Cookies managing
We use cookies to provide the best site experience. More
Accept All
Cookie Settings
Cookies managing
Cookie Settings
Cookies necessary for the correct operation of the site are always enabled.
Other cookies are configurable.
Essential cookies
Always On. These cookies are essential so that you can use the website and use its functions. They cannot be turned off. They're set in response to requests made by you, such as setting your privacy preferences, logging in or filling in forms.
Analytics cookies
Disabled
These cookies collect information to help us understand how our Websites are being used or how effective our marketing campaigns are, or to help us customise our Websites for you. See a list of the analytics cookies we use here.
Advertising cookies
Disabled
These cookies provide advertising companies with information about your online activity to help them deliver more relevant online advertising to you or to limit how many times you see an ad. This information may be shared with other advertising companies. See a list of the advertising cookies we use here.

What Is Price Discrimination?

By Priceva
on January 25, 2022
When it comes to pricing strategies, personalization never hurts because it allows you to generate the maximum income from each particular buyer. A price discrimination strategy is a great option for businesses that want to scale their revenue and market coverage. This guide explains how this pricing approach works, shows different levels of price discrimination, and compares its pros and cons.

Understanding Price Discrimination

Price discrimination is the practice of charging different prices for the same product depending on the target group. This strategy is based on the seller's belief that certain groups of customers are ready to pay more or less depending on their demographics or how they evaluate the product quality.

Consumers’ ability to pay depends on the relative elasticity of demand for the product. Consumers in a relatively inelastic market can pay a higher price, while customers in a relatively elastic market expect to pay less.

What Are the Types of Price Discrimination?

Depending on the basis for price differentiation, the strategy can be implemented in different ways and degrees. Let’s check them out in detail.

First-Degree Price Discrimination

Also called perfect price discrimination, this means charging consumers the maximum price they can pay. Theoretically, it allows the retailer to maximize their profits. However, it’s hard to predict exactly how much consumers are ready to pay. For this reason, such a pricing strategy is rarely used.

Second-Degree Price Discrimination

This pricing strategy involves charging a different price depending on the quantity or amount. For example:

  • Mobile operators charge more for minutes used on top of a prepaid package.
  • Membership cards provide shoppers with discounts on future products.
  • Most brands use bundle pricing and allow consumers to purchase a certain amount of goods with a discount.

Third-Degree Price Discrimination

Also called group price discrimination, third-degree price discrimination implies charging different prices for particular market segments or groups of customers. As a rule, target groups have different demographic characteristics. For example, movie or museum tickets are sold at different prices for children, adults, and seniors.

Requirements for Successful Price Discrimination

A price discrimination strategy is not equally suitable for all businesses and retailers. There are several conditions that should be met for this pricing approach to work.

Imperfect Competition

As a rule, pricing discrimination is more efficient and successful when a company has some type of monopoly on a market. In case of perfect competition, this pricing strategy will not work because there will be less flexibility and opportunity to influence prices.

Market Segmentation

Segmenting the market is crucial for price discrimination to work. A retailer should be able to divide the market depending on certain factors, such as demographics (age, gender, etc.), geography, customer preferences, time, and so on. This division is helpful for dynamic pricing as well.

Note that market segments should not be mixed if your price discrimination is direct: customers will be frustrated, because some will end up paying more than others. Besides, you shouldn’t let one market seep into another because it would make resale possible.

Prevention of Resale

When a company offers bulk purchase discounts, it needs to ensure that buyers will not resell these items or services at a higher price. Otherwise, the original seller will start losing direct customers to resellers. Furthermore, some customers will have to pay a higher price for the same thing, which might cause frustration and affect brand loyalty.

Elasticity of Demand

For price discrimination to work properly, consumers should demonstrate different elasticities of demand. For example, low-income consumers are more elastic compared to higher market segments.

Price Discrimination Examples

A price discrimination strategy can be executed in different ways. Here are some examples that will help E-commerce projects make their pricing more flexible and effective.

Coupons

It’s safe to assume that customers who use coupons are more price-sensitive than those who don’t. By introducing coupons, a retailer can attract more buyers from lower market segments and sell at a higher price to upper market segments.

Premium Pricing

Premium products are sold far beyond their marginal value, and they can be offered not only by luxury brands. For example, clothing brands produce premium-quality clothes aside from their regular offerings, and charge different prices for them.

Retail Practices

Retailers use different incentives such as bulk selling, rebates, seasonal discounts, etc. It helps them attract more customers, get a bigger market share, or raise the profit on certain products.

Discounts for Certain Groups of Customers

Some businesses offer discounts for certain target groups, for example, seniors, veterans, large families, etc. This strategy can be useful if some of your customers are price-sensitive.

Advantages and Disadvantages of Price Discrimination

Price discrimination can be very effective in terms of boosting profit, but it comes with risks and might fail if it’s used in a very competitive market. Weigh its pros and cons before you decide whether it fits your business.

Advantages

Here are the major benefits of using a price discrimination strategy:

  • You can maximize your profit when a price is justified for specific market segments. The consumer surplus will generate more income.
  • You can scale your business, because you increase sales by attracting new consumers entering the market.
  • Efficient usage of space. Price discrimination can help you get rid of existing product stock. As a result, you can use your store, warehouse, and/or factory space more efficiently.
  • Controlling customer flow. When a business introduces “happy hours” and similar time-bound discounts, it can predict customer flow and avoid traffic overload during busy hours.

Disadvantages

At the same time, price discrimination comes with a few drawbacks as well. Sometimes it’s not attractive from the consumer’s point of view, and here’s why:

  • Customers overpay in an inelastic market. For example, they have to buy expensive airplane tickets during holiday seasons and periods of high demand. That affects loyalty to the brand.
  • Price discrimination can spoil the company’s image if the same products are available at lower prices from other sellers. It evokes a sense of unfairness in consumers, some of whom might stop buying the brand’s products.
  • Consumer surplus becomes lower because price discrimination transfers it to the manufacturer. As a result, customers believe they got less value than they expected for the price they paid.
  • Lower choice of goods. In the case of a market with imperfect competition, monopolies can take advantage of a discrimination strategy. They set high entry barriers for other brands and capture the majority of the market share. As a result, competitors can’t launch their own products, customers have a poor choice of goods, and some customers can’t even afford the high prices charged by the market leader.
  • It implies extra administration expenses. To carry out price discrimination, a company needs to prevent customers from reselling goods on the same market. That means paying employees in the back office to monitor the situation.

Conclusion

If your company is seeking ways to improve profit margins and make pricing more flexible, pricing discrimination may be a great strategy. It does not imply any changes to the product or service delivered – you just need to divide your target audience into groups and find out who can be charged more, and who would generate more sales if you offered discounts. That means price discrimination can be equally effective among different market segments.

However, this strategy is risky to implement if you don’t know your market well. If you are unsure about how much to charge, consider implementing price optimization software by Priceva. It allows you to test different pricing scenarios and provides price suggestions based on real-time data.

FAQ

Is price discrimination illegal?

No, price discrimination is neither illegal nor unethical. It refers to companies that charge dynamically as market conditions change, or that offer different prices for different groups of customers. That does not violate any U.S. laws.

However, the Robinson-PatmanAct of 1936 bans large companies from discriminating against small businesses in pricing, promos and ads. It prevents wholesalers from pushing smaller businesses out of the market by making suppliers charge the same prices to all clients.

Also, some US states (such as California) prohibit price discrimination based on gender, nationality or religion.

How do you calculate profit in perfect price discrimination?

You need to figure out where marginal costs meet demand. At this point, a company no longer produces goods, and instead counts total profits. They are calculated by finding the area between the demand and marginal cost curves.

What companies use price discrimination?

According to economists, a company should meet three conditions for price discrimination to work properly. Firstly, it should have enough market power. Secondly, it should be able to differentiate customer segments. Thirdly, the company should be able to prevent customers from reselling the product.

What type of price discrimination do airlines use?

Airline companies use third-degree price discrimination because they sell economy and business class tickets, thus dividing buyers into two groups. This distinction is based on customer behavior and purchasing ability.


Ready to get started?
Get a free demo project
More to explore