Business & Finance

Perfect Price Discrimination – Types & Practical Application

Perfect Price Discrimination

Price discrimination or price differentiation is a popular measure of providers’ pricing policy. How so? It has decisive advantages for companies. But what does this term mean and how can price differentiation be applied in practice?

Definition: What does price discrimination mean?

Price discrimination is simply a pricing strategy in a company’s pricing policy. By using perfect price discrimination, providers can charge different prices for the same service or product – without violating the law. A distinction is made between different types of price discrimination.

Since the term price discrimination is now often associated with negative connotations, more and more providers and companies are using the word price differentiation instead of price discrimination.

Legal basis: Are price differentiations permitted by law?

Price differentiation is permitted by law unless companies use it to exploit a dominant position. In Austria, price differentiation based on race and ethnic origin, gender, religion and belief, disability, age (any age), and sexual identity can also be banned.

The basis for bans is the General Equal Treatment Act, in Austria the Federal Act on Equal Treatment.

The different types of price differentiation

Price differentiation can be done in different ways. A distinction is made between temporal, spatial, qualitative, and quantitative as well as personal price discrimination.

Time price differentiation

With perfect price discrimination based on time, you vary your product prices at different times (times, days of the week, seasonal focus) or freely defined periods (opening price, premiere price, early bird price). Decide for yourself whether you

  1. lower the prices in a certain period such as the classic happy hour or
  2. increase the prices such as the fair prices in the hotel.

Spatial price differentiation

In the case of spatial price discrimination, prices are adjusted to local circumstances. It is widely accepted that you naturally charge different prices for your products or services in different countries.

After all, you have to take into account customs duties, taxes, different demands, and income levels in the respective country in your pricing. However, micro-locations also enable different pricing for your products and services: higher prices apply in airports or train stations. And the sign service that is closest to the registration office usually has the highest price.

Personal price discrimination

In the case of personal price discrimination, the price varies depending on the person or customer group. A product is therefore sold at different prices to different target groups. In this way, the willingness to pay for all customer groups can be fully exploited.

Quantitative price differentiation:

With quantitative price differentiation, the price of a product falls as larger quantities are sold. This form of price differentiation, the volume discount, is well known and is often even demanded by many customers.

Qualitative price differentiation:

Customers have no problem at all if they get higher quality for a higher price. What is important is what the customer perceives as higher quality. For example, a different color or a different choice of material for a product does not necessarily have to result in higher costs. The main thing is that the product is perceived as more valuable.

What are the three degrees of perfect price discrimination?

In economics, however, price discrimination is divided into three degrees. However, the three degrees of price differentiation overlap with the types of price differentiation presented above.

The 1st degree of price discrimination

The first degree of price discrimination is also known as “perfect price discrimination”. The reason: Every customer pays the price that is perfect for him, i.e. the price that the consumer can pay for the product or service based on his willingness to pay. Through this price differentiation, a company achieves a consumer surplus of 0. The consumer surplus represents the difference between the willingness to pay and the actual purchase price.

The first degree of price discrimination is difficult to implement in practice since on the one hand the individual customer’s willingness to pay is not always known and on the other hand, the products cannot always be sold at different prices.

Nevertheless, some practical examples allow perfect price discrimination. This includes, for example, auctions and targeted price negotiations.

The 2nd degree of price discrimination

In the second degree of price discrimination, the product is made available on the market in different variations, giving the customer the choice of which product he would like to consume. The variations often result from the quantity, the quality of a product, and different product versions.

The second degree of price discrimination therefore includes the following types of price differentiation:

  • quantitative price differentiation
  • the qualitative price differentiation
  • the price differentiation over time
  • spatial price differentiation

Despite self-selection by the consumer, a consumer surplus of 0 cannot usually be achieved with the second degree of price discrimination.

The 3rd degree of price discrimination

The third level of price discrimination involves market segmentation. The market is usually segmented into different customer groups with different willingness to pay. In this way, perfect price differentiation and thus a consumer surplus of 0 should also be achieved.

In practice, however, market segmentation requires extensive market knowledge and thus distinctive market research. Classic examples of the third degree of price discrimination are senior or student discounts.

These price differentiations require sensitivity

If you use age, origin, gender, or income as arguments for a different pricing, extreme caution is required:

  • Seniors’ prices are accepted in principle, but anyone who is entitled to the seniors’ price must be justified acceptably for those affected. If you take the age of 65 as a condition for the senior citizens’ prize, you deny the senior citizens’ prize to numerous early retirees, who may also belong to the socially disadvantaged. It is better then to dispense with age as an entry hurdle and, for example, to demand a pension certificate.
  • Student and youth prices, as well as family prices, are generally accepted. But in the latter case, caution is called for In many blended families, the father/mother/child principle no longer works.
  • Different prices for women and men are heavily criticized. Anyone who cannot credibly justify why women should pay more for a certain product or service can expect a headwind.

What are the benefits of price discrimination?

Price differentiation offers your company advantages that you shouldn’t do without. These include, among other things

  • the acquisition of new customers,
  • covering niches (sub-markets),
  • dodging the competition,
  • skimming off customers’ willingness to pay,
  • the optimization of pricing,
  • increasing customer loyalty and
  • addressing many different target groups.

and much more!

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