Segmenting Customers for Price Discrimination

According to Tom Nagle and Reed Holden in their book The Strategy and Tactics of Pricing, there are seven effective segmentation strategies to specifically identify different types of customers in order to capture the consumer surplus.

Segmenting by Buyer Identification

Senior discounts, children’s prices, college students, and coupon clippers are all examples of different buyers. Barbers may cut children’s hair at a substantial discount, realizing that home haircutting is an effective substitution. They may offer these prices when they have excess capacity (midweek, usually), so as to not interfere with the demand of customers who can get their haircuts only on certain days (on Saturdays, for example).

Airlines, hotels, and rental car companies discriminate against business travelers, and while they don’t have ways to specifically identify them, they use other methods that approximate this information. These includes the booking dates compared to the departure dates, Saturday layovers, etc. While these methods are by no means absolutely certain to identify a business traveler from a leisure traveler, they produce approximate results, which are relatively accurate.

Another way to identify the price sensitivity of different customers is through salespeople. This is why car salesman are trained to ask a litany of questions designed to approximate the value to any one customer of purchasing from their dealership: Where do you live, is the car for business or pleasure, what do you do for a living, how long have you lived in the area, what kind of car do you drive now and where did you purchase it, what are the alternatives you are considering, etc. This is all valuable information for the salesman to place the particular buyer on the demand curve and gauge their price sensitivity.

Segmenting by Purchase Location

Ski lift and amusement park tickets can be purchased cheaper at grocery stores than they can on–site, where the less affluent (or those seeking deals) would tend to take the time to purchase them. Dentists, opticians, and other professionals sometimes maintain separate offices, in different parts of the same city, or in different cities, that charge different prices based upon the economic and demographic make-up of each. When you factor in the international market, location becomes very complex. Note the prices for golfing in areas favored by Japanese tourists, who cannot get tee times in Japan.

One of the dangers of segmenting by location is arbitrage. Norplant, for example, sells for $350 in the United States, but for as low as $24 in less developed countries. With arbitrage, some buyers might purchase in the low–cost area and sell in the high-priced area, thereby keeping the consumer surplus for themselves. This isn’t an issue with services or goods that are consumer on location, but it certainly is if you are selling widgets in different locations. With the increasing use of the Internet to make purchases, being able to segment by location will become more and more difficult.

Segmenting by Time of Purchase

Theaters offering midday matinees, restaurants having cheaper prices for lunch rather than dinner, cellular and utility companies pricing based upon peak and off–peak times, vacation spots vary prices between on– and off–season, and publishers pricing hardcover books higher than soft covers because of their earlier publication dates.

All of these methods are a way to segment the market between high–value and low–value users. If one is making a cellular phone call on the way home to order a pizza (at an off–peak time), that is a low–value use. If the same person made a call in the middle of the same day and closed a big account, that is a much higher–use call, and thus they will be less sensitive to its price. Again, the company does not possess perfect information on what each customer is doing, so they resort to methods that approximate the value delivered.

Segmenting by Purchase Quantity

Quantity discounts are usually based on volume, order size, step discounts or two–part prices. Customers who buy in large volumes tend to be more price sensitive, less costly to service and have more incentive to shop for a cheaper price. Thus, they are offered volume discounts. When offering discounts to business buyers, one must be careful not to violate the antitrust laws against price discrimination, as discussed in Chapter 18. Order discounts are usually given based upon the size of one order. Sometimes it behooves competitors to pool their orders in order to receive these favorable prices and maybe even transportation discounts. Step discounts, on the other hand, don’t apply to the total quantity purchased, but only to the excess beyond a specified amount. The rationale behind this policy is to encourage the individual buyer to purchase more of the item, without discounting the price on smaller quantities for which they might be price insensitive.

Two–part pricing involve two separate charges to consume a single product. Amusement parks might charge an entrance fee and then price tickets for certain attractions extra. Rental car companies use a flat price plus a price per mile, health care and country clubs charge both membership fees and monthly dues, while night clubs charge a cover at the door as well as for drinks and food.

Segmenting by Product Design

Different versions in a product or service offering are a very effective way to segment a market. Premium gasoline, for instance, only costs the oil companies approximately $0.04 more in refining, but sells at the pump anywhere from $0.10 to $0.15 more. Business travelers value highly the ability to change, on short notice, their tickets, and thus one advantage to paying the higher prices they do is this privilege. This is one reason airlines require positive identification of the passenger; otherwise, firms would soon start-up to purchase discounted tickets and sell them to businesspeople closer to flight times.

Certainly cosmetics use design features in their packaging and ingredients to cater to different market segments. Cadillac sells for a relatively higher premium over its cost to manufacture than, say, an Oldsmobile, even though are manufactured in the same plants, with slight cost differences.

Segmenting by Product Bundling

Newspapers usually have a morning and evening edition, selling advertising in bundles for each. Restaurants bundle food on the dinner menu as opposed to a la carte, usually at cheaper prices. Symphonies, theaters, and sports teams bundle a package of events into season tickets Why is this such an effective pricing tactic? Because the bundled products have a particular value to different buyer segments. Advertising space in the morning edition of the newspaper is valued more by one segment (grocers, retailers) than by another segment (theaters, restaurants), whereas the reverse is true for the later edition.

Microsoft bundles its Internet access software with its operating system, and new computers come bundled with various software packages. Automobiles can be purchased with various options, and come with standard options, a very effective way to bundle of offerings to different price sensitive segments. Airlines will sometimes bundle entire travel packages, offering golf, tennis, or other activities. Disney’s cruise line bundles a trip to Walt Disney World in Orlando, Florida, as part of the price of the cruise. (See the discussion of menu pricing, and how this type of bundling applies to the professional service firm, in Chapter 12).

Segmenting by Tie-Ins and Meterings

In Chapter 5 we discussed how IBM used to sell their punch cards at a price premium in order to charge a higher price to those who used and thus valued their computers more. Before the Clayton Antitrust Act of 1914, tie–in sales were common. American Can, for instance, leased its canning machines with the requirement that they be used to close only American’s cans. Since the passage of the Clayton Act, the courts have refused to accept tying agreements, except for service contracts where it is essential to maintain the performance and/or the reputation of a new product. While using the tying method with a contract may be illegal, opportunities still exist to use this tactic without contract. For example, razor–blade manufacturers design unique razors that require customers to purchase their blades for refill.

Segmenting by metering is common among photocopy manufacturers, because they know a customer who makes 20,000 copies a month values their machine more than the customer who makes 5,000 copies a month. This tactic is also employed by printer manufacturers, charging a premium for toner cartridges and other supplies, thereby effectively charging higher prices to those customers who use and thus value the product more.

Segmented pricing is among the most effective pricing tactics that a business can employ, and it also among the most difficult. It takes enormous creativity, market and customer research in order to be effective. With the increasing propensity for customers to utilize the Internet to make their purchases, market segmentation will take on a new dynamic. While it will become easier to segment potential customers based upon their profiles and buying habits, it will also require experimentation with different pricing policies. Nevertheless, customer segmentation is a part of any effective marketing strategy, and its potential to add to profitability should never be ignored.

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