Each and every day, seemingly small decisions about coupons, bundles, sales and retail pricing are made by retailers. The truth is almost all of these decisions are calculated with a purpose, based on consumer data and behavior. Here’s what you need to know about these retail pricing models, which some call price discrimination.
What Is Price Discrimination?
Price discrimination is the act of selling an identical product or service to different people at different prices. Of course, the word “discrimination” implies a negative undertone — and understandably so. After all, does anybody really like the thought of someone else getting a better deal for the same product?
You might experience price discrimination most often in the travel, insurance and internet/cable industries, but the retail industry is somewhere price discrimination also happens on a daily basis. But while price discrimination sounds pretty bad, it can, in fact, be a win-win situation for both retailers and consumers.
Examples of Price Discrimination
Technically speaking, there are a number of qualifications that need to be met for price discrimination to occur; for the sake of simplicity, the most important thing to remember is that the retailer often needs some degree of market power (the ability to set prices) and a way to segment its market in order to vary its prices among individuals or specific consumer groups.
Coupons, it may surprise you to learn, are a fantastic way for retailers to discriminate according to consumers’ willingness to pay for products. Coupons allow retailers to sit back and relax while a customer segment with a lower willingness to pay comes to them. Organizations draw more surplus out of the consumer (money that could’ve been saved or used elsewhere) and are able to sell to a bigger market, while still profiting from discounted items (there is often still a markup, just not as big).
Meanwhile, the coupon clippers are happy as clams knowing they can get a discount on a product they may not have originally purchased. Even those customers with a higher willingness to pay can take advantage if they are frugal and patient enough to wait for coupons. Otherwise, they will almost certainly end up paying more for the same exact product.
There can also be pricing discrimination across a certain time frame — for instance, that new gaming system that was $500 in the first month of its release is now, three months later, down to $400 with a game bundle to boot!
The people who bought the system when it was marked up to $500 had a higher willingness to pay because they wanted to be the first to have it, and once the system manufacturer calculates they have milked as much as possible from its high-paying customer segment, it then lowers the price to attract the next tier of consumers. This is why it’s usually advisable to avoid buying a brand-new tech product until it has been released for some time, in addition to rapid advance of technology and quality issues.
Price discrimination can take other forms, some of which are even less obvious. Have you ever been walking down the shampoo aisle at your local retail store and noticed just how many different shampoos are offered by a single brand? Often, it’s several — one the salon-quality product, the other moisturizes and gives volume — and they all offer slight differences in price due to additional features or perceived quality.
This is often referred to as menu pricing, and while it isn’t technically pure price discrimination (the products aren’t identical after all), there is often a disparity between how significantly the productions costs vary versus the mark up in store. For example, the perceived higher quality product could cost 50 cents more to purchase, but it might have only cost an extra 4 cents to produce. Here, the manufacturer is presenting a pricing choice to the consumer, which forces them to select which segment they fall into.
Using Your Data
The major component of price discrimination that would probably make consumers most uncomfortable is that the practice requires gathering and tracking individual spending behavior and using the data to make these pricing decisions, and even selling it to other retailers so they can do the same.
What retailers and other companies are beginning to do, mainly by way of data mining through online shopping profiles, store cards and other firms’ information, is gather a wealth of data in order to profile consumers. Companies such as Facebook and Verizon (to name a few), which have massive amounts of information about all of their users, are actively selling it. All the while retailers like Target carefully track customer information — to the point their analysts can predict whether certain customers are pregnant and even how far along they are. All of this is used for the purpose of personalized advertising and pricing.
Why Price Discrimination Isn’t All Bad
At the end of the day, price discrimination can be a good thing if the company implementing it isn’t looking to scam or swindle their consumer base, or use the data gathered for the purposes of price discrimination in illegal or unethical ways. In fact, according to FTC commissioner Joshua Wright, it can make pricing more equal across incomes:
“One important aspect of the economics of price discrimination is that it is almost always the case that it involves reduced prices for the price-sensitive group and higher prices for the price-insensitive group. To the extent that it is true that the lower income groups are the price-sensitive group, price discrimination generally benefits the lower income group at the expense of the higher income group. It is quite ironic that a type of discrimination actually has the potential to equalize the purchasing power of lower income groups with the purchasing power of those with higher incomes. It’s getting easier and easier to imagine a world where bus stop billboards and mall ads light up and begin speaking to you as an individual, knowing your purchase history and preferences in depth, suggesting items and discounts which are personally tailored to you.”
Although the trend might seem a little too Orwellian to some, price discrimination doesn’t necessarily mean bad news for consumers, especially those who are less willing to pay higher prices. Regardless of class, consumers can, and often do benefit from price discrimination and personalized advertising.
Photo credit: Thomas Kristensen