Online cash-back shopping: Implications for consumers and e-businesses

Through reimbursing a portion of the transactional amount to some consumers in a form of cash back, merchants are able to exercise third-degree price discrimination by offering two asymmetric prices via an online dual channel. To better understand such a novel pricing mechanism, we develop a game theoretical model and start our analyses with a market consisting of one merchant, one affiliate site, and consumers heterogeneous in their product valuation. From a price point of view, cash-back shopping appears to provide site users with a saving opportunity since the effective post-cash-back price they pay is perceived to be lower than the regular price targeted at nonusers. However, we find that under some conditions, this seemingly lower price could be actually higher, compared with the optimal uniform price when the merchant does not price discriminate. An important implication is that all consumers may end up suffering from higher prices in the presence of the cash-back mechanism. This surprising result, referred to as the cash-back paradox, defies a common intuition that a price-discriminating firm must raise the price for one segment of consumers but decrease it for the other. We also develop two extensions to seek explanations behind various industry practices.We find that it is in a merchant's best interest to affiliate with multiple sites, and the resulting competition improves overall market efficiency. Moreover, merchants who are disadvantageous in brand valuation should target price-sensitive consumers by strategically offering cash-back deals. Our results, consistent with several real-world observations, have useful implications for marketers.