Price Discrimination is a pricing strategy/tactic typically falling under the tags of marketing and micro-economics. It’s basically the purchase of the same product (industrial, consumer,) to different customers at different prices, and hence the term discrimination. Note here that customers are differentiated by segmenting them following different criterions depending on the type of good at hand (mass produced vs. customized), type of industry (product vs. service), nature of the firm vis-à-vis the industry (monopoly, oligopoly etc), product classification (simple, easily substitutable products vs. premium products) and finally, customer classifications based on age group (teenage vs. adults), occupation (student vs. professionals), gender, income group (higher end of market vs. the lower end) etc.
This tactic typically involves selling the same product to high end customers at higher price to absorb consumer surplus and selling at lower prices to low end customers in order to expand sales. This may have a tendency to hurt competition but in a perfectly competitive market, where access to full market information by consumers is assumed, price discrimination usually fails to achieve arbitrage (surplus/differential profit). Price discrimination can be a part of pricing strategy the management decides to pursue for a given product. Price skimming is one closely related tactic, where manufacturers sell a product initially at high price usually owing to higher initial cost of production and lower economies of scale, but eventually lowers prices as economies of scale set in and per unit costs get low. This is where price discrimination tactic is based on the product lifecycle and not the customers. This is true for mass customized products and FMCGs.
Generally, in industries where firms have an oligopolistic network or even a monopoly, manufacturers or service providers are able to strike profitable deals with different customers by providing them the same product/service at different types. But in order to prevent those discounted customers from becoming resellers and hence direct competitors, certain measures are taken, for e.g. limiting information access, highly segmenting customers and discouraging any means of resale. This tactic is usually successfully applied in service industry where resale is virtually impossible. An example can be of all the various discounts that students and retirees can avail from museums and travel agencies etc. Since those services are available at discount and can’t be resold, it achieves the purpose the service provider has in mind, reaching out to customers with high price elasticity, i.e. people who wouldn’t otherwise buy the services at the regular price due to budget restraints etc.
The paper would discuss several aspects of price discriminatory tactic, which roughly fall under the following heads:
- Consumer surplus and discriminatory pricing
- Major types of discriminatory pricing tactics
- Robinson Patman Act (US Antitrust Laws)
- Marketing pricing tactics: predatory pricing and skimming
Consumer Surplus Discriminatory pricing is basically aimed at absorbing maximum consumer surplus. Consumer surplus is basically the difference between the maximum price consumers are willing to pay for a certain product and the actual price of the product. In a typical Supply and Demand curve, if we are to take aggregate demand and supply, the price above the market equilibrium that some customers are willing to pay, is the maximum price producers can get. The equilibrium price is of course less than the maximum. Discriminatory pricing helps suppliers transfer some of that consumer surplus to the producer. The pink area in the picture (Bob Beachill) shows consumer surplus p
ertaining to aggregate demand of a certain product. Consumer surplus is the surplus money the producer might have gained if higher price was charged, though at a sacrifice of number of units sold. If considered from an individual buyer’s perspective, it’s important to know the ‘reservation price’ of each buyer, i.e. the maximum price they’re willing to pay for a product and above which the demand for the good becomes extremely price-elastic. Producer surplus (indicated by the blue area), on the other hand, pertains to the price below the market clearing price for which the supplier could’ve produced more but is above their maximum productivity at that price
Types of Discriminatory Pricing
Sellers may employ different discriminatory pricing tactics depending on the nature of industry, the amount of information available, price elasticity of consumers and different customer orientations. The following are major tactics:
First Degree Discrimination
This discrimination is based on the subjective product utility and price elasticity of each individual customer. As such, this tactic takes into account every customer’s price elasticity and charges them based on that. For this the seller needs to know the reservation price of each customer and then charge to maximize surplus profit. But first degree discrimination is a characteristic of a market where perfect competition does not exist i.e. the buyers don’t have enough information to base decisions on, monopoly exists or sellers sell considerably differentiated products which are hard to substitute. In a perfectly competitive market, consumers absorb all surplus. But a first degree discriminatory market is not undesirable too since it has no social deadweight loss and the market continues to operate at full efficiency.
Second Degree Discrimination
Second degree discrimination is similar to bulk discounts, i.e. the more quantity purchased the more discounts granted. The trend is usually common in industrial goods case where firms enter into strategic partnership with suppliers and form a large block of units which trade at discounted prices. Also, as in the case of industrial goods, any category of goods that are otherwise difficult to differentiate, discriminatory pricing can be the differentiation strategy adopted by the seller to gain market share.
Third Degree Discrimination
Third degree discrimination is based on segmenting the market according to different customer classification such as age, gender, income group, even geography etc. An example can be of specially priced food for kids available at certain restaurants. Also, it’s generally noted that goods being sold at posh areas of a locality are priced higher than those sold in localities where lower income groups reside. The inclusion of ‘mall price’ to items being sold at higher prices at malls as opposed to other on-the-street stores is also an example of price discrimination.
Price skimming is a pricing strategy employed by a company while introducing a new product in the market. Generally, prices are high initially due to high cost of production and low economies of scale. After per unit costs become low the price is reduced, output is expanded and the product penetrates the low end of the market. Here, pricing is defined based on the product lifecycle.
A company may choose to keep its pricing strategy flexible and adapt a tactic as when it’s required and may decide to grant different types of discounts o different customers. An example can be of travel industry where airfare is charged depending on the day and timing of booking, the schedule for the customer, the availability of un-booked seats and even the country the airline is operating in (depending on fuel charges etc).
Rules and Regulations
Whichever tactic a company may employ to price discriminate, it needs to take into account certain rules and regulations. In certain cases, price discrimination can lead to legal actions against the company since in order to absorb consumer surplus, the seller must be selling highly differentiated products or might be a monopoly. The US Anti Trust Laws generally discourage monopolization of the market by one firm in order to encourage competition and innovativeness of firms. Price discrimination is one way firms seek to monopolize markets without indulging into R&D or being innovative. The Robinson Patman Act requires all manufacturers on the same footing to charge the same price on the same product. This may be discouraging to certain manufacturers that price discriminate on the sole basis of quantity purchased by the retailers.
Examples of Price Discrimination
Price discrimination happens across the board in almost all industries. Following are some of the examples:
When manufacturers price discriminate virtually identical products, with similar production costs by charging a ‘premium’ or superior version higher than it’s simpler version. An example can be of coffee sellers where instant coffee is sold cheaper than cappuccino despite having identical production costs. Pharmaceutical industry also price discriminates the heavy dose pills by charging them higher than lighter doses despite having same mg units or total dosage.
Travel industry has the most flexible pricing strategy of all as it discriminates prices based on many factors. Kids travel at almost half the price, if you want to buy a ticket a day before the flight, you’ll be charged more, if you’re buying it online than the information you enter would be used to gauge your location and other income related background and you’ll be charged accordingly to the extent that people travelling on the same airline have paid different prices for the same flight.
Hotels regularly price discriminate on the basis of time of booking, etc. the same quality of room may be charged differently to different customers on the same given day. If you show up on the hotel at a late hour, the receptionist would let you in at cheaper price, to fill in their empty rooms!5 Also single rooms sometimes cost more than double rooms, owing to the fact that businessmen usually travel alone, and are able to pay higher prices.
Many hospitals price discriminate for providing supposedly ‘luxurious’ service and capitalize over the monopoly they have established over some time in the society. Even though two hospitals might provide the same ‘quality’ of medical service, one might price discriminate on any of the contexts of being a non-profit organization or ‘been there for a long time in serving humanity.
Many industries price discriminate while selling the same product in a different country as opposed to home country. Pharmaceutical industry is required by certain humanitarian laws to sell below regular price to African and other poorer nations than back in US. Book and publication industry also price discriminates when it sells the paperback version of a fine quality colorful book at minimal prices in Asian countries. Also, the car industry regularly price discriminates, when it sells cars at a higher price in export markets than in home country.
Electricity, gas and other energy related utilities are also sold at discriminatory pricing during different times of the day.
Retail outlets are able to sell greater quantities at lower prices by offering bulk discounts, bulk pricing, quantity pricing and seasonal discounts.
Age and Gender Discrimination
Children and elderly are able to buy a lot of products and services at lower prices and are provided huge discounts by transport, recreation, government agencies, air travel etc.
Governments price discriminate while providing certain goods and services to citizens as opposed to non citizens.
Employee Discounts and wage rates
Labor may be paid different wages for the same quantity of work. Employees are given special financial options and other incentives that are directly tied up with heir performance at work. This discrimination is used to enhance performance. Also, businesses may tie up with certain manufacturers or service providers to haggle special discounts for their employees on the purchase of their goods and services.
Price discrimination is a prevalent practice in almost all type of businesses. Whilst some customer might find themselves paying higher prices than others, price discrimination may outweigh social costs with social benefits. As long as market efficiency is not at stake and monopolization is not intended by unfair practices price discrimination can be a fruitful tactic. Also, the environmental context in which prices are considered may have an impact on the overall fairness and feasibility of price discriminatory tactics. It can be used as a political and economic tool to effect policy. For e.g., EU is currently working toward setting universal prices for goods and services produces and traded in its member nations to maintain justice by saving customers from being exploited by suppliers and encourage innovation and competition among businesses.
Microeconomics1/Bob Beachill. (2004). Price |Changes and Consumer Welfare. Web.
Economics Help.org/ Tejvan R.Pettinger. Price discrimination. 2008. Web.
US Government/ Federal Trade Commission/ Donald S. Clark (2007) The Robinson Patman Act. Web.
The New York Times Company/ About.com/ Mike Moffatt (2008). Real Life Price Discrimination- An Example. Web.
Economics Help.org/ Tejvan R.Pettinger. Price discrimination. 2009. Web.
Business Education Association/BNET/ Ken Heather (2002). Price Discrimination: Are we being exploited. Web.