As a pricing strategy price discrimination tries to address the fact people assign different values to a product and better align prices with those values in order to maximize profits.
Imagine a company that creates a new product at a cost of $40. They do some research and see that people are prepared to pay between $50 and $100 for it. If they price it at $50 they will sell the greatest quantity, but they will also be “leaving money on the table” because there was a large group of people that were prepared to pay more, sometimes much more. That potential profit is never realized if they sell at a lower price.
If on the other had they sold it at $100 they would have much fewer but far more profitable sales. The people that placed a very high value on the product would pay the $100, and the company would make a great profit on each of those sales, but they would be missing out on a great many still profitable sales at lower prices.
What about a compromise? If the company sold the product at $75 it still doesn’t solve the problem. Anyone who assigned a value of less than $75 doesn’t buy it, and the company misses out on sales that could have been profitable. The customers that were prepared to pay more than $75 enjoy a savings they never asked for and the company misses out on that extra profit.
Price discrimination attempts to sell to each of those customers at the value they assign to the product.
1st Degree Price Differentiation
Also called one-to-one pricing this involves selling to each customer at a different price. If perfectly implemented this would result in perfect price discrimination, which means the price each customer pays is maximized.
One example would be buying a used car (where there is no absolute reference price) from a skilled salesperson (who was good at determining the value the customer really placed on the vehicle). If middle aged customer walked into the dealership and started off by explaining that they were driving by and saw the very same car they had always wanted, but not been able to afford, in high school the salesperson can assume they will place a high value on the vehicle and price it (or negotiate) accordingly.
Another example would be a bride looking at banquet rooms. If she explained that she just needed a place somewhere in the city she likely places a lower value on any one particular facility and the salesperson should price accordingly. If on the other hand the bride explained that she absolutely needed to be married in the same facility as her mother, sister, friend, etc. she likely places a much higher value on that venue, and the salesperson will probably be looking for a higher price.
Perfect price discrimination is very difficult to achieve because there is no way of knowing exactly how someone values something or what they are prepared to pay. And, in general, 1st degree or one-to-one pricing is very difficult to implement unless there will be some kind of one-on-one discovery and negotiation – something that is almost impossible online or in most kinds of retail.
Almost all other approaches to price discrimination involve streaming customers using a variety of tactics including but not limited to:
Hurdles involves making a customer prove they are serious about having a lower valuation by making them jump over a figurative hurdle to get a lower price.
Coupons & Rebates
A coupon or rebate lets someone who is serious about getting a discount save money, while those who are less focussed on price won’t bother. The end result is the ability to pay one of two different prices based on how serious the customer is about saving money.
Restaurants use this kind of special to offer discounts at a time when most people don’t want to eat. You can get a discount, but only if you are prepared to eat dinner at 4:30 PM – a hurdle most people won’t jump if they are willing to pay full price
Black Friday, Boxing Day & Midnight Madness Sales
The hurdle here is an unpleasant shopping experience – crowds, long lines and sometimes weird hours. Only those truly committed to saving money will make the effort, those willing to pay full price will choose the more civilized shopping experience instead.
Same Day Discounts
Someone who plans a trip to New York to see a couple of Broadway Shows clearly places a high value on the experience and is likely to pay full price. A local, who can go to a show anytime, is willing to face a hurdle in the form of uncertainty and buy from the discounted same-day ticket booth.
When a product attribute changes things can get fuzzy… is it really the same product at a different price or a different product altogether. Sometimes though the product attribute in question can be so inconsequential to the true value of the product that it is really a hurdle. In some circumstances something as simple as color can be a hurdle – people can save money if they buy the “ugly” color of a product where color really doesn’t matter.
Demographics & Affiliations
Assumptions about the willingness of someone’s willingness to pay can sometimes be made by looking at their age, profile or affiliations.
Senior Discounts & Special Pricing
Seniors are generally assumed to more sensitive to price and have a lower willingness to pay. This can be a combination of a fixed income and having seen a lifetime of inflation – it’s hard to justify paying almost $20 to see a move when you can remember paying less than a dollar. Kids on the other
Students tend to have less money and ability to pay so student discounts, offered upon presentation of a student card, are used to offset this.
Automobile & Discount Clubs
It is generally accepted that membership in an auto club like AAA or CAA denotes thriftiness – that the people who join those clubs are very serious about saving money. With that in mind many business will offer discounts to cardholders. Members of Costco or Sam’s Club are also serious about saving money, and some independent businesses have started offering discounts to customers that present those cards.
Women pay more for haircuts and dry-cleaning because they tend to place a higher value on those products. On the other hand they benefit from free or discounted drinks and cover charges on ladies night, where men are willing to pay higher prices.