Retailers use price discrimination to ensure that they get the most out of every product they sell. A consumer’s willingness to pay usually declines with the more he buys or owns. Say a retailer wants to sell X amount of a product, he prices it at Y. However this is not efficient more him as the first units of the product can actually be sold for more than Y. But he has to sell at Y if he wants to sell X amount due to that identical products must have the same price. Thus there are techniques to minimize the “wasted” amount.
The green portion is the profit. However the triangle above the green area is the wasted portion.
Here we list out 10 ways they maximize the profit at your expense of course. Generally it will help you understand why some products have weird pricing scheme that doesn’t make sense. Once you know about their trick, you can then come up with defenses to go around them.
1. First Degree (or Perfect) Price Discrimination
This method tries to match the price of the unit to the ability of the consumer to pay. It means that for the same product, each consumer gets a different price. How can this be done? Usually this can only be done for products that have a large price tag and have many options making direct comparison pricing difficult.
How many times have you been to a car dealership, got started bargaining on price and the salesperson said he has to check with his boss on the new price you quoted? What the salesperson is actually doing is to test your maximum budget. Of course you won’t be that dumb to tell him your budget directly. The salesperson will keep coming back and say that your price is too low, offer you a high price that comes down on successive bargaining. Once the price comes to your acceptable price(even though it will most likely be higher than your initial offer), he will push to close at that price.
How do you ensure you get a better price? You can simply try to walk away at an early stage and see if the price comes down fast. Or visit many shops, quote each shop a lower price than the others and hope one desperate salesman will bit.
2. Quantity Discounts
This is most commonly seen as pricing the 2nd or 3rd thing you buy at a discount. Amazon has this offer where you get 25% off the second book that you purchase. Of course you might think that they are passing the savings in shipping fees to you. However in actual fact, the first book that you are buying is subsidizing your second book.
3. Segment Discrimination
This is pricing a product differently according to some aspect of you that can be identified. This is different from 1st degree price discrimination as they do not have to individually test your maximum price that you are willing to pay. The products offered to different segments is usually varying in some important aspect.
An example of this will be the purchase of notebook computers on campus. The notebooks are usually discounted. Because you are a student, they know that your purchasing power is weaker. To move a certain quantity, they will lower the price of each notebook and make it up on volume. However the specifications might be less powerful that what you can get outside.
4. Indirect Segment Price Discrimination
But what if you cannot be so easily identified? Students are easily identified by their student card and in our previous case, only students will be able to purchase the notebook. How can the retailer then target different prices for different people?
They do this by creating a menu and letting you make the choice of purchase. Your choice of purchase will of course be the most beneficial to you. However the way the menu is structured is such that there is a variable that is important to some segments and not important to others. The price of the variable will then be set according to the ability of the segment to price.
We can find this example in the airline industry. Usually we will not able to tell if someone is rich and will pay more for an airline seat. But say we have 2 choices, business and economy class. Comfort is the variable here and someone rich will of course be able to pay more for a comfortable flight than an economy passenger.
5. Coupons/Rebates
Price conscious consumers will collect these coupons and rebates so that the effective price they pay is less than the retail price. However not all consumers will do that. There are many whom do value their time more than price. This is the reason why it is such a hassle to get rebates and use coupons, it is for the retailers to separate who will pay more for a product and charge them the higher price.
6. Intertemporal Price Discrimination
This method changes the price with time. As time passes, the price of the product usually drops. We can see this in many media related industries. Books are released in Hardcover first and readers who are interested in the book will pay more to read that edition. A few months later, a cheaper paperback edition is released. At this time, the buyers will most likely be the mass market who did not have an interest in the book before.
7. Two Part Pricing
Two-part pricing consists of a fixed fee and a per unit charge. An example will be Theme parks where they charge you an admission fee and a per ride fee. Business use this where they cannot charge different prices as the product has no differing qualities. Usually the admission fee will be their profit and the per ride fee will cover the cost of running each ride.
8. Package Pricing
Package pricing is the practice of packaging multiple units of an identical product together and selling them as one package. We know that your willingness to pay will drop as you have more of that product. Say for the 1st can of coke, you might be willing to pay $1.50. But when you reach the 6th can for coke, you might only be willing to pay $0.50. Instead of charging you only $0.50 for all 6 cans, they average the price of all 6 cans and charge you for that amount for each can when you buy a six pack.
9. Price Matching
Business sometimes advertise a price and a promise to match any lower price offered by a competitor. Because of this, no firm has an incentive to lower their prices. Each firm charges the monopoly price and shares the market.
10. Randomized Pricing
A strategy of constantly changing prices. This decreases consumers’ incentive to shop around as they cannot learn from experience which firm charges the lowest price. It also reduces the ability of rival firms to undercut a firm’s prices as the consumer is no longer sure who has the lowest price.
Benefits and costs of price discrimination
These of course depend on whether you are the firm or the consumer. Price discrimination means that consumer surplus can be appropriated, and as long as the cost of the marketing scheme (adverts, identity cards, ticket inspectors etc.) is less than the extra revenue the scheme brings in then it is advantageous to the firm. At first sight it would seem the loser is the consumer. But a second examination reveals that students are gaining, they pay less than if there was a single market price. But an even deeper examination shows how adults might gain. If by price discriminating the firm can increase output substantially, the average costs may fall because of economies of scale. These economies may even outweigh the price difference between adults and students. In conclusion, it is necessary to look at price discrimination on a case-by-case basis.
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