to differential pricing, a careful weighing of the likely costs and benefits of any potential policy solution is essential, with appropriate consideration given to potential competition and consumer price effects, as well as the impact on vulnerable consumers.