Price Discrimination
Charging different prices to different customers – fair or not?
By Hidayah Hassan

It may sound like a dirty phrase that would bring on consumer lawsuits, but discriminatory pricing has long been a common and viable strategy for sellers. It basically equates to charging different prices for the same product or service, though there are a few variations of this:

-          By customer. Prices depend on certain attributes of the consumer, for example fast food outlets like Burger King and KFC often offer student-priced meals (based on their age/occupation, students form their own section of the market). In this case, prices were adjusting according to a type of consumer that tends to have less buying power. Because of this, they are more sensitive to price changes, or in economics, they have higher elasticity of demand.
 

-          By quantity. This is easily seen in discounted rates offered for bulk buys, a common feature in industrial and other B2B segments.
 

There are a few other situations that may come under price discrimination as well, such as even by time or place. For example, prices of many forms of travel costs – from airline tickets to accommodation – vary according to the time of the year. They are routinely bumped up during peak periods and more favourable seasons. Also, many bars have a ladies’ night, setting apart female customers as a different customer segment for that set period. Early-bird discounts are another example, often for bookings to events. Interestingly, the converse can also happen at the last-minute, where lower rates are offered when there are seats left over (this is also found in hotel and airline industries).

Some observers also question what we see as ‘premium pricing’. In Tim Harford’s book, The Undercover Economist, he talked about coffee sellers identifying the customers who could (and would) pay more by offering regular coffee and more expensive “premium” coffees. However, it may be more complex than this. The fact is that customers are not created equal – whether in their ability to purchase from you, their willingness to do so, and their needs. As such, sellers may need to organise and break up their market in order to have separate strategies for each section.

Perfect price discrimination is not possible (and certainly not ethical or legal), but is utilised to a certain extent by many sellers. To better understand the nature of what to do, some factors and conditions surrounding this practice must be understood. One is that while a customer may feel that you are selling the same product at different prices, this can be justified by issues of production costs or perfect substitution.

What You Need To Know

Whatever industry you’re in, have you noticed that you spend more money, time and/or effort on certain customers than others? This is one lead-up to many sellers taking on the price discrimination strategy. Look at hairdressers. Notice how they charge more for services to longer-haired customers than those with shorter hair? This is justified by differences in “production costs” according to the two different types of customers. When airlines charge first-class flyers more, they are also catering to them with upgraded services. The extra room for first-class seats also represents a trade-off – sacrificing airline space for the customer’s comfort, at a price to be covered by them.

What about perfect substitution? Here’s an example – consider network operators like Singtel, M1 or StarHub. They may have peak period rates and off-peak period rates according to time. You could be making the same call for the same number of minutes, but how much it’s going to cost you can depend on what time you make that call. They can charge you different prices because the phone calls don’t fit the theory of perfect substitution. Calling your friend at three in the morning is not a perfect substitute for calling him at a more popular (and more expensive) time. Unless the market is indifferent to changes in situation for your product, it is possible for you to make use of this strategy.

What You Can Do

When you have a better idea of how and when price discrimination works, you can think about the conditions that actually help facilitate it: 
 

1)      Market segmentation – that means categorising your customers, especially according to their elasticity of demand. In a way, this is similar to the old expression ‘divide and conquer’. They may be divided according to their buying behaviours, demographic makeup or their needs. There must be a different price elasticity of demand from each group of consumers (their sensitivity to price changes). You can then charge a higher price to the group that is less sensitive, and lower prices to the groups that is more sensitive.
 

2)      One problem you have to be wary of is seepage and reselling. If your goods can be bought in a market where prices are lower, and then resold in markets where they are higher, that will threaten your position and create competition. To prevent such resale, keep the different price groups separate, making price comparisons difficult, or restrict your pricing information. There has been some controversy over differences in airline ticket prices with the rise of Internet use. With customers gaining access to more transparent information, it is easier for them to make comparisons and question price structures.
 

3)      Price discrimination is more common, and easier to impose when a service is involved. What you’re providing is intangible, and thus tends to be of different worth to different people based on their subjective tastes and opinions (for example, one customer may be willing to pay more for a facial than another).

Price discrimination has brought on some arguments over evils it can create – from monopolies taking advantage of the market, unethical price hikes and so on. In such cases, the “discrimination” was taken too far on not based on real differences reflected by consumers and unique value propositions you can offer them. If done right, this is a strategy that not only helps you maximise profit and capture more market surplus, but also distributes resources equitably across buyers, and offers them more choice.