When the price is right: managing price segmentation
Is price segmentation fair? One of the most valuable levers a company has when pricing its products is charging different customers different prices, also known as price segmentation. In essence, a company estimates a buyer’s willingness to pay and does its best to charge as close to that as possible.
Of course, there is no way to tell precisely how much a buyer is willing to pay. So instead companies use different statistics and techniques to divide up the customer base and ensure that those willing to pay more actually do. There are four main ways that companies do that: customer characteristics, transaction characteristics, behaviours and product portfolios. But the question is, is this really fair?
What is fair?
Fair is in the mind of the buyer. If a buyer thinks it’s fair, then it is. On the other hand, when a buyer, or more importantly, when a lot of buyers, think it’s unfair then it’s a problem. In the early 2000s, Amazon used zip codes to help determine the price it would charge. People in wealthier areas were shown higher prices than those in less affluent areas. As a price segmentation scheme, this works exceptionally well, but when this was discovered and published, the outcry was huge. Amazon does not do this anymore.
Price segmentation techniques
The question of fairness really differs depending on the segmentation technique used. Let’s take a look.
The first technique is customer characteristics. You have likely seen these as senior discounts or student discounts. It is also quite common, although Amazon found it to be a problem, to see these based on geography. For example, if you live in Florida you get a discount at Disney World. To make this feel fair to customers, set a high list price and then offer discounts to a specific group. As long as most people find that group reasonable, then they will see it as fair.
A word of caution – there are certain customer characteristics, such as race, that should never be used for price segmentation. And while gender is sometimes used, for example for insurance or ladies night at a bar, be cautious here as well.
Transaction characteristics are what you can learn at the time of the transaction that will help you understand your buyer’s willingness to pay. For example, buyers who need it as soon as possible probably have a higher willingness to pay. Weather, season, day of week, time of day and purchase volume can be characteristics that may drive or indicate willingness to pay. Companies may offer a discount to a sporting event if the weather is bad for instance. Or they may offer discounts on winter clothes as spring approaches.
How you present the differing prices matters though. Gas stations in the US used to have a 2c surcharge if customers paid with a credit card. They got a lot of push back; it didn’t seem fair. Now they offer a 2c discount if customers pay with cash. It’s the exact same thing to the company, but to the market one looks fair and one doesn’t. As with customer characteristics, in most cases you are better off setting a high list price and then offering discounts.
The third technique, behaviours, is about putting hurdles in front of buyers so they have to prove they are price sensitive. The easiest example of this is coupons. Some people use coupons, some don’t. Those who do are more price sensitive. They are willing to invest the time and energy to find and use the coupon. That’s the hurdle. As long as everyone has the ability to find and use the coupons, this technique is seen as fair.
The final method for price segmentation is creating a product portfolio to get different buyers to select different products. First class versus economy class on an airplane is a great example. People pay a lot more for first-class seats even though it’s essentially the same experience as coach just with a little more room and a meal. By creating a different product, the airlines could get one segment to pay them significantly more. Creating high-end versions of products and charging more for them is typically seen as fair.
The problem with fairness and product portfolio pricing arises around race and gender. A department store had two identical versions of a baby doll except one was black and the other was white. So far that’s OK. The problem was they were charging two different prices. It doesn’t even matter which one was more expensive, there was no way that would be seen as fair. (And the problem was fixed as soon as the store found out.)
As a whole, women’s products are more expensive than men’s products. And while we’ve seen stories pop up in major new outlets about this periodically, any uproar around the topic seems to die out quickly. That’s because often product pricing is defensible in this regard. For example, deodorant for men and women costs about the same to make, but women’s is more expensive on average. However, because they are clearly different products with different brands it seems to be accepted. The bigger problem comes when the products are essentially the same except for colour or packaging. A department store (luckily not the same one) had two nearly identical bicycles, one blue the other pink, priced at two different prices. This is pretty hard to justify and it is easy to see why buyers found it unfair.
Just because we can, does that mean we should?
The good news is that buyers all over the world are used to seeing price segmentation. They have learned to accept most of it as fair. This gives companies a lot of leeway to charge more to some customers than they do to others. However, you want to be vigilant to stay on the good side of your customers, to make the price segmentation seem fair. The best advice to achieve this: put yourself in the shoes of each type of buyer. Would that buyer think it’s fair?
Just because we can segment on price, doesn’t mean we should. But if we don’t do it at all, or don’t do it well, we leave a lot of money on the table. Segment carefully.