The effect of demand variability on the adoption and design of a third party’s pricing algorithm

Abstract

Consider a data analytics company supplying a pricing algorithm that adjusts price to a changing demand state. For this setting, I show the pricing algorithm is designed and priced so that higher demand variability results in more firms adopting the pricing algorithm. Furthermore, there is a critical threshold for demand variability whereby there is complete or near-complete adoption of the pricing algorithm. While widespread adoption of a third party’s pricing algorithm among competitors has raised concerns of collusive conduct, it could instead reflect a strong efficiency delivered by a third party.