So now we're going to do some pricing segmentation and that's about what it sounds like. We're going to group customers into different buckets, into different groups. Why are we going to do that? Well, we're going to charge different prices to them. Now, turns out this is often a very profitable thing to do. You might remember this from a previous course, or maybe you've seen something that looks like this before. This is a demand function, right? We've got quantity on the horizontal axis and price on the vertical axis. Then I have a demand function sitting right here, the nice linear demand function. And then this is marginal cost. So we have a constant marginal cost. Now, if I'm pricing and setting a single price in the marketplace, what I'm going to try to do is find the price that maximizes profit. And profit on this graph is this green box right here. Why is that the case? Well, you're selling Q*, you're pricing it in P*, so those two things multiplied together are kind of the area of this box. And then you have to subtract out this little part down here. That's not profit because you got some cost associated with that. So that's the profit you would make setting one price. Now, it turns out you can often do a bit better than that. Now, look at this particular graph, look at the grey shaded areas. What's that? Well, this entire triangle, include the green box right here, is the total amount of profit available in the marketplace if you are able to charge everyone their willingness to pay. I mean, you would like to get the person that's even willing to pay just down here, just a little bit of money. Why? because they're still willing to pay more money than your marginal cost. You'd also like to get the people way up here, right? They're willing to pay a lot. The key is, in order to do this right, and in order to capture some of this grey area profitability, you've got to get the people who are willing to pay a lot to pay a lot, and still capture some value from those individuals who are willing to pay a little, but more than marginal cost. The key here though is you want to make sure that these individuals who are willing to pay a lot don't end up coming down here and paying a little. So you have to set up some barriers to make it difficult for that to happen, and that's the essence of price segmentation. And we're going to talk about some tactics for making that happen in real world situations. So let's start by doing that. What does it take to really practically serve a customer segment? But there are different ways you can do it. One is straight up identification. And that's just what you would normally think of the word identification. In this situation what you do is you identify individuals, perhaps by a card they're carrying in their wallet or their person. The key to this tactic is to make sure that these different groups, these different identity groups have different willingness or ability to pay. That's why in the marketplace you'll often see things like senior citizen discounts, or student discounts, or military discounts. It's not that the businesses are doing this out of the goodness of their heart. I mean, they're good business people, I'm sure they like doing that, but it's also more profitable for them. Why? Because someone who's a student, someone who might be elderly, or someone who might be in the military may be willing and able to pay less. And there's an easy way to figure that out. You can ask them to show you an identification card and you can get that information. So if there's a way to do that, that's a very nice clean way to do price segmentation and charge maybe two or three different groups different prices. Now, this is legal, all of this I'm telling you is legal under commercial law but you gotta realize I mean you gotta follow social norms here. You can't look at someone and say, well you look white, or you look black, or you look Hispanic, so I'm going to charge you a different price, right? That might run afoul of civil rights law. In many cases it would run afoul of civil rights law. So you have to follow social norms and civil rights laws. But in situations where you have these different groups and they do have an ID card, you can use that information to set prices differently. What’s another way to do it? Well, suppose you can’t use that identification card. You can also do self selection. What’s that mean? Well, you can require consumers to do something time consuming or maybe a little bit painful, painful in a broad sense of the word, kind of annoying, in order to get the discount. The reason that works is that people who are willing to take the time and energy to get the discount are often the individuals who are willing and able to pay less, their time costs are just lower. Look at this pile of coupons sitting right here, look at that mess. So if you want to use these coupons you've gotta cut them out, right? You've gotta cut them out of the newspaper or wherever you're getting them. You gotta organize them, you gotta store them, you gotta remember to bring them to the store when you go shopping. So that takes time and it's, for most people, that's not a very fun activity. So that's why businesses put out coupons. Manufacturers put out coupons. Because they know some individuals, people with more time on their hand, perhaps people that are retired, people that don't have really busy jobs, maybe very high paying jobs, right? They don't have that situation in their life. They're more likely to take the time and energy to cut the coupons out. While the people who are very busy, and maybe have a lot of money, they're just not going to do that. This works for coupons, works in a lot of other situations. Think of discount malls. Where do they put discount malls? Do they put them right downtown? No, they don't, they put them out in the middle of nowhere. Why? Because they want to make sure that in order to get the discount, if you to a Brooks Brothers, if you go to an Anne Taylor, you have to drive way out of town in order to get the deal and some people just aren't willing to do that and those are probably the individuals who are willing and able to pay more. So that is a price segmentation mechanism, not by straight up identification, but by setting up a system that makes it easier for some people to get the discount relative to others. Now, third in this group is product lines or versioning. And what does this mean? Well it means that one way to do price segmentation is to set your product line up so that you have some inexpensive products, and then some products which are very expensive. Now, people may naturally self select into the product that they want to buy. The person who has a lot of money is more likely, more tempted to buy the expensive item, but you can still serve the segments who are willing and able to pay less by having less expensive items. Now, marketers of course would like to have lots of products at lots of different prices to segment the market very effectively. Realize there is a marketing and operations trade off here, though. If you have lots of different products, your production process may be more costly. You may have to hold more inventory, and you may have to give retailers incentives to carry all of your product. So you can't go crazy with this. You can't usually make 200 different versions of your product, but making several different versions of your product at different price points can be a very effective way to do price discrimination by setting up these segments. And finally I want to talk to you about dynamic pricing. This is a very common pricing tactic. Takes a couple of different forms. One is, you notice that in some markets, like fashion markets and car markets, what happens is, if I put price here and time, over the course of a particular season the price may come down over time. If you're buying a dress at the beginning of the season in the early spring, you may pay a lot of money for that dress. Now, why do companies set it up that way? Because they know that the people that come in in the early spring want the latest fashions. A lot of them want that newest thing and they want it right now, and they're willing to pay a lot of money for it. After those people buy it, then they'll drop the price down lower and try to capture different market segments who may be willing and able to pay less. The key with that tactic is you can't drop the price too fast, or even the individuals up here who are willing to pay a lot will end up waiting and paying a little. So there are nuances there, but it's very common. Same in the car market, right? As soon as that new sports car comes out, you can get it, but you're going to pay a lot more for it. If you wait nine months later you can probably get a better deal on that car. That is very purposeful price discrimination. The other way this happens is more like this grocery basket sitting right here. Sometimes this is called high-low pricing. What does high-low pricing mean? It means that some products in the store are priced quite high, some are on deal, they're very low, but what the retailer does is he or she mixes that up from week to week. Why do they do that? And do you notice a lot of stores do that? They do that because they know some people are willing and able to pay less, and they're going to shop things on deal. They may go to one store for one group of items and another store for another group of items. And they want those people to come to the store because they can make money on them. They know there is another group that doesn't pay any attention, they're not looking to the feature flyers, they're not cutting out coupons. They'll come to the store and they'll buy whatever's on their list, and they're not going to pay that much attention to price. They want to capture those people as well. So if they had constantly high prices, the low willingness to pay would never come to their store. If they have constant low prices, then the people are willing to pay a lot, well, they'll come to the store but they get a great deal. So what do stores do? They go high, low, and essentially they randomize prices in order to capture both segments of consumers. So what are some practical tactics for price segmentation that leads to price discrimination? One is that identification, ID cards. Self-selection, key there is, make something difficult or painful for the high willingness to pay group to capture, to get the deal. Product lines or versioning, setting up different products at different price points. And finally, this dynamic pricing, changing prices over time to better capture the value in the market place.
