Price Discrimination for Product Management

We were recently asked our opinion on price discrimination and to provide steps for Product Managers to price their products ‘discriminately’. Our initial thoughts about price discrimination are that it looks and smells like the promotional offers, discounts and specials that Product Managers regularly develop.

Price discrimination comes in all shapes and sizes. Sometimes it looks just like a straightforward discount, other times, it is slightly more complex. There are several ‘degrees’ of price discrimination.

However, there are differences between price discrimination and the standard promotions and discounts that Product Managers create to deliver more value to their customers. The key differentiator is that price discrimination seems to have more permanence than a once off offer or discount. The practice of price discrimination delivers more of a constant price point in the market place.

Let me illustrate. A bus ticket is priced differently for a pensioner and a regular bus rider. The differences in the price point is considered price discrimination because the bus company is offering the same service at 2 different prices. Unlike a promotion or offer or discount, this difference remains at a constant and is always available to the pensioner. If a promotion was offered, the cheaper priced ticket may only be available for a certain period to the pensioner.

Given that a key function of Product Management is to set and review pricing for products and services we thought that we would would explore the concept and the relevance of price discrimination within the Product Management domain.

Definition of Price Discrimination

Price discrimination is an economic “term”. The words are rarely used by Product Managers. Within the Product Management domain, the concept however is applied through carefully structured discounting based on market segments and bundling of various goods and services.

Melbourne economist Joshua Gans refers to price discrimination as “situations where firms charge more complicated prices than simple linear prices”.

A quick search on Wikipedia uncovers a more conventional definition. It states that price discrimination “exists when sales of identical goods and services are transacted at different prices from the same provider.”
More specifically, Adam Armstrong from the University College of London states that price discrimination occurs “when 2 similar products with the same marginal cost to produce are sold by a firm at different prices.”
Overall though, price discrimination is a method for charging different types of consumers varying prices for essentially the same good or service.

Types of Price Discrimination

There are various degrees of price discrimination.

Individualised Pricing

This type of price discrimination refers to the practice of charging the maximum amount for that good or service that each consumer is willing to pay.

According to Gans, the most common form of first-degree price discrimination is the personalised pricing strategy where companies set different prices for customers based on the personal information they have about the customer. The value for the good or service is different for individual consumers and consequently the price is dependent on each individual’s willingness to pay more for the good or service.

This is evident in the business to business market in industries that sell “technology” services where standard price lists are not available and projects are priced at the discretion of the sales representative.
Gans provides additional examples in the consumer market. He mentions that the car industry often sells the same type of car to customers at different price points. The sales representative engages in conversation with the customer to gauge the customer’s desire for the product, their budget and their willingness to pay for the car.

Volume Discounts

This form of price discrimination occurs when the standard price per unit is discounted based on the volume of the good or service purchased. Conference tickets for example are often offered with a volume discount for 2 or more tickets purchased. The second and third ticket price is often cheaper than the first ticket price.

Segmentation Pricing

Segmentation or otherwise known as group pricing is third degree price discrimination. The price of the good or service is differentiated by some form of market characteristic such as age, education, longevity of tenure and sometimes even gender. Software providers often have 2 price points for the same product. There is generally a price point for every day users and a price for academics.

The concept of segmentation pricing is that consumer groups value the same product differently. Therefore in order to extract the most revenue out of the total available market, the price of the good or service varies by segment. According to Gans “although this strategy does not increase profits as much as personalised pricing, it does allow the firm to extract more consumer surplus (and profits) than it would by charging a single price.”

Bundling

Product Managers working in Telecommunication or in Software companies should understand the concept of bundling well.

Bundling occurs when companies package a suite of products and sell it as a single unit for 1 price. The total price of the package is generally lower than the sum of the individual products. Consumers are generally more attracted to 1 product within the bundle but tend to buy the whole package in an attempt to derive more value.

For example, telecommunication companies often bundle a subscription tv, fixed line and internet service for a single monthly subscription fee. These types of bundles allow the company to sell additional products to markets that may not necessarily want all 3 individual products, grow subscriptions across all 3 product categories and subsequently grow their overall revenue.

Why Use Price Discrimination?

Product Managers can use price discrimination to:

  • Sell surplus product
  • Gain additional revenue
  • Tap into a different market segment

Is Price Discrimination a Technique that Product Managers should Employ?

Perhaps not knowingly, Product Managers across a range of industries are already employing price discrimination techniques.
However, before utilising these techniques Product Managers must first understand:

  1. 1. Their market segments
  2. 2. The value of the good or service to the various segments
  3. 3. The unit cost of the good or service
  4. 4. Their overall product objectives

Pricing is a strategic activity and conveys many messages to the market. Using price discrimination as a tool to set pricing without a good grasp of the above is fraught with danger.