Pricing experience goods: distinguishing product quality through behavior-based pricing

This study investigates the effect of behavior-based pricing (BBP) on consumer switching behavior, firm profits, consumer surplus, and social welfare in an experience goods market with a quality difference. By incorporating the quality difference under BBP, we identify two pure-strategy price equilibria for firms, in contrast to the single pure-strategy equilibrium that emerges when product quality is identical. Specifically, both firms poach new consumers when the quality difference is relatively small, whereas only the high-quality firm poaches new consumers when the quality difference becomes sufficiently large. Contrary to the extant literature, which suggests that BBP can intensify competition and lead firms into a Prisoner's Dilemma, we uncover that BBP could reduce competition and overcome the Prisoner's Dilemma when the quality difference is relatively large. Furthermore, BBP consistently increases consumer surplus and improves social welfare specifically when the quality difference are sufficiently large. In the extended analysis, we separately examine the effect of myopic consumers and endogenous BBP decision-making on firms' pricing strategies and BBP implementation decisions. This work offers management insights to better understand the practical application and regulation of BBP in the experience goods market.