Pricing for maximum profit in your business requires discrimination. Now, it’s a word that we don’t like too much as it brings up images of prejudice and unfair treatment of people. However, there are some significant legal protections against discrimination, especially in the area of HR. Discrimination in pricing your products or services, however, is not only legal but also both ethical and profitable.
Price discrimination is a pricing strategy that charges customers different prices for essentially identical goods or services. This means that the price is not set in relation to cost but by what the customer is prepared and able to pay. There are two principal reasons for this strategy:
- To maximise market penetration
- To increase margins by soaking up consumer surplus, which is the difference between the price charged and what the consumer is willing to pay.
You may not have given this too much thought before, but you come across price discrimination in your travels every day. Let’s examine the three levels of price discrimination:
First Degree Price Discrimination (Perfect Price Discrimination)
First, we have first-degree price discrimination, also known as perfect price discrimination. This involves charging customers the maximum price they’re willing to pay for your goods or services. Car dealers sometimes exercise first-degree discrimination based purely on how the purchaser is dressed. Theoretically, the perfect price is just before the customer says no, but in practice, a customer’s maximum willingness to pay is actually difficult to determine. However, without this first-degree discrimination, you could actually be leaving money on the table.
Second Degree Price Discrimination
Second-degree price discrimination involves charging customers a different price based on the quantity or quality of what they purchase, usually by choosing from a set of alternatives. Examples include “buy two get one free” offers, volume discounts, and product bundling. For instance, hopping into a taxi and seeing the fare increase as the distance grows is a form of second-degree price discrimination. Booking an Uber also presents a choice between UberX and Uber Black, each with a different price point. Similarly, when booking a flight, you can choose between economy, flex, premium, or business class, representing various price points for different service levels.
Third Degree Price Discrimination (Group Price Discrimination)
Third-degree price discrimination, also known as group price discrimination, involves charging different prices to different market segments or customer groups based on their demand and price sensitivity. The objective is to maximise volume and profit within each customer or market segment. Special pricing for pensioners and students for tickets on public transport is an example of third-degree price discrimination. Public transport for these groups is cheaper because they are more price-sensitive and, therefore, would rarely use public transport if charged the full price. Using concessional pricing means that take up within the student and pension markets is maximised, and the overall profitability is higher.
The challenge for businesses is to evaluate their pricing strategy. Have you given it enough thought? Can you use price discrimination to capture market segments you aren’t reaching currently? By implementing the right pricing strategy, you can increase penetration into existing markets and avoid leaving money on the table due to consumer surplus. Taking the time to examine your pricing strategy can lead to substantial benefits, and embracing discrimination, when done ethically, may be the answer to optimising your business’s profitability.
Partnering with Quantum Advisory allows you to focus on what you do best – running your business – while leaving the financial aspects in capable hands. Contact us today to experience the benefits of working with Quantum Advisory.
