Real World Examples of Differential Pricing
Differential pricing is very prevalent in the real world. Varian (1996, p. 12) indicates that differential pricing goes hand-in-hand with industries that encounter large fixed and shared costs. This would include the airline industry for example. Varian adds that differential pricing is evident in highly concentrated industries that are highly competitive. Varian offers four industries where one will find differential pricing employed. The grocery industry could also be placed with the following groups.
- Airlines – This industry is highly competitive. There are a variety of forms of price discrimination that take place in the airline industry. In fact, you have probably encountered this with airlines on a very personal level. In the industry, it is common for different consumer groups to be offered different fares. Examples of offering different fares for different consumer groups are manifested in senior citizen discounts, major corporation rates, and convention packages. Airlines offer different classes of service such as, first class, business class, and tourist class. Members of the industry are known to offer restricted fares. Consider the use of advanced purchase options or Saturday night stay-over restrictions. Reece and Sobel (2000, p. 2) offer an excellent example of how price discrimination benefits airlines. Consider the case of an airline offering a particular flight with 130 coach seats. The airline may create three fare categories; deep discount, discount, and full fare. These fares would require a 14-day advance purchase and a Saturday stay-over, a 7-day advance purchase reservation and Saturday stay, and no restrictions respectively. A portion of the seats are allocated for each category. One will observe that as the date of the flight approaches, the airline may reallocate seats to different categories depending on sales. The lower fare seats become filled and the category becomes unavailable. What typically occurs is that leisure travelers reserve discount and deep discount seats. Unfortunately for business travelers, restrictions cannot be fulfilled, and a full coach fare must be paid.
- Telecommunications – The long distance telecommunications industry employs many forms of differential pricing. Firms offer quantity discounts to both large and small customers. Companies charge businesses and individuals different rates. The practice of offering calling plans that feature discounted rates based on individual characteristics and usage patterns are very common. Providers of cellular telephone service commonly employ differential pricing. Consumers that are heavy cellular telephone users benefit from cellular telephone firms that institute this pricing strategy. Packages that offer more minutes per month tend to have lower incremental prices per minute, per month.
- Publishing – A book may sell for 40 dollars, but the book can be produced at a marginal cost of two dollars. Book clubs, hard cover and paperback editions, and remaindered books are all examples of how differential pricing is used in the publishing industry.
- Lighthouses – Varian (1996, p. 12) states lighthouses are used because of the historical perspective. The cost of serving incremental users is negligible. The cost to society is zero extra costs to permit one extra ship to use the service. The point is made that, “Hence, any ships discouraged from the waters will represent a social economic loss.” The pricing structures used by lighthouses were quite efficient. The operators of lighthouses charged on a sliding scale based on the number of voyages a trip took per year. It was determined after six to ten trips per year that the incremental price for the service of the lighthouse was zero.
Believe me, there actually are some beneficial aspects to differential pricing to businesses and consumers alike on different levels and under various circumstances. How about I offer some examples where differential pricing proves beneficial to all concerned. Von Mises (2000, p. 1) uses the example of physicians in describing how price discrimination is utilized in a beneficial manner for both provider and consumer. Consider a physician that is able to complete 80 given treatments in a week and charges 30 dollars for each treatment. Assume the doctor is fully employed by attending to 30 patients and makes 2,400 dollars a week. The doctor charges the 10 wealthiest patients, of which normally consume 50 treatments, 40 dollars per treatment. In this condition the wealthiest patients will only consume 40 treatments. The doctor offers the remaining 10 treatments for 20 dollars to patients whom would have not expended 30 dollars for the service. The remaining 30 treatments still are offered for 30 dollars. The physician’s weekly earnings for the treatments after the price restructuring would be 2,700 dollars per week. In this case, not only the physician receives an advantage, but also the patients to whom were charged 20 dollars. In all fairness, it is true in this example the 10 wealthiest patients were damaged.
The ever-changing business world is also experiencing an incredible change in technology. No kidding, huh? New technology has some interesting implications in the economic environment. In a general sense, consider the Internet. Computer technology offers the ability to firms performing business on the Internet to price discriminate much more easily than in the past. Nielsen (2000, p. 1) indicates that it is extremely easy for firms conducting business on the Internet to modify prices to individual consumers. Therefore, different prices can be offered to every consumer based on purchasing history and other tracking information. On a company web site the firm may charge more from those customers that will buy at a higher price. The firm is not constrained by a physical sign with a fixed price in a store.
A user may be monitored as the user moves through the website. If the customer continues browsing the company website without clicking any items into the “shopping cart”, the customer is considered unwilling to buy at the current price, so a discount may be offered. This practice of offering a lower price by the firm on the website may become common knowledge. Then customers may simply click through the website until a discount is offered.
Another strategy used by firms that offer purchases from the company web site is to offer lower prices to consumers that enter the site through shopbots. The shopbots would tend to attract users that are serious about purchasing a good or service. Nielsen (2000, p. 2) also notes that both Etrade and Datek allocate access to “hot” IPO’s to the firm’s most active users.
Safeway uses price discrimination in two efficient methods. Ben-Zion, Hibshoosh, and Spiegel (2000, p. 2) report Safeway utilizes price discrimination through the direct-mail coupon book. This is specifically an example of second-degree price discrimination. The authors state, “Every coupon in the monthly Safeway coupon book is restricted to a limited number of per household.” This method of restriction is more effective when, “Customers are deal-prone, purchase small quantities, and have a high elasticity of demand, while loyal customers are few and purchase large quantities.” Ben-Zion, Hibshoosh, and Spiegel (2000, p. 2) say the purpose of coupon restriction is a means of optimizing price discrimination. The authors continue, “The use of a restricted number of coupons per customer is an effective way of inducing limited and voluntary price discrimination
Safeway also utilizes differential pricing through the implementation of the Safeway Club Card. Kiser (1998, p. 2) reports that cards like the Club Card increase the feasibility of customization of prices to individual households. The consumer, by presenting the card at the checkout counter, allows Safeway to be able to record all of the household’s purchases. Customers are rewarded with discounts on selected items and point-of-purchase coupons. The advantage to Safeway, and other retailers using the technology, is that demand estimation may be performed at the household level and individually tailor coupons. In the case of the coupon book and the Club Card, consumers’ exchange buying products at lower prices for offering Safeway data to help them be more efficient in their purchasing.
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