A pricing strategy in which a business charges different prices for the same product or service to different customers
It is the opposite of cost-based pricing where a product has a fixed price determined based on the cost of production.
Why do companies apply this strategy? To make as much profit as possible. Depending on the price elasticity of their product or services, companies can figure out if the market is segmented.
That is if there are customers who are willing to pay more for their product or services. Customers can be segmented based on demographics or the value attached to the product.
With this knowledge, the company can decide to give a higher price to the customers who are willing to pay more and a lower price to the more price-sensitive customers.
Types of price discrimination
There are three types of price discrimination. These are;
First-degree or Perfect price discrimination - this is when a company charges the highest price possible for their product or services. This is most feasible when the product is price Inelastic.
Second-degree price discrimination - here the company charges its customers different prices based on the number of goods or services that were purchased. For example, customers who buy in bulk will pay a discounted price while those who buy less will pay more.
Third-degree price discrimination - in this case, companies charge different prices for their products or services based on their demographics or background.
Advantages and disadvantages of price discrimination
Price discrimination has several benefits for the company. First and foremost it guarantees more profit especially when the market makes this possible. It also allows companies to compete for a larger share of the market since they are able to meet each customer at their desired price.
However, since price discrimination requires a degree of monopoly in the market, it means customers have fewer choices.
Also, in addition to the unfairness surrounding price discrimination, the company has to bear the additional cost that comes with preventing customers who buy at a lesser price from reselling to other customers who perhaps aren’t in the demographic or background that qualify for a reduced price.
In essence, price discrimination favors the company more than it does the customers and this strategy depends on three factors. These are;
- The company has a degree of control over the market. The higher the degree of monopoly, the better.
- It should be possible to divide the customers into different segments
- Variation in price elasticity