You may well find this post simply more informational than inspirational…hopefully if nothing else, maybe some “fun” reading. I’m not here on this go around to convince you one way or another. I simply find this subject fascinating because it deals with one of the four basic tenets of marketing…pricing; more specifically, differential pricing. Before I go on, to select the correct pricing strategy can prove crucial in “moving” your product or service. How you price what you offer and to whom for how much is worth serious consideration.
Whether you know it as differential pricing or price discrimination, it is the same thing. Another glaring fact that goes along with this strategy…some people like it, and then some people don’t. First of all let me provide you with a nutshell explanation of differential pricing. On a very basic level it is when a business offers their products and/or services at different prices to various marketing segments. In laymen’s terms, selling your product or service at varying prices based on specific customer characteristics. For example, the price is determined by the customer’s income or age.
The use of differential pricing in marketing of a firm’s products and services is a very aggressive pricing strategy. The fact that some people see differential pricing in a “very gray area” and hence do not believe this pricing strategy should be employed. Opponents claim differential pricing is an anti-trust violation, where proponents report that differential pricing gives the firm the ability to market products or services to consumers of whom would not normally be able to afford the product or service.
Tom Weir’s article, “FTC Raises the Ante with McCormick Order” takes the opposition viewpoint. Wier cites the ruling against McCormick and Company by the Federal Trade Commission (FTC). Here’s a little overview, after a four-year dispute the FTC ordered McCormick to restrain from utilizing price discrimination in the supermarket channel, and explore antitrust implications of slotting fees and other practices. The circumstances that brought the FTC into the dispute was Burns Philips Foods, makers of the Spice Island line, complaint that McCormick was using differential pricing to gain an unfair advantage in the market. Burns Philip Foods point of contention stated that McCormick was using this strategy to market McCormick products to one retailer more cheaply than to competitors. Weir (2000, p. 2) says that the FTC discovered, “At least five instances where McCormick favored one buyer over another without such justification and commonly demanded as much as 90 percent of the retailer’s shelf space in exchange for the lower deal rate.” Weir specifies that incentives were offered to retailers in the form of up-front cash payments, free products, off-invoice discounts, cash rebates, and performance funds.
The FTC concluded that, “competition in general at the retail level was harmed by McCormick’s trade practices.” The decision by the FTC is two-fold.
1. The retailers that paid lower prices received an unfair competitive advantage.
2. The FTC was not able to determine if the discounts were passed on to consumers or simply added to the retailer’s bottom line.
Not a very “glowing” recommendation of price discrimination, huh? Price discrimination believe it or not that there are benefits for companies marketing goods and services, as well as consumers that purchase those goods and services. Obviously, the article does not propose the benefits of differential pricing. Therefore – ergo- hence, let’s take some time and take a mite of look for some clarification and delineation of price discrimination? Are you game for that?
Implications of Differential Pricing
Okay, so we have already established that differential pricing is the selling of a specific good at more than one price. Personally I like the sound of differential pricing over price discrimination. Anyway…movie theaters, airlines, restaurants, magazines, and computer software companies are a sample of industries that utilize this pricing strategy. There is an important factor that must be present. Price discrimination is present when the exact same product is sold to different consumers at different prices.
How about a little economics lesson? Prices are based on price elasticity of demand in the marketplace. Therefore, price discrimination is only profitable if and when specific target group’s price elasticity of demand differ to the point where specific prices for the specific consumer groups yield to profit maximization for each group. In the case with all consumer groups, marginal revenue equals marginal cost. In other words, the broader the price range consumers are willing to pay the broader the price range businesses are able to charge for specific products and/or services. The key to price discrimination is the ability of the firm to effectively and efficiently collect, analyze and act upon data gathered about the different consumer groups.
There are three basic conditions that must be in place for price discrimination to be effective.
1. Consumers must be divided into, and identified, as groups with different elasticities of demand.
2. The firm must be able to easily and accurately identify each customer.
3. A significant resale market cannot be in existence.
Price discrimination is an effective method for firms to sell a higher quantity of goods and reap a higher profit margin on products the firm sells. This form of pricing also allows businesses to build a broader consumer base.
Anonymous (2000 February). Coalition for a level playing field llc et al vs. autozone, inc. et al. [3 pages]. LawMall.com. Available: http://www.lawmall.com/autopart/ap_comp1.html#Sum
Ault, R., Beard, T., Laband, D., & Saba, R. (2000 October). Rebates, inventories, and intertemporal price discrimination. [10 pages], Economic Inquiry. Available: http://proquest.umi.com
Baumol, W. (1999 Winter). Having your cake: how to preserve universal-service cross subsidies while facilitating competitive entry [11 pages], Yale Journal on Regulation. Available: http://proquest.umi.com
Belobaba, P. & Wilson, J. (1997 April). Cleaning up on yields. [7 pages], Airline Business. Available: http://infotrac.galegroup.com
Ben-Zion, U., Hibshoosh, A., & Spiegel, U. (2000 November). Price discrimination by coupons restriction. [7 pages], Abingdon. Available: http://proquest.umi.com
Carroll, K. & Coates, D. (1999 October). Teaching price discrimination: some clarification [17 pages], Southern Economic Journal. Available: http://proquest.umi.com
Fact Monster. (2000). Robinson-patman act [1 page], FactMonster.com. Available: http://www.factmonster.com/ce6/history/A0842115.html
Fishburn, P, & Odlyzko, A. (2001). Dynamic behavior of differential pricing a quality of service options for the internet [1 page], AT&T Labs-Research. Available: http://www.research.att.com/~amo/doc/differential.pricing.abst
King, S. (1999 June). Price discrimination, separation and access: protecting competition or protecting competitors. [19 pages], Australian Journal of Management. Available: http://infotrac.galegroup.com
Kiser, E. (1998). Heterogeneity in price sensitivity and retail price discrimination. [6 pages], Journal of Agricultural Economics. Available: http://www.oclc.org
Klewin, B. (2000 October). It’s time to rethink old lending strategies. [2 pages], Credit Union. Available: http://proquest.umi.com
Nielsen’s, J. (2000 March). Profit maximization vs. user loyalty. [2 pages] Jakob Nielsen’s Alertbox. Available: http://www.useit.com/alertbox/20000305.html
Nielsen’s, J. (1997 August). Loyalty on the web. [3 pages] Jakob Nielsen’s Alertbox. Available: http://www.useit.com/alertbox/9708a.html
Park, D. (2000 Winter). Price discrimination, economies of scale, and profits. [9 pages], The Journal of Economic Education. Available: http://oclc.org
Prada, V. (1999 July). Price discrimination does not support inference of collusion. [2 pages], Sidley and Austin. Available: http://www.vprada.com/antitrust/summaries/9909-023.htm
Reece, W. & Sobel, R. (2000 April). Diagrammatic approach to capacity-constrained price discrimination. [9 pages], Southern Economic Journal. Available: http://oclc.org
Shugan, S. & Xie, J. (2000 October). Advance pricing of services and other implications of separating purchase and consumption. [17 pages], Journal of Service Research. Available: http://proquest.umi.com
Solingo, R, & Myers-Jaffe, A. (2000 January). A note on saudi arabian price discrimination. [11 pages], The Energy Journal. Available: http://infotrac.galegroup.com
Stavins, J. (2001 February). Price discrimination in the airline market: the effect of market concentration. [9 pages], Review of Economics and Statistics. Available: http://infotrac.galegroup.com
Truett, L. & Truett, D. (2001). Managerial Economics. Cincinnati, OH: South-Western College Publishing.
Varian, H. (1996). Differential pricing and efficiency. [16 pages], First Monday. Available: http://www.firstmonday.dk/issues/issue2/different/
Von Mises, L. (2001). Price discrimination on the part of the buyer. [1 page], Ludwig von Mises Institute. Available: http://www.mises.com/humanaction/chap16sec11.asp
Von Mises, L. (2001). Price discrimination on the part of the seller. [1 page], Ludwig von Mises Institute. Available: http://www.mises.com/humanaction/chap16sec10asp