30 October 2021
Price discrimination is a pricing strategy where identical products or services are sold to different market segments or individual customers at different prices.
Common examples of price discrimination are...
- Offering different pricing for a seat in a cinema based on age (Children, Adults, and Seniors).
- In public transport: ticket prices are frequently priced differently for commuters, students, seniors, and time of day or day of week.
- Software vendors often have different rates for business, home users, government, and education.
- Self-employed house cleaners will often adjust their hourly rates depending on their perception of the customer's capacity to pay, charging people in wealthy suburbs higher rates than others. Trades people often adopt the same pricing strategy.
- In Australia, under the National Disability Insurance Scheme, some providers of allied health or medical services (for example physiotherapists) charge a higher price for NDIS funded customers than normal consumers (because "the government is paying"). Generally NDIS issues maximum fee schedules that it will fund for many services (for example a physiotherapy visit) but the provider may offer services to non-NDIS funded customers at more favorable rates if it perceives it has spare capacity that can only be filled by discounting. Of course a provider will charge the maximum published NDIS rate.
- In the crash repair industry, it was common for the repairer to ask "is this an insurance job?" Knowing that the customer wasn't paying they would routinely charge more or perform a more extensive repair. Realizing this, the insurance industry switched to arranging for three quotes itself choosing the lowest and eventually bought their own crash repair businesses (vertical integration).
- Price checks on the same basket of goods often reveals that pricing within the same supermarket chain varies from suburb to suburb. This is explained by the chains as simply the store manager exercising discretion in response to competition or clearing slow moving stock, however it is suspected that prices are set in response to the willingness of consumers to pay. Some socioeconomic groups are more price sensitive than others, and some categories or brands are in greater demand in different locations.
Three degrees of price discrimination
Various references talk about three types of price discrimination...
- First degree: the price is customized to EVERY customer i.e. no two customers pay the same price for exactly the same product. This is seen where each sale is negotiated and the sales person is balancing the probability of achieving each sale with maximising the profitability of each sale. This occurs in Yield Management particularly the sale of airline tickets where a computer algorithm determines the price offered based on a range of factors, but this is more properly called Yield Pricing because there is a maximum number of seats available on each flight. However, first degree price discrimination is also used when a firm bids for a contract (see low balling) and to some degree is also present in relationship pricing. However, in these last two examples, the product is not exactly the same - it is highly customized.
- Second degree: The price varies with some other factor such as sales volume (price volume breaks), delivery deadline etc. In other words a more favorable (lower) unit price is offered to customers if they meet certain criteria. In second degree discriminatory pricing all buyers are offered the same opportunity to select more favorable pricing by agreeing to the sale terms.
- Third degree pricing: Different pricing is offered to different customer segments. This is most often seen in public transport or public performances (theatre or cinema) where different ticket pricing is offered to children, adults, families, pensioners etc.
Price discrimination works best if...
- The seller gains from adopting the strategy. Normally, it aids in maximizing sales yield; capacity is sold first to those who are prepared to pay higher, and then offered to those who can't pay the higher price next.
- The buyers do not communicate with each other and have no opportunity to compare the prices they are paying for the same product or service from the same vendor.
- There is little opportunity for one customer segment profiting by reselling the product at a profit to another customer segment thus becoming a competitor.
The disadvantages of price discrimination are...
- The damage to brand reputation when one customer discovers another customer being charged less for exactly the same product or service.
- The additional administrative workload that may be required to ensure customers are honest about their personal criteria that qualifies them for the lower price.
- Losing market share through inadequately communicating to customer segments they qualify for a lower price tier.
Other pricing strategies:
Pricing strategy overview: