How does it feel to pay more than somebody else for the very same thing? Should your company start charging different prices? The answer is yes in most cases. Price discrimination has multiple benefits:
- Goods and services become available to customers who could not afford them otherwise.
- Goods and services are better available to customers who are willing and able to pay a premium for availability.
- Limited resources are directed to customers who need them most.
- The seller earns more.
In general, price discrimination increases the output of goods and services on a market. There are cases when buyers easily accept that other buyers pay less. Consider these examples:
- Museums offer significant discounts on entry fees to students. Most students would not otherwise afford a museum visit, and most full-fare visitors understand this.
- Some airline passengers pay very little for their flights. Most airlines are however not in business for these early birds or stand-by customers but for full-fare business passengers. The low-price passengers get a chance to travel and the airline gets to cover some of its fixed costs. If it was mandatory to apply a flat rate to all customers, some customers would never get to fly. There would be fewer destinations and fewer flights to them. With the help of advanced price discrimination, airlines provide their business passengers with flexibility and superior service.
The following diagram illustrates why price discrimination is usually a good thing.
However, some forms of price discrimination cause irritation (and may even be against the law in some jurisdictions):
- Industrial sellers may apply quantity discounts to large-scale buyers. Small buyers may get frustrated if they need to pay more for everything they buy compared to their big competitors. This is why there might be competition laws that promote equal treatment of buyers and thus require that any price difference is based on differences in cost-to-serve, for instance.
- Many attractions in Russia have traditionally applied two rates: one for Russian visitors and another for foreigners, the latter being much higher. The rates should now be flat now in the Kremlin, Moscow but Peterhof Gardens, St. Petersburg has long charged a higher rate from foreign tourists.
- Night clubs may have free entry for women but men need to pay.
- Viking Line, the Nordic ferry company, got caught running different price levels in its web shop based on the language selection of the user: Finnish and Swedish speaking users paid the normal price while Estonian speaking users got an automatic discount. English speaking customers were shown premium prices. The company had assumingly tried to match the differences in average willingness to pay between the language groups. The revelation caused fury among some customers.
While price discrimination usually increases the output of goods and services in the marketplace, sellers have sometimes an incentive to produce lower quality than they would without price discrimination (also known as the damaged goods dilemma):
- Airlines do not let passengers with a discount ticket change to an earlier flight even if did not cost the airline anything.
- Hotels may limit the speed of complimentary wifi to defend the price of premium wifi.
- Car manufacturers sometimes market different levels of engine power even if the cars are physically similar. In such cases, the only difference is that the engine power of the cheaper model is limited by software.
- A café may have the incentive to make standard coffee taste worse to promote the sales of premium coffee.
- And lastly, the story goes that the French railways were not willing to put a roof over third-class carriages while fearing that second class passengers would start traveling third class. This was apparently before the TGV.
Competition in the marketplace reduces this tendency fortunately: it makes little sense to damage your no-drills offering if it gives an advantage to your competitors.
How would you develop your pricing?