Economics of Privacy in the Future Internet Competition in Markets for Personal Information Future Internet Assembly, Budapest, May 2011 Dr. Nicola Jentzsch DIW Berlin

2 Disclaimer: Privacy is a human right. Thinking about it in economic terms does not change this basic fact.

Definition. Privacy is a state of asymmetric distribution of personal information among market participants. Private information – Information that is not common knowledge. This must not necessarily be personal information. Personal information – Information that is associated with an identifiable individual. This must not necessarily be private information.

I. Conditions for Existence of Personal Information Markets Conditions for information markets Mechanism design II. Consumer Choice Valuation of personal information III. Competition in Markets for Personal Information Competition strategies Customer lock-in 4

Conditions for Existence for Personal Information Markets 1. Property rights to personal information To commodify personal information, property rights must be specified 2. Infrastructure Technical or other infrastructure for transfer of personal data 3. Incentives to trade personal information Firms must have an incentive to collect and trade consumer profiles; consumers must have an incentive to disclose personal data I. Conditions for Information Markets

I. Property rights Bundles of rights define action space Bargaining power C C F F TP C C F F Without commitment With commitment  Compensation rules  Rent transfers  Externalities Conditions for Information Markets Conditions for Existence for Personal Information Markets Action

I. Insights from Economic Theory (Hermalin and Katz 2006) Firms offer products based upon consumers’ signal of type Two types of consumers (high, low), they signal Conditions for Information Markets (I) Firms hold PR > Can compel consumers to disclose signal > All consumers disclose signal (II) Consumers hold PR > Firms write incentive-compatible offers > Consumer decide whether to reveal > High type disclose signal Conditions for Existence for Personal Information Markets

I. Mechanism Design Social exchange Intermediation Direct sale Auctions Conditions for Existence for Personal Information Markets Ecosystem of exchange mechanisms

I. Mechanism Design Unclear definitions or imperfectly specified property rights lead to excessive trade of personal data Firms have an incentive to strategically impact on consumer foresight, shrouding their action options in privacy policies Lack of salience of information transaction exacerbates situation Consumers are unclear about their reservation price for their personal information Conditions for Existence for Personal Information Markets Problems

Consumer Choice Valuation of personal information II. Privacy calculus Benefits Costs v = valuation of good b = benefit from personal. p = price c = costs of data disclosure β = sensitivity re disclosure d = data set μ = probability of event Function maps betting preferences of individuals regarding uncertain outcomes

Consumer Choice Valuation of personal information II. Social comparison Anchoring at reference points Salience (priming) Firms have an incentive to influence comparison, referencing & salience, impacting on consumer foresight and utility Influences on privacy calculus

Competition in Markets for Personal Information Competition strategies III. Firms’ strategies change to:  Targeting with personalized offers  Behavior-based pricing  Social sorting (classification based upon similarities) Firms’ strategies as well as competition intensity and distribution of social welfare. Compilations of consumer profiles impact on:

Competition in Markets for Personal Information Competition strategies (Lee et al. 2005) III. Differentiated duopoly Consumers have heterogeneous privacy concerns (high/0 costs) Privacy-unconcerned (λ) choose personalized offers All others receive uniform offers from A, B Outcome: Firms set high prices for personalized offers (low for standard) Prices rise, if segment with unconcerned consumers increases Price competition intensifies with more anonymous consumers AB

Competition in Markets for Personal Information Customer lock-in III. Personalization increases fit with consumer preferences Decreases willingness-to-switch (loyalty) Endogenous: function of 1 st -period purchase, i.e. transportation costs & lost benefits (Pazgal & Soberman 2008) Exogenous: function of network effects Firms use euphemistic language to shroud lock-in effects Salience on benefits and not on less obvious lock-in effects If personalization costs outweigh benefits, sophisticated consumers will strategically invest in anonymity.

Competition in Markets for Personal Information ENISA P/34/10/TCD Project An Economic Model for the Pricing of Personal Information III. Question: What’s personal information worth to consumers and does disclosure of personal data produce lock-in? Duopoly model with privacy-heterogeneous consumers - Static and dynamic model Behavioral experiment with real economic transactions: - Implementation in the lab (website) - Implementation as field experiment (website) Final results expected in September 2011.

Vielen Dank für Ihre Aufmerksamkeit. DIW Berlin — Deutsches Institut für Wirtschaftsforschung e.V. Mohrenstraße 58, Berlin Redaktion