  The emerging marketplace for online free services in which service providers
earn revenue from using consumer data in direct and indirect ways has lead to
significant privacy concerns. This leads to the following question: can the
online marketplace sustain multiple service providers (SPs) that offer
privacy-differentiated free services? This paper studies the problem of market
segmentation for the free online services market by augmenting the classical
Hotelling model for market segmentation analysis to include the fact that for
the free services market, a consumer values service not in monetized terms but
by its quality of service (QoS) and that the differentiator of services is not
product price but the privacy risk advertised by a SP. Building upon the
Hotelling model, this paper presents a parametrized model for SP profit and
consumer valuation of service for both the two- and multi-SP problems to show
that: (i) when consumers place a high value on privacy, it leads to a lower use
of private data by SPs (i.e., their advertised privacy risk reduces), and thus,
SPs compete on the QoS; (ii) SPs that are capable of differentiating on
services that do not directly target consumers gain larger market share; and
(iii) a higher valuation of privacy by consumers forces SPs with smaller
untargeted revenue to offer lower privacy risk to attract more consumers. The
work also illustrates the market segmentation problem for more than two SPs and
highlights the instability of such markets.
