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Differential Pricing Strategy: What It Is and How to Use It Effectively

By Priceva
on August 1, 2022
Regardless of the market, customers have different pricing expectations and purchasing power. If a company wants to sell its products to several market segments, it is crucial to deliver a fair cost for as many people as possible. This can be achieved with a differential pricing strategy.

In this guide, you will find out how this pricing model works, learn about the ways to segment your audience and introduce pricing mechanics, and discover its pros and cons. In the end, we will provide a few guidelines for increasing the efficiency of differential pricing.

What is Differential Pricing?

A differential pricing approach is based on charging diverse prices for several groups of customers. This strategy aims at customizing the price for each buyer depending on their characteristics (purchase profile, connection to brand, or behavior). Also, differential pricing can be based on situational factors, such as timing, demand, and the competition.

The major goal of this strategy is to adapt to consumers’ needs and pricing expectations in order to attract buyers, plus increase sales volume and profit margin. Every customer has particular quality requirements and pricing expectations, and differential pricing allows matching the product value with its cost in consumers’ eyes. Optimal pricing can accelerate the decision-making process and encourage buyers to make a purchase.

Types of Differential Pricing

Differential pricing can be provided in a multitude of ways:

  1. Lower price for certain groups of people. For example, museums often provide free or low-cost admissions for students. Bookstores offer discounts for students, teachers and librarians.
  2. Bundling or bulk discounting. When someone makes a purchase of several units, they can be provided with a rebate.
  3. Coupons and discounts. In e-commerce, they are distributed on partners’ websites or given to customers after making an order.

Differential Pricing vs. Dynamic Pricing

This is not the same thing, because differential pricing can be viewed as part of a dynamic pricing strategy. Differential pricing is based on customer profile and buying behavior, while dynamic pricing is related to market conditions. Differential pricing is a more narrowly focused approach because you cater to your audience’s needs instead of following general price trends.

Dynamic pricing requires more frequent price changes because rates can fluctuate every day, hour or minute. Differential pricing allows setting prices for longer terms, however, a business will still need to keep an eye on competitors and be able to adjust.

How to Perform Segmentation

At first glance, it may seem that differential pricing is based on customers’ willingness to pay. However, this is a more complex approach, and the cost of products should be based on product attributes, buyers’ behavior, competition on the market, and many other aspects.

The list of segmentation criteria includes, but is not limited to:

  • Customer groups. Clients can be divided into segments with the help of loyalty programs, where regular buyers are offered bigger discounts.
  • Brand image. The same company may have a different reputation in certain countries, so it will need to adjust pricing in order to penetrate markets.
  • Product options. A single product may be available in different variations — one is more popular than another. In this case, the most highly demanded item will be more expensive.
  • Geography. A company can charge more or less for a product in certain locations because of such factors as competition, buyers’ average income, cost of marketing, transportation expenses, and so on. This is a common approach for international retailers.
  • Season/timing. During a peak season, some products become cheaper because the supply is bigger than the demand — fruits and vegetables are a good example. In some industries, retailers do the opposite. For instance, clothing stores charge more for swimwear in summer while the demand is high, and provide discounts on winter clothing in order to liquidate the stock from previous collections.

When you are analyzing your customers in a more personal way, you need to study the following:
  • Find out your prospects’ needs, problems and wants.
  • Analyze their spending behavior, what products they like and dislike.
  • Study their demographics and lifestyle.
  • When applicable, study the average check of each market segment.
  • Consider the potential risks that price changes can pose.

Advantages of Differential Pricing

Price management is essential because it allows you to reach target market segments and helps to define your product value. Let us observe the major benefits of differential pricing for online retailers – this strategy comes with a large number of perks.

More Target Market Segments Reached

With the help of differential pricing, you can reach a wider number of people because you offer relevant prices to every market segment you work with. This strategy enables you to extend your customer base and sell more items from your assortment.

Increase in Revenue

As a logical result of point 1, your revenue can grow exponentially. By being able to deliver fair-priced services or products to all targeted market segments, you decrease churn rate and improve profit margin. Differential pricing is a chance to allow as many customers as possible to try the product at an affordable price.

Cost Management

To manufacture a product or develop a service, a company needs to invest a certain amount of time and resources. On top of that, the cost of a unit includes transportation and other expenditures. In order to cover all these expenses, a company needs to come up with an optimal price that meets both customers’ expectations and the business’s revenue goals.

Not everyone can afford to pay the same price for a product. Thanks to differential pricing, people have the opportunity to make a purchase at an agreeable rate. That allows a company to reap maximum benefits from increased sales volume — all that is left to do is calculate the speed and ease of cost covering. With a differential pricing strategy, the same product or service sold at a higher price can recoup the losses of selling it at a low price.

Faster Product Turnover

When products remain on shelves for a long time, they can expire or lose their quality. The longer they stay in a warehouse, the harder they are to sell. This problem is particularly significant for businesses that sell perishable goods, but is also relevant for service providers (for example, when they offer flight or theater tickets). By introducing different prices, you can sell your products faster and make sure that your budget is fulfilled, so you can produce more.
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Disadvantages of Differential Pricing

Sometimes, differential pricing is not a win-win solution — a company puts its revenue at risk when it targets price-sensitive market segments. Here are a few drawbacks of this strategy that may compromise the success of your pricing efforts.

Loss of Revenue

While differential pricing allows you to get a wider exposure for your items, it may come at the cost of revenue because you will not receive the regular amount you usually charge. When you are offering discounts on a continuous basis, your profits decrease over time. If prices eventually return to the usual level, some people will no longer be able to afford them. Hence, some buyers will enjoy your discounted product as long as it lasts, and switch to competitors once you charge the full price.

Fueling Competition

When it comes to trading physical products, someone who can purchase goods with a large discount can resell them at a higher price. That allows consumers to make profit on your product without your company generating income. Such buyers become direct competitors.

Limited Affordability

If you practice differential pricing with discounts or coupons, when prices get back to normal, you may lose a share of customers, to be more precise – the ones who were attracted to your low prices but cannot afford to pay the full cost.

How to Develop a Solid Differential Pricing Strategy

First, we should mention that many companies have concerns about the efficiency of pricing differentiation — they are not sure if this strategy will fit their format of business. In fact, you can set various prices even for one and the same item. The cost can be lowered when you sell in bulk or increased when you deliver extra services.

How can you craft a differential pricing strategy that generates maximum benefits for your brand? Here are a few guidelines to follow:
  1. Segment your audience correctly. We have already mentioned the ways to profile your customers. You can also try the rate fence method — it allows buyers to segment themselves into appropriate categories.
  2. Understand whether your products have elastic or inelastic demand. That will help you define to what extent prices can be corrected.
  3. Research the market and keep your rates competitive. To streamline the repricing process, you can leverage automatic price tracking and price optimization tools by Priceva. This software allows you to monitor the market and correct your prices as frequently as you need.

Conclusion

Although differential pricing requires a lot of time for meticulous market research, this strategy can be very fruitful in terms of revenue and market outreach. There are different ways to implement this pricing approach, so your business can figure out a suitable one. If you have not had success with other pricing strategies, this option might be just right for you.

FAQ

Why is differential pricing used?

This pricing strategy allows a company to reach different market segments by providing more personalized rates. One and the same product can be delivered at different quotes, which allows a business to reap maximum profit from each target group.

Is differential pricing legal?

Generally, this is a legal practice in both e-commerce and offline retail industries.

Why is differential pricing important?

This pricing strategy can be very useful for any company because it encourages thorough research of the target audience. A business that knows its customer persona can appeal to the right needs and requirements: this is a win-win scenario because everyone benefits. The company increases sales volumes, and customers can enjoy a good deal.

What is the difference between single pricing and differential pricing?

With single pricing, every customer has to buy a product at the same price, which means not everyone can afford it. Differential pricing involves selling cheaper to price-sensitive buyers and charging more for upper customer segments. Thus, a company ensures that a higher number of potential consumers will be able to buy goods.

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