A Customer Management Dilemma: When Is It Profitable to Reward Existing Customers?

This study attempts to answer a basic customer management dilemma facing firms: When should the firm use behavior-based pricing (BBP) to discriminate between its own and competitors’ customers in a competitive market? If BBP is profitable, when should the firm offer a lower price to its own customers rather than to the competitor's customers? This analysis considers two features of customer behavior hitherto ignored in BBP literature: heterogeneity in customer value and changing preference (i.e., customer preferences are correlated but not fixed over time). In a model where both consumers and competing firms are forward looking, we identify conditions when it is optimal to reward the firm’s own or competitor’s customers and when BBP increases or decreases profits. To the best of our knowledge, we are the first to identify conditions in which (1) it is optimal to reward one’s own customers under symmetric competition and (2) BBP can increase profits with fully strategic and forward-looking consumers.