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When algorithms set prices: winners and losers

A new discussion paper published today by leading economics and finance consultancy, Oxera Consulting LLP, looks at the risks and benefits to consumers when companies set prices using algorithms and artificial intelligence (AI).

Much has been made in the media and organisations such as the European Commission and the OECD—particularly with reference to Uber and Amazon—of the possibility that AI-driven algorithms could, in theory, collude to drive up prices for consumers, in favour of the companies. Oxera’s paper suggests there can also be pro-competitive benefits from the use of algorithmic pricing. Algorithms can make markets more competitive through faster price adjustments to market changes, making it easier for new firms to enter, and harder for collusive arrangements and cartels to be maintained.

We live in an increasingly digital world where AI is now commonplace. Today’s businesses are able to capture, store and analyse data about competitors, consumers and the wider world, helped by technological advances such as cloud computing. However, algorithms will pose new challenges to policymakers, regulators and competition authorities.

With algorithms, traditional approaches to finding collusive activity by incentivising whistle-blowers are no longer likely to work. Moreover, with algorithms making autonomous decisions based on information in the public domain, there is no record of pricing decisions, so what would constitute evidence of collusive activity?

What impact could this have on consumers day-to-day?

Oxera’s paper demonstrates that pricing algorithms could, in many cases, swing markets in favour of the consumer, as consumers themselves use technology to help them find the most competitive prices. The use of algorithms is already opening up in new markets, such as popular email (e.g. Gmail) and music streaming services (e.g. Spotify) that are free of charge to consumers and funded by personalised advertising. Using algorithms to undertake pricing can bring new entrants to existing markets, such as online travel retailers, and can increase the visibility of travel options in the market, helping consumers get a better deal.

Why do I care whether my neighbour paid the same amount as I did?

When algorithms set prices, it is much easier for them to set prices that vary by customer or group of customer. Early experiments by Amazon in 2000 showed that consumers dislike the perceived unfairness of personalised pricing, and can punish companies that try to use it. For example, Uber recently experienced some reputational fall-out over its ‘route-based pricing’, whereby those on routes between wealthier neighbourhoods were charged more than those between poorer ones, even though the distance was the same.

However, flat pricing may not be fair either, particularly when some customers use a service, such as music streaming, much more than others. Algorithms may well start to unwind hidden cross-subsidies and lead to the information we provide about ourselves being used to inform the price we pay. As society starts to look more closely at the distribution of outcomes across people, companies will have to consider whether they are comfortable with the outcomes for different types of consumer before the media or government do it for them.

The full report is available on the Oxera website, click here.

Notes to editor:

This discussion paper has been inspired by a meeting in May 2017 of the Oxera Economics Council, a group of leading European academics, and officials of the European Commission. The views expressed in the paper are those of Oxera and cannot be attributed to the Council members or the European Commission.

Oxera is grateful to the participants for their input on this topic.

Oxera advises companies, policymakers, regulators and lawyers on any economic issue connected with competition, finance or regulation. We have been doing this for 35 years, gathering deep and wide-ranging knowledge as we expand into new sectors. We have a reputation for credibility and integrity among those we advise, and among key decision-makers, such as policymakers, regulators and courts. From our locations in Berlin, Brussels, London, Oxford, and Rome, we are able to advise our international clients in a highly flexible way, including providing advice in several languages.

To arrange an interview with Oxera Partner, David Jevons, please contact presthaya@the10group.co.uk or call +44 (0)20 7637 0656.