The term “price discrimination” refers to the strategy of selling the same product to different buyers at different prices. Businesses engaged in a pure form of price discrimination may interact with each customer, charging them the maximum they are likely to be willing to pay. More commonly, price discrimination involves placing customers into individually defined groups according to such factors as age, sex, occupation, location and others, setting prices for each group to earn the maximum profit. To explore this concept, consider the following price discrimination definition.
Definition of Price Discrimination
- The practice of offering identical merchandise, which has been obtained at the same cost, to different buyers at different prices.
Types of Price Discrimination
Other terms used to describe different types of price discrimination, which date back to the 1920s, include “equity pricing,” “preferential pricing,” and “tiered pricing.” Modern terminology for such classifications runs toward first through third degree “price differentiation.”
First Degree Price Discrimination
Also known as “personalized pricing,” first degree price discrimination involves a practice of one-to-one marketing. This form of “perfect price discrimination” enables the business to obtain the maximum price each individual customer is willing to pay. In practice, this form is rare, as there is no reliable way to discover an individual’s precise willingness and ability to pay.
Second Degree Price Discrimination
Second degree pricing discrimination is also referred to as “product versioning.” Versioning refers to the practice of creating or offering the same product in slightly different quantities, or slightly different products for the purpose of charging different prices. For example, a smartphone in basic black may be offered at one price, while the provider offers attractive colors such as pink, blue, and lemon-lime, at a higher price. Menu pricing is another form of versioning.
Third Degree Price Discrimination
Third degree price discrimination refers to “group pricing,” in which the business divides the market into segments or groups, charging different prices to each group. While, in many cases, this is done covertly, group pricing is also seen when businesses openly provide discounts to various groups, including “seniors,” “students,” and “veterans.” Even such common practices as charging different amounts for adult and child theater-goers, or offering separate senior and child menus at a restaurant, fall under the category of group pricing. Third degree price discrimination is the most commonly used method of price differentiation.
A Combination of Methods
The various types of price discrimination are not mutually exclusive, which means that many companies combine the methods that best suit their needs. For example, a retailer may offer different pricing by location, as well as offering discounts for bulk purchases. Airlines and cruise ship operators offer incentive discounts for travel agents and corporate buyers to increase sales volumes, as well as offering seasonal discounts, discounts based on dates of purchase, and discounts based on location of departure and destination. All of these discounts are carefully choreographed to increase sales among sectors that would otherwise lag behind.
Requirements for Successful Price Discrimination
For a company to successfully use price discrimination to increase their profitable margin, certain market conditions must exist:
- Identification of Market Segments – the company must be able to determine market segments as they apply to the company’s business.
- Elasticity of Price Across Segments – the difference between prices according to quantity demand.
- Market Segments Must Remain Separate – market categories for which different prices are charged must be kept separate, whether by physical distance, time, or nature of use.
- No Seepage Between Markets – consumers must be prevented from purchasing the product at the lower price offered to one segment, then reselling at a higher price to consumers in another submarket.
- Monopoly to Some Degree – The company must have a monopoly on the product or service it is offering, otherwise when the company tried to sell the same goods at different prices, buyers would migrate to another business offering the same or similar products.
Consumer-Driven Price Differential
In modern society, a phenomenon exists in which price discrimination is seen between goods that appear to be substantially the same. For example, a product referred to as a “cappuccino” brings a substantially higher price than coffee with cream. Such a differentiation cannot explained by higher costs of production or procurement, and so appears to be without purpose. Economists have expressed the opinion that this form of price differentiation serves as a way for consumers to show their willingness to pay higher prices for products that may appear to be luxuries.
Effects of Price Discrimination
While, on the surface, price discrimination may sound negative, the actual effects of price discrimination are not all bad. Price discrimination often refers to the practice of certain businesses charging different prices to various consumers, based on their sensitivity to price levels, and on their willingness to pay more. This generally results in the generation of a larger income by the company, and enables more people to afford to buy the goods or services offered. For example:
- Gas stations charge different prices in different areas, based on relative demand, and relative ability to pay.
- Movie theater prices vary, based on the location of the theater, and the age of theater-goers. Seniors and children are charged less, as they are more sensitive to price changes. As a result, the theater enjoys increased ticket and concession sales, and more consumers enjoy the big-screen movies.
- Grocery store discounts for quantity or bulk purchases target large families, offering such deals as “buy one, get one free” on gallons of milk. A family with four children benefits from the resulting lower per-gallon price, while a small family, or couple with no children, would not even consider buying milk two gallons at a time.
Related Legal Terms and Issues
- Market Segment – An identifiable group of individuals, businesses, or organizations, the members of which share certain characteristics or needs.
- Monopoly – Complete control over an entire supply of goods or services in a particular area; the market condition that exists when there is only one provider of specific goods or services.
- Profit Margin – A measure of a company’s profitability, and determining the relationship of gross profits to net sales.