Should your firm target your competitors' customers with lower prices than the competition charges them? When might it make sense, instead, to offer discounts to your own customers? Under what conditions might this sort of approach -- known as "targeted pricing" -- backfire by driving everyone's prices down too far?

Once widely hailed as a panacea, "targeted pricing" has also been condemned by many as a potential road to ruin. But is "targeted pricing" really either a panacea or a peril? Recent research by Wharton marketing professor Z. John Zhang and several colleagues examines the complex dimensions of "targeted pricing" and suggests that while this approach isn't for everyone, it can be an effective tool under the right circumstances. Zhang and his colleagues also lay out guidelines to help companies understand when "targeted pricing" might play an effective role in their marketing strategy.

Why has "targeted pricing" attracted so much attention among consumer marketers? According to Zhang, the reason is that targeted pricing allows firms to sidestep the inherent drawback of classical, uniform pricing. As Zhang noted during a recent presentation, "With uniform pricing, a firm always faces the tradeoff between 'money left on the table' and 'foregone profit.' [That is,] it has to go for either volume or margin, and therefore cannot capture all the value it has created in the market."

Targeted pricing, in contrast, allows firms to "charge lower prices to new customers without giving discounts to those who do not need any inducement to purchase from the firm," says Zhang. "Big firms with large market share really value the flexibility of targeted pricing because it allows them to act like niche companies. Who wouldn't want the incremental sales?"

The good news is, targeted promotions are now possible because, as Greg Shaffer, a professor at the William E. Simon Graduate School of Business, and Zhang recently wrote in a paper entitled "Competitive One-to-One Solutions," "consumers are individually addressable and firms know something about each customers' preferences." For the first time in history, marketers can easily collect an enormous amount of data about individual consumers, and mine that data quickly to understand preferences and buying behavior. They can automate a process of making "dynamic one-to-one" promotions that zero in on preferences, and change as customers' needs are changing.

Why then has "targeted pricing" become so controversial? The bad news for marketers is that data processing is a two-way street. Also for the first time in history, customers can easily collect an enormous amount of data about pricing offers of various companies with products or services that interest them. This extra layer of knowledge can lead to all sorts of changes in the way customers respond to promotions.

Zhang's research probes the complex, unintended pitfalls of "targeted pricing" in the fast-moving Internet age. Using a combination of game theory and behavioral experiments, Zhang's statistical analysis shows how and when "targeted pricing" can provoke strong feelings of "betrayal" and "jealousy" among loyal customers who feel left out of pricing promotions given to new customers. In those experiments, Zhang's team designed behavioral scenarios of target-pricing scenarios and surveyed the responses of students to various possibilities.