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Price Discrimination: Definition, Degrees, and Takeaways

Price Discrimination: Definition, Degrees, and Takeaways

May 15, 2018


E-commerce experts and marketers often use the phrases e-commerce price discrimination and dynamic pricing interchangeably. This is partly true, however, there are strategy differences that set the two apart.

In this article, we’re going to look at what price discrimination is, how it’s different from dynamic pricing and how you can apply it on your own e-commerce store.

What is price discrimination?

It is a tailored approach to pricing where an identical item could have different prices. It works on three different degree levels:

  1. First degree: Consumers are charged the maximum they’d be willing to pay for any given product. For example, auction or bidding sites, where one customer might pay lots more for a similar item, based on what they’re willing to pay.
  2. Second degree: Consumers can choose their discrimination. For example, they might be offered a lower price if they buy a product in a higher quantity.
  3. Third degree: Products are priced differently based on customer segments.

In essence, it involves taking customer data including their behavior and perception, segment customers based on that data and then generate prices specific to each segment.

Price Discrimination Graph

Why it is different between dynamic pricing and price discrimination?

Dynamic pricing is a type of price discrimination and is an approach whereby e-commerce store owners change the price of their products based on a number of different factors.

These factors could be changes in the market. For example, if goods are lower in stock, you might consider raising your prices to reflect the shortage of goods. You may decide to change your prices based on what your competitors are currently or have previously charged.

You could also change your pricing based on your own personal goals. For example, if you’re hoping to achieve a certain level of revenue by a certain time, you might increase the prices on your most popular items to increase the chance of hitting your targets.

Largely, dynamic pricing is an approach that takes outside influences to control the price of products. It’s especially important in highly-competitive industries.

Strategy Differences Dynamic Vs Static

Whereas, as explained above, discrimination involves offering different prices to different types of consumers based on how, when and why they shop.

So the crux of it is, the difference between the two terms is the outside vs inside influences and the basis on which prices are changed.

Dynamic pricing affects everyone in the same way. Price discrimination could affect me differently to the way it affects you because of our own personal buying habits.

How to apply it

If you want to start implementing this strategy to your e-commerce store you need to start using big data. This will help you take into account factors such as time of day, day of the week, and other behavior practices to define your price point.

We’re now going to look at three examples of how e-commerce stores have implemented the three degrees of pricing discrimination.

First-degree

First-degree price discrimination involves allowing customers to pay as much as they’d like. This works especially well for auction marketplaces like eBay.

For example:

Price Discrimination Example

This iPhone 6 in gold is currently listed at £100.00 and has no bids. Whereas this iPhone 6 is listed for £120.00 and has had a total of 6 bids.

Price Discrimination Example 2

You cannot be certain why one would sell for more, or generate more bids than the other. However, in this degree of discrimination, consumers are in full control, and while they might pay more than the product is worth, they’re still paying what they’re happy to pay.

The first degree also works well where you A/B tests product emails, sending half the recipients one price and the other half see the second price to see which fares best.

I.e.

You send an email promoting one of your products.

Half of the recipients see the $400 price point. The other half of the recipients see the $550 price point.

If the $550 works out well, you stick with this price on your website.

Second-degree

Second-degree discrimination usually works best when you’re bundling products. It allows you again to give your customers a choice of whether they want the higher or lower package.

For example, when you buy from wholesaler Alibaba their business premise is that you buy in bulk. When you do so, you get better discounts.

For example, these sunglasses range from $3-5 and has a minimum order of 300. However, buying more in bulk is likely to get you closer to paying $3 than $5.

Price Discrimination Bulk Buying

Third-degree

The third type is probably the hardest to execute well. It requires you to keep track of your customers behavior.

This is most commonly done in businesses like airlines. Airlines often take into consideration details like the day of booking, how far in advance you’re booking your flight as well as other details like previous purchase history.

They then use this data to present you with a price specific to you. It’s often why when booking a holiday people suggest you delete all your cookies to try and get the best deal.

Flight Prices Price Discrimination

This process is also seen in the computer/tech industry where online retailers will increase their prices based on geographical location and how far away you are from alternative brick and mortar stores.

Takeaways

In this post, we’ve talked about some of the ways price discrimination is different from dynamic pricing.

Please do remember, if you are going to employ these tactics that some consumers are prone to pick up when their prices are being discriminated against and they soon start to believe the prices are ‘unfair’.

So while this strategy is legal, you must do it in the right way if you want it to work. It works best for companies who have already built trust with their customer base, who understand they are still being treated fairly, despite the company maximizing their sales, and profits.


Frequently Asked Questions

What are some examples of price discrimination?

Airline companies apply price discrimination based on your purchase history.

What are the 3 types of price discrimination?

1. First degree: Consumers are charged the maximum they’d be willing to pay for any given product. For example, auction or bidding sites, where one customer might pay lots more for a similar item, based on what they’re willing to pay.
2. Second degree: Consumers can choose their price discrimination. For example, they might be offered a lower price if they buy a product in a higher quantity.
3. Third degree: Products are priced differently based on customer segments.

What is the purpose of price discrimination?

The purpose of price discrimination is to segment the market and target each segment at different price levels. In other words, to capture a large audience.



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