On an earnings call with investors in July, Delta Air Lines president Glen Hauenstein praised a new pricing scheme the company was testing with help from artificial intelligence.

This approach, called “personalized pricing,” lets companies set prices based on what each customer is willing to pay. Using AI and algorithms to quickly process data and adjust prices, Delta ran a pilot program where three per cent of ticket payments were personalized.

Hauenstein was upbeat about the profit potential. He said Delta planned to individualize 20 per cent of ticket prices by year’s end, calling it a “full re-engineering of how we price and how we will be pricing in the future.”

Welcome to a new era of payment. Instead of charging everyone the same, companies can now tailor prices using such factors as perceived wealth, location, purchase history or online behaviour.

The idea isn’t new. Businesses have long dreamed of charging based on ability to pay, but mass-scale execution was hard. Now, with vast amounts of consumer data and the computing power of AI, it’s becoming easier, says Liyan Yang, professor of finance at the Rotman School of Management.

“Digital technology has allowed firms, particularly platform firms like Amazon and eBay, to tailor their prices,” he says.

Some examples in action: Dating app Tinder has charged older users more, assuming they have higher incomes than younger ones. Fintech lenders can check digital footprints to judge your ability to repay a loan. An iPhone user, for example, might be seen as wealthier than someone with a budget phone, Yang says.

Companies like personalized pricing’s profit potential. But Yang and fellow researcher Yan Xiong, a Rotman PhD graduate and now associate professor at Hong Kong University Business School, wanted to know how personalized pricing affected businesses and customers.

They built a theoretical model to explore what happens when companies use it in “network effect” markets – places where a product becomes more valuable as more people use it. Uber is a classic example: The more drivers and riders join, the better the service for everyone. Amazon, LinkedIn and airline booking sites also benefit from the network effect.

Their findings, published in the study “Personalized pricing, network effects, and commitment,” offer some warnings for businesses, especially in the digital economy.

The main lesson: Personalized pricing hurts profits in network-based markets. One reason is reduced price transparency. If customers learn they’re paying more than others, they may feel misled and lose trust, possibly walking away altogether.

Personalized pricing also tends to be opaque, with discounts only going to certain users. This slows down user growth, which is crucial for network businesses where value increases as more people join.

The result: “Consumers may be inclined to spend less,” Yang says.

What can firms do to overcome these obstacles? The researchers found that a firm can still successfully implement a personalized pricing strategy if it commits to lower prices overall.

This could mean lowering prices as part of a corporate social responsibility pledge to make products and services affordable for everyone. Another option is to introduce a price or margin cap, which Yang says can grow the firm’s network and therefore bolster overall profits.

To prove effective, however, “firms must publicize their commitment to lower prices,” he says.

Yang points to two Chinese companies. In 2018, smartphone maker Xiaomi Corp. pledged to cap its net profit margin on hardware sales at five per cent indefinitely, giving extra profits back to customers. More recently, online retailer JD.com committed to lower prices.

Lower price strategies work, Yang says, due to the network effect. When a firm commits to lower prices, more consumers will join, ultimately creating a more robust network and a greater willingness among consumers to pay for its products and services.

Even with potential safeguards against consumer backlash, there’s another reason to tread carefully: Regulators are taking notice. The European Union is considering restrictions on personalized pricing, while the U.S. Department of Transportation says it will investigate airlines that use personalized pricing.  

Why the concern? As Yang points out, personalized pricing is also known by another name. “It’s ‘discriminatory pricing’ because it discriminates against individuals,” he says. And that’s not something consumers will reward.