When it’s ok to Discriminate
No, this isn’t a message on behalf of one of the political parties. This is about something called ‘price discrimination’ as it applies to both commercial and consumer markets.
Let’s start with a definition: price discrimination, a fundamental concept in pricing theory, refers to the strategy of charging different prices to different customers based on their willingness and ability to pay.
I have a couple of problems with that. First, I hate the term ‘price discrimination’. The very word ‘discrimination’ is highly negative, and this can be a positive way to present different prices. I would much rather this had been called ‘selective pricing’ or ‘price differentiation’.
Second, saying it is about charging different customers different prices based on their willingness or their ability to pay makes this sound highly unethical, when in fact there are many ethical and rational reasons to charge different prices.
A more nuanced definition of price discrimination is that it involves creating slightly different product or service solutions tailored to various customer segments and pricing these solutions differently based on the distinct value they offer and the varying costs associated with delivering them.
Let’s look at commercial (or B2B) markets first.
The most obvious price discrimination method is volume discounts. The more you buy, the less you pay. And this is where the ethics of pricing comes in. Selling in larger volumes means lower handling costs, lower carriage costs, and probably lower input costs because the business is buying components or goods themselves in higher quantities. Some of those cost savings can be passed on to the customer, while at the same time the business can sell at higher margins. That’s a win-win – the business makes more money, and the customer buys the goods for lower per-unit prices.
Examples of B2B price discrimination include:
1. Volume Discounts: Offering lower prices per unit for customers who purchase in larger quantities, as we’ve just discussed.
2. Tiered Pricing for SaaS: Software companies often offer different pricing tiers based on features and the size of the business. Small businesses might pay £20 per month for basic features, medium-sized businesses £50 per month for additional features, and large enterprises £100 per month for comprehensive access and premium support.
3. Geographical Pricing: Charging different prices based on the customer's location. This can account for variations in local market conditions, competition, and cost of living.
4. Contract Pricing: Customising prices for long-term contracts. For example, a company might offer a discount to businesses that commit to a three-year contract compared to a one-year contract.
5. Customer Loyalty Programs: Providing discounts or rewards to repeat customers. This encourages long-term business relationships and increases customer retention.
6. Seasonal Pricing: Adjusting prices based on the time of year or season. Such demand smoothing helps to reduce costs (assets are better utilised, reducing demand peaks also reduces the need to hire temporary labour, which generally increases costs and can impact quality).
7. Payment Terms: Offering discounts for early payments. For example, a 2% discount if the invoice is paid within 10 days, encouraging quicker payment and improving cash flow.
8. Retainer: Usually applies to services, and means the clients knows they have access to expertise and advice whenever needed; and in return the provider gets regular repeat income, so can reduce prices.
Typically, the methods businesses use to find ways to create different price solutions for customers break down into:
Cost savings (volume discounts; geographic pricing)
Cash management (seasonal pricing; payment terms)
Usage (SaaS type tiers; customer loyalty)
Certainty (contract; retainer)
Why bother looking at whether the are elements of price discrimination that you can apply to your business? The pros and cons are:
Pros:
Increased Revenue: By capturing more consumer surplus, businesses can significantly boost their revenue.
Better Customer Segmentation: Allows businesses to cater to different segments more effectively, and this links back to increased revenue – capturing more segments means greater market share.
Enhanced Customer Relationships: Tailored pricing can improve customer satisfaction and loyalty, and can increase switching costs for customers.
Optimised Resource Utilisation: Helps in managing demand and production more efficiently.
Cons:
Complexity: Implementing and managing multiple pricing strategies can be complex and resource-intensive.
Customer Perception: Some customers might perceive price discrimination as unfair, leading to dissatisfaction (so remember the golden rule – do this ethically, and create price alternatives based on genuine value delivered).
Legal and Ethical Concerns: In some jurisdictions, price discrimination can raise legal issues, particularly if it leads to anti-competitive practices.
Perhaps you want to improve your market share by having segmented offers at prices relevant to the segment; perhaps you want to demand smooth. Whatever your reason for wanting to consider price discrimination, how do you go about it?
First, understand your customer segments. Conduct thorough market research to identify and understand each different customer segment, what their needs are, how those needs translate into value, and their willingness to pay.
Then plan how this will be communicated. If your prices are transparent (perhaps published on a website) then ensure that the rationale behind different prices is clear to avoid misunderstandings and resentment.
Next, use technology wherever you can. Automate and systemise using pricing software and data analytics. This helps to manage complexity and reduces human error.
Finally, monitor and adjust. Continuously review the effectiveness of your pricing strategies and be ready to make adjustments based on market feedback and performance metrics.
How does price discrimination work in consumer (B2C) markets?
Coca Cola is a master at price discrimination, and came up with an acronym for their methodology – OBPPC: Occasion, Brand, Price, Package and Channel. This is also called Price Pack Architecture. It’s a way to stimulate your thinking – for example, are there different pack sizes we could offer for different occasions, such as small sizes for lunch packs or large sizes for parties; can we offer unbranded versions of our product for people on very tight budgets; or could we charge less for online sales vs prices in our shops?
And, just as with B2B markets, that’s the fundamental starting point to price discrimination – understanding the ways to offer different prices to different customers by creating solutions that are valued by each specific customer segment.
So what are some examples for consumer markets?
Package Sizes: Offering products in different sizes to cater to various needs. As we’ve mentioned, Coca Cola might sell small cans for lunch boxes, standard cans for regular use, and large bottles for families or parties.
Occasion-Based Packaging: Creating special packaging for holidays and events such as Christmas, birthdays, and anniversaries.
Brand Variants: Developing sub-brands to target different customer segments. For example, a fashion brand might have a premium line for high-income consumers and an affordable line for price-sensitive customers. Brand variants can also focus on different needs – for example, Procter & Gamble offer four different fabric detergents in the UK (Ariel, Bold, Fairy, Daz) which satisfy different requirements (e.g. softness vs whiteness) and which occupy different places on the spectrum from premium to budget.
Channel Pricing: Charging different prices depending on the sales channel. Online stores might offer lower prices compared to physical stores due to lower overhead costs.
Coupons and Discounts: Offering discounts through coupons, loyalty programs, and special promotions to attract price-sensitive customers while maintaining higher prices for those willing to pay more.
Dynamic Pricing: Adjusting prices in real-time based on demand and supply conditions. This is commonly used in industries like airlines, hotels, and ride-sharing services.
Membership Pricing: Providing discounted rates to members or subscribers. For instance, supermarkets often offer exclusive discounts to loyalty cardholders.
Extended Life: Resealable packs mean that customers are inclined to buy larger packs because contents will last longer.
Eco Sustainable Options: This is linked to smaller packs for convenience, but the underlying value for the consumer is different – this is about being environmentally aware. Smaller packs mean less waste for smaller families or single people; recyclable or reusable packs are better for the planet.
Premium Sizing: Sometimes a premium option can seem too expensive – for example, six packs of regular beer might be priced similarly, but a premium craft beer might be much more expensive if buying 6 cans or bottles; so they are offered as a four pack instead, and although the contents are less the buying price for the pack is then similar.
Just as with B2B markets, there are pros and cons to price discrimination in consumer markets.
Pros:
Maximised Profits: Because businesses can capture a larger share of the market.
Customer Satisfaction: Tailored pricing can meet diverse customer needs and enhance satisfaction.
Cons:
Customer Dissatisfaction: Consumers might feel exploited if they perceive pricing as unfair.
Managing Variety: Managing different prices for different segments can be logistically challenging. And managing the operations to carry a vastly larger range, possibly with different channels, can significantly add to costs.
Market Segmentation Risks: Incorrectly identifying or segmenting the market can lead to lost sales and customer alienation.
And like B2B, there are some steps to go through when approaching price discrimination.
First, undertake detailed research to understand consumer behaviour, preferences, perceived value, and price sensitivity.
Next, ensure that the value differences between product versions are clear to justify the price variations. Remember, it’s never the customer’s job to work out what value they get from a product or service – it’s always your job to be blindingly clear about the value they will get.
Then plan your pricing models. Where possible, automate as much as possible, and use technology to implement and adjust pricing strategies dynamically based on market conditions.
Finally, monitor your competitors. In consumer markets prices tend to be much more transparent. Keep an eye on competitor pricing strategies to ensure your pricing remains competitive.
As a closing thought, remember that price discrimination is not inherently exploitative or unethical. As long as you deliver real value to justify the price difference, and you clearly communicate that value, you will be fine.