Case Study:

Jason Lee has been selling specialty teas for fifteen years. It all started when, as a teenager, he was helping his father manage a brick-and mortar shop selling imported teas in a Chicago suburb. His father's knowledge of the tea market helped establish relationships with importers and bring in specialty teas directly from India, Sri Lanka, China, and Japan. Upon graduating college with a business degree, Jason chose to take over the operations, in part because of his father's health issues combined with the strong reluctance to sell the business. Tea is the most widely consumed beverage in the world, but other than the iced tea version it has not been quite as popular in the US Midwest. However, the twenty-first century has brought a revolution to the tea market in the US as the millennials have taken a taste to the beverage, and the search for a healthier lifestyle brought millions of new customers to tea sellers. Jason wanted to position his business to benefit from this market change. Jason has always been fascinated with technology. Ever since he took his first and only college course in e-commerce, he was thinking of giving his family business a stronger online presence. Finally, two and a half years ago the online store of Lee's Teas went live. Along with exposure to a broader market, that transition came with a handful of new headaches. The sales volume increase resulted in greater expenses required to ensure the availability of the product. Jason considered outsourcing some of the logistics to Amazon's fulfillment program that is designed to help small businesses sell through the Amazon platform while taking advantage of Amazon's expertise in order fulfillment. He also worried about the promotion of his online store to help it rank highly on the search results lists. This required doing some research on how the content and keywords on the e-commerce site reflect on its search results placement. Making the website mobile-friendly and easy to share on social media also helped its visibility and drove additional customer traffic. The most important challenge, however, consisted in the changed nature of the competition he was facing. Previously, he had a well-established niche in his geographical region and had a consistent pool of loyal customers who learned to appreciate his father's quality teas as well as fair pricing. The new environment, however, was very different. On the Internet, no one knew him. There were plenty of other online stores selling a similar selection of teas. All this made his profit margins decline.

Growing Tea Market in the USA

Tea is the second most popular beverage in the world after water. People have been drinking tea for nearly 5,000 years. According to Chinese legends, tea was discovered in 2737 BC by Chinese Emperor Shen-Nung when some tea leaves were accidentally blown into the Emperor's pot of boiling water. The growth in US tea consumption in recent years has been very impressive. USA is currently the fourth country in the world in tea consumption behind only China, Russia, and Japan, and is the second largest importer of tea behind Russia. The total wholesale value of tea sold in the US grew from $2 billion in 1990 to over $10 billion in 2014. (Tea Association of the USA, 2015) The preference for healthier beverages is driving consumers away from sugary drinks and boosting the demand for tea. According to the USA Tea Association, "tea is an allnatural and environmentally sound product from a renewable source. Tea contains flavonoids, naturally occurring compounds that are believed to have antioxidant properties. Tea flavonoids often provide bioactive compounds that help to neutralize free radicals, which scientists believe, over time, damage elements in the body. Every day, new findings from the international scientific community lend credibility to tea's healthy properties." The USA Tea Association lists a number of academic studies that have shown health benefits of tea for prevention of heart and neurological diseases, certain cancers, and osteoporosis. The majority of the tea consumed in the US is ready-to-drink bottled teas such as Snapple, Lipton, and Gold Peak owned and promoted by food industry giants PepsiCo, CocaCola, and Dr.Pepper. However, specialty teas including high-quality loose-leaf teas constitute a healthy 17.5% of the market and saw total sales of $1.9 billion in 2014 (Tea Association, 2015). Specialty teas include different varieties of white, green, and oolong teas. They are typically of higher quality and have higher prices both on the wholesale and retail markets. Specialty tea is attracting affluent, young, educated and health conscious consumers who like to experiment with unique and organic flavors. The recent acquisition of Teavana chain of tea stores by Starbucks has helped fuel significant growth in this segment. As the number of restaurants serving specialty tea and the number of tea salons have also been increasing, the consumer exposure to this segment of the tea market and the consumer demand have been on the rise. Traditionally, specialty teas have been popular with customers who were brought up in a tea-drinking culture such as Chinese, British, or Russian. This has been the traditional base of customers Lee's Teas has built upon. More recently, new and distinct segments of demand come from the millennials attracted by the variety and the organic properties of teas, as well as from the aging baby-boomer population interested in the health benefits of tea consumption.

Can Price Discrimination Help?

Looking for a way to increase the sustainability of his e-commerce profits, Jason started thinking about possible ways to differentiate among his customers instead of charging everyone the same price. As an avid Internet user, he knew that companies such as Google and Netflix have successfully used personalization to provide tailored services to their customers. He was also aware of coupons distributed by retailers and manufacturers alike and has himself used them many times. However, he wanted to explore this idea further and see if there is something that works for him as a small e-commerce business owner. He recalled the discussion of price discrimination in his college Managerial Economics course. Under this pricing method, sellers are able to boost their profits by identifying their customers' willingness and ability to pay and setting their prices accordingly. Economics textbooks distinguish three types of such pricing strategies (Baye and Prince, 2013). First-degree price discrimination occurs when each individual customer is charged the price equal to their willingness to pay. With second-degree price discrimination, sellers openly offer a variety of fee options linked to the volume of purchase - with such examples as discounts for buying large quantities of a product, or reduced bank fees for keeping large account balances. With third-degree price discrimination, the seller attempts to segment the market into various groups that have different levels of price sensitivity and charges the groups accordingly. Common examples of third-degree price discrimination include senior-citizen and student discounts. Price discrimination may also involve changing prices over time which is common for electronics products such as Apple's iPhone (Chulkov and Nizovtsev, 2014). Jason couldn't remember much more from that discussion so he used one of his afternoons to research the Internet for additional details. He was able to find several examples of online price discrimination, some of which were in fact quite prominent. That encouraged him to explore the topic further.

Variation in Prices on Travel Websites

The first study Jason came across (Hannak et al., 2014) was authored by a team of computer scientists at Northeastern University who recruited three hundred users and tracked their search experience on different e-commerce sites. The researchers also developed hundreds of fake accounts to see whether browsing and purchase histories as well as clicks through the sites had an impact on the prices seen by the users. They found that six of sixteen popular e-commerce websites charged consumers different prices for a similar product and none of the sites alerted their customers to that fact. For example, online travel agencies Cheaptickets and Orbitz favored the members of these sites and charged users looking for hotels an average of $12 more per night if they were not logged into the sites. Meanwhile, Travelocity charged users of Apple Inc.'s iOS mobile operating system $15 less for hotels than other users. Priceline personalized the order of search results based on the user's history of clicks and purchases. According to the same study, Expedia and Hotels.com online travel agencies appear to break their users into groups and steer users from one group at random to pricier products. Expedia and Hotels.com are both units of Expedia Inc., and the company confirmed that it constantly refines its pricing strategies using a method called A/B testing, the researchers said. Customers are randomly placed in a group that highlights either less or more costly hotels. In an example, one group of customers was shown an average hotel listing price of $187 a night. The other group saw prices that were about 10% lower. Expedia spokesman Dave McNamee was quoted saying in an interview to the Wall Street Journal that "presenting different booking paths and options to different customers allows us to determine which features customers appreciate most. Pricing is not manipulated by Expedia.com" (Dworkin, 2014). Orbitz, an online travel site, popped up in Jason's search two more times. As it turned out, Orbitz has been accused of price discrimination as far back as year 2002 (Clemons, et al., 2002). Another Wall Street Journal investigation found in 2012 that Orbitz steered Mac users to pricier hotel offers, which effectively resulted in those customers paying as much as 30% more than PC users for a night's lodging. The company later discontinued the practice, which it characterized as a month-long experiment (Mattioli, 2012).

Online Retailers' Pricing Practices

The Northeastern University study also found that Home Depot's website didn't charge users different prices for identical products but showed more expensive products, as much as $100 more expensive on average, to people who shopped using a smartphone. "In the real world, there are coupons and loyalty cards, and people are fine with that," said Professor Wilson from Northeastern University who led the research team. "Here, there is a transparency problem. The algorithms change regularly, so you don't know if other people are getting the same results." (Dworkin, 2014) In an interview with the Wall Street Journal, Home Depot didn't dispute the accuracy of these findings, but the company claimed that they were not "intentionally steering search results," said company spokesman Stephen Holmes. Many factors could influence what a customer sees on the company's website, including prior browsing and purchase history, the location of the store, and whether the customer is on mobile or not, said Mr. Holmes (Dworkin, 2014). Staples Inc. varied its online prices based on the users' location (Valentino-Devries et al., 2012). The office supply chain uses not only the customer's location, but also the customer's distance from competitor stores such as Office Depot as a factor in setting its. One fact that Jason found very interesting was that the majority of consumers are unaware of the elaborate pricing practices used by online retailers. A study from the Annenberg Center at the University of Pennsylvania (Turow et al., 2005) found that 64% of American adults who use the internet do not know that online stores "charge different people different prices at the same time of day." When presented with various scenarios of price discrimination, between 64% and 91% of respondents in this survey voiced their disapproval and 87% believed that online stores should not charge different people different prices for the same products. The study concluded that while consumers may be used to the idea of coupons and sale prices in retail stores, they expect the online environment to be a level playing field with similar prices for different buyers of the same product.

Pricing by Car Rental Websites

Just as Jason was contemplating his own pricing strategy, life suddenly gave him more food for thought. He was researching the options for a Christmas vacation with his family, choosing between trips to California or Spain. He needed to rent a car for ten days and went to the Budget Rent-a-car websites. The rates quoted by Budget.com and BudgetInternational.com looked somewhat high to him but most interestingly, they were different! This fact baffled him. Being resourceful, he asked his cousin who lived in Spain, to run a similar search on the same websites. This exercise revealed an interesting pricing pattern in the rental car market. Budget's websites offered different prices for the exact same rental dates and type of vehicle to customers coming from the US and from Europe. As Figure 1 demonstrates, for a local US customer Budget's US website offered a lower price compared to the price offered on the international version of the website. At the same time, Budget's international website offered a substantially lower price to the European customer compared to the price offered to the same customer on the US site. European customers also were offered lower prices overall. For a ten-day one-way rental of a small sport-utility vehicle (SUV) in California over the Christmas holiday period, the price for a US customer ranged between $1236 and $1722. In contrast, the price for the same type of vehicle offered at the same time to a European customer ranged between $781 and $958. Frequent flyer customers received a discount on the US website, but not on the international website

Figure 2 reports the prices for similar rental queries for a ten-day one-way vehicle rental in Spain. In a reversal of pattern from the case of the California rental, in this case USbased customers were offered overall lower rates. A US customer renting in Europe saw a price as low as $369. Meanwhile, a European customer would pay between $743 and $846 for the same type of vehicle over the same period in Spain. Budget's US website also offered much lower prices to local US customers than the international website.

Legal Considerations

At some point in his search, it became clear to Jason that price discrimination practices benefit the sellers, while some buyers seem to be worse off as a result. A thought crossed his mind, "Is it even legal to do that?" and so he dug deeper into the available sources. As it turned out, using market power to charge different prices to different customers has been outlawed in the US since the Clayton Act of 1914. Furthermore, the RobinsonPatman Price Discrimination Act of 1936 focused on the elimination of monopolies in wholesale trade and required that: "It shall be unlawful for any person engaged in commerce, in the course of such commerce, either directly or indirectly, to discriminate in price between different purchasers of commodities of like grade and quality, where the effect of such discrimination may be substantially to lessen competition or tend to create a monopoly in any line of commerce... Provided that nothing shall prevent differentials which make only due allowance for differences in the cost of manufacture, sale, or delivery." (United States Code, 1936) Legislation in the US also prevents charging different prices on the basis of race or religion. However, courts have allowed application of different prices in such cases as men being charged a higher rate for car insurance than women. The justification has been the fact that women have better driving records and therefore lower insurance cost than men. Not all price differences on e-commerce sites may be attributed to conscious efforts at price discrimination by the firms and therefore have no such legal obstacles. A study by the Wall Street Journal finds that some websites may change prices randomly for the same customer multiple times over the course of a day (Angwin and Mattioli, 2012). Figure 3 presents the pattern of pricing for the same product - a high-end microwave oven - at three popular websites over one day that was discovered in the study. One rationale behind this pricing strategy is that the unpredictability of price changes makes it less advantageous for the customers to delay their purchase as the price may increase at any moment.

Lee's Teas' Dilemma

Jason came to the realization that the variety of pricing practices in the online environment creates both challenges and exciting opportunities for consumers and firms. He saw the ubiquity of online price discrimination examples as an indication that such practices are effective, or at least promising, in boosting sellers' profits. One thing Jason didn't want to do, however, is alienate his present and potential customers. Not surprisingly, consumer advocates have long protested price discrimination by online stores. In one highly publicized case, Amazon.com upset its customers with a policy that used buyer profiles to charge different prices for the same DVDs. The resulting customer outrage prompted Amazon.com CEO Jeff Bezos to apologize and characterize the pricing differences as an internal research program in which consumers were shown different prices for identical products. He called the experiment a "mistake." (Dworkin, 2014) The growth in the specialty tea market brings increased demand from various groups of customers - millennials attracted by the organic properties of tea, baby-boomers interested in the health benefits, as well as the traditional tea drinkers brought up within the tea culture. With the growth in the industry comes increased competition from larger firms such as Teavana, and from online sellers all over the nation. Should Jason experiment with his pricing strategy and if so, how should he proceed to help sustain the success of his business?

CASE QUESTIONS 1.

1. What are the conditions for a successful implementation of price discrimination? In your opinion, can price discrimination help increase Jason's profits? Why or why not?

2. Which of the companies mentioned in this case - Orbitz, Expedia, Hotels.com, Home Depot, Budget - actually uses price discrimination? Provide argumentation to support your opinion.

3. Should Jason experiment with first-degree price discrimination? Why or why not? Which type of price discrimination would you recommend Jason consider?

4. Do the Internet and e-commerce make the implementation of price discrimination easier or harder for sellers? Provide your argumentation.

5. When implementing price discrimination for Budget car rentals, for which customer groups would you charge higher prices and for which lower? What could be the rationale for the price differences reported in the case?

6. In your opinion, are price discrimination practices ethical? Is price discrimination good or bad for the society? Should it be illegal to engage in such practices? If Jason decides to go that route, should he alert his customers to the fact that he uses these practices?

7. If Jason uses price discrimination, what criteria do you recommend he uses to estimate his customers' willingness to pay?

8. The case mentions frequent flyer programs. What is the rationale for the firms to offer such programs? Would you recommend Jason to implement a similar scheme?