What is price discrimination?
Price discrimination is a price-setting policy when different customer groups are charged different prices for the same products at the same time. The difference in cost is not attributable to any objective reason: the production and transportation of products do not cost manufacturers any additional money; various prices make a product seem more attractive to a particular consumer segment.
In this case, the term "discrimination" should not be interpreted negatively: it does not mean bias against a certain group of consumers but a desire to differentiate between various types of customers and create a more agreeable environment for them.
Price discrimination aims to sell more goods for the maximum price that consumers are willing to pay. There are different kinds of price discrimination, depending on how prices are formed.
Types and degrees of price discrimination
The categories of price discrimination depend on the producer's knowledge of the buyer's purchasing power. There are in total three different types, or degrees, of price discrimination:
First-degree price discrimination (perfect price discrimination)The manufacturer has analysed their customers and their preferences to such an extent that they can sell a product at a maximum price that each customer is willing to pay. To carry out this type of pricing policy, you must gather a huge amount of information about your customers and supply them with a product or service at the most acceptable price. The pricing policy is difficult to implement because of obvious reasons: it is hard to collect this amount of data and process it.
Second-degree price discriminationIn this instance, the seller sets the product's price depending on the order volume. Although the price for the same product differs depending on the order volume, the buyer is free to choose the suitable price for them.
Third-degree price discriminationThe vendor sells a product or service to different customers at different prices depending on their income level. For example, they offer discounts to customers who are facing tough financial circumstances.
The market conditions dictate how businesses set the price of a product. In fact, only monopolies have the power to freely set the terms for price discrimination. Therefore, it is easier to establish your pricing policy in a monopoly. If a company is not a monopoly, on the other hand, well-thought-out price discrimination is indispensable.
Price discrimination examples
Price discrimination is a modern practice. It was used for the first time by the Victoria’s Secret lingerie brand. In 1996, their customers got catalogues for the company's products, featuring different prices for different customers. When a customer found out about the different prices presented in the catalogues, she was so outraged by the pricing policy that she filed a lawsuit against Victoria's Secret, accusing the company of fraud. The customer, however, lost the case because the court ruled that the flexible pricing strategy was legal.
For brands that sell exclusive products, using ill-conceived price discrimination can destroy customer relations, which means a drop in sales. Price discrimination policy in this case may be applied very subtly, first you need to study the opinion of loyal customers using psychological methods. If this is the case, a prerequisite for the effectiveness of the price discrimination policy is that the customer should not be aware that the pricing is any different for other customers.
In the case of price discrimination for mass-market, the principle is no different. The conditions of applying this pricing policy, however, are very different. For the mass market, second-degree price discrimination is more common: when a customer, for example, can purchase two things and receive a third one as a reward. Many popular brands like H&M, O'STIN, Burger King, KFC and many other companies use these strategies.
Companies employ price discrimination because it is profitable, it attracts attention to the brand, and increases sales. But this strategy also has its pitfalls.
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Advantages and disadvantages of price discrimination
For certain types of companies, the effects of price discrimination can be positive and negative: if successful, the business will achieve its goals and dramatically improve its performance, and if it fails, it will incur losses. When it comes to the economy of any country or even the entire world, price discrimination, on the one hand, makes goods more accessible to different groups of customers. But, on the other hand, it can lead to the creation of monopolies.
The price discrimination could manifest itself, among other things, in the emergence of monopolies. For example, suppose a company regularly buys raw materials at a reduced price because it can buy them in bulk. This situation will set a lower price for the end consumer, forcing out competitors and leading the company to dominate the market or become a monopoly. This is how price discrimination may lead to an emergence of a monopoly.
At the same time, price discrimination can contribute to the obliteration of monopolies. The situation occurs when different companies, including startups, benefit from price discrimination. Favourable prices allow smaller companies to enter the market.
Price discrimination is when different prices are set for different customers. This strategy helps capture consumers' attention and makes the product more affordable to customers with different financial circumstances. Nonetheless, if only a limited number of companies benefit from price discrimination, this could create monopolies.