Pricing is one of the most crucial aspects of any business campaign. When companies set their rates, they take a plethora of factors into account. When these factors result in variable pricing for different segments based on specific characteristics, it can result in price discrimination.

Price discrimination refers to the act of selling the same product at different prices to different customers. There are multiple degrees of discrimination based on what strategy is being used to set prices. For a firm to price discriminate, they need to have varying prices for the same exact product but differentiate between markets.

While there are many advantages to price discrimination, it also has a bad reputation among consumers. Is this warranted? Let’s dive deeper into this topic.

3 Degrees of Price Discrimination

The different types of price discrimination can be summarised in the following ways:

• First-degree: Each consumer’s willingness to pay is used as the basis for price setting.
• Second-degree: The quantity of the purchase or the version of the product alters the going rate.
• Third-degree: Using identifiable characteristics, different prices are set for different groups.

On some level price discrimination is very natural, at least in terms of the first and second degree as compared to the third.

First-Degree Price Discrimination

Also known as perfect price discrimination, this form of price setting occurs when sellers charge consumers the maximum payable price. This entails that the consumer will pay the highest possible price for each unit of a good or service. This strategy gains the optimal surplus for the supplier, getting the most from each transaction. Think of an auction or eBay, where prices are determined by the highest bid.

This form of discrimination requires finding out the maximum amount the consumer will pay and charging that, which can be the main issue. Pricing information is difficult to determine without a system in place that clarifies prices for the supplier.

Second-Degree Price Discrimination

While the first degree requires cooperation from the customer and their rates, the 2nd degree of price discrimination involves charging different prices based on the quantity consumed or the version of the product purchased. We see this all the time with supermarkets and supply stores in the form of bulk discounts and other deals. However, there are other variants of this strategy such as menu pricing or versioning, which can be seen in models like freemium vs premium pricing on apps.

Here, different versions of a product are offered at different price points, such as basic, professional, and enterprise software packages. These allow for consumers to be separated into different tiers so that companies can maximise value for different levels of consumer willingness to pay.

Third-Degree Price Discrimination

This one is the most controversial and is often a source of contrition among customers. Here, different consumer groups are identified and different prices are set for them based on specific attributes or behaviours. This can include examples like student discounts, senior citizen discounts, and geographical pricing variations but also situational price changes such as apps charging based on location.

Amazon retail pricing strategies are a version of this when it sets prices based on prior behaviour. Similarly, an extreme form of this can be seen in how companies can charge based on desperation within a consumer segment, which is seen as exploitative. Uber is an example of this when they utilise distinct data points to differentiate prices based on location or time (and other factors we’ll discuss below).

Corporate Pricing Examples

Here are a few price discrimination examples that illustrate how prices are set and what data points they can utilise.

Uber

Uber engages in price discrimination in a number of ways, which can be a great insight into how the company operates. For an example of second-degree price discrimination, you can look at the various types of cars and the prices they offer. These range from larger or high-end cars that cost more to more modest offerings.

For an example of third-degree price discrimination, we can look at how Uber alters prices based on various metrics. Controversially, Uber is capable of checking the battery life on your phone to charge you extra based on the desperation of your enquiry. A data-based price discrimination technique like this utilises sophisticated tracking and pricing techniques.

Airbnb

The Airbnb pricing strategy is a perfect example of price discrimination and its pitfalls (both intentional and unintentional). Users have previously reported instances where prices did not match up for the same listings. This was due to the geo-based pricing scheme the company uses. An app user detailed how when they made a reservation from an international location, they were charged a higher price.

Another PR disaster for the company happened due to its Smart Pricing algorithm. Originally, designed to help hosts set competitive prices, it was found to unintentionally exacerbate racial disparities. Studies showed that Black hosts had wide earnings gaps when compared to hosts of other ethnicities. This disparity has been attributed to the algorithm’s deployment.

The McDonald’s App

The McDonald’s app offers deals and better prices based on a number of factors. The most interesting form of competitive pricing strategy they use is to track the time at which many customers eat. They choose to offer deals at exact moments when some customers would be expected to pay more. Factors that play a role include the time of day, order preferences and habits, financial information, location, weather, and even when they estimate the customer’s payday.

Allegedly, the company tracks people’s lunch times to offer more competitive pricing. Keep in mind that this is not just general lunchtime but specifically the app user’s lunch break, which requires time-tracking. With several data points, they can charge more or less for the same items. This uses option volatility and pricing strategies to induce demand.

The Orbitz Controversy

The company Orbitz provides travel solutions to its users. The company came under fire for using a practice known as “steering” to differentiate prices between Mac users and others. They segmented the Mac users into more expensive hotel choices than PC users, betting on higher incomes in that demographic.

While the company was not showing higher rates for the same hotel services, it showed Mac users more expensive hotel options first. Many felt that this was a betrayal of consumer trust since users wanted to see the best options available to them and this put a thumb on the scale or rearranged the data to create a biased set of choices. Others did view it as a legitimate strategy based on audience findings.

Amazon pricing strategy

Amazon employs algorithms that adjust prices several times a day. It can utilise several data points based on factors like demand, competition, and inventory levels. They also use customer data such as browsing history, purchase behaviour, and location, which can cause consumers to see different prices for the same product.

In terms of second degree price discrimination, they offer exclusive deals and faster shipping to Prime members. They also tend to segment books based on date of release, with newer books being more expensive. If sales continue over time, indicating a profit-making book, they then lower the price to stimulate more sales.

Pros & Cons of Price Discrimination

The benefits of price discrimination include:

• Variable pricing increases profits: The most obvious advantage for the company is that it can optimise profits. It can also provide better pricing structures based on the willingness per customer. If you can charge some customers less, it helps procure their business when it may not otherwise be available under higher prices.
• Can provide better deals: A smart consumer can learn when to make the most of their buying behaviour. By tracking patterns, many users are able to save money.
• Allows for more market access: Some price discrimination measures allow for targeting a more diverse range of customers. Different prices can allow for attracting different economic stratas.

On the other hand, it also has many disadvantages:

• Unfair pricing for certain customers: A price-discriminating monopolist can increase profits by charging whatever they can get away with.
• Can be expensive to implement: As you may have noticed, the majority of the cases we discussed involve massive corporations. This is because price discrimination requires a lot of information and the ability to corner a market or a niche.
• Potentially unethical or illegal: Many governments crack down on certain kinds of price discrimination due to the potential for unfair or exploitative practices.