Have you observed that the fuel prices are higher on motorways? Fuel companies know that a driver needing fuel will pay extra as there is no other pump in the vicinity, and without fuel, a driver will not risk continuing their journey on the motorway. The same fuel company probably offers standard prices in nearby cities. This is an example of pricing segmentation.
Fuel example of price segmentation, Pixabay
Price Segmentation Meaning
Price segmentation is used for many products. Price segmentation divides the market into different segments.
Price segmentation is a strategy in which prices are freely adjusted based on "fences" like time of purchase, place of purchase, customer characteristics, product characteristics, etc.1
Market segments are created based on customers' willingness to pay.
Willingness to pay is defined as the highest price a customer is willing to pay for a product.2
Sometimes, a seller may accept a lower price for a good than what the customer is willing to offer. This concept is known as customer surplus.
Consumer surplus is the difference between the price a consumer is willing to pay to buy a product and the price they actually pay.3
Higher customer surplus means happy customers.
The purpose of price segmentation is to increase profits. Companies cannot employ a 'one-size-fits-all' pricing model, nor can they provide personalised prices for each customer. The best option is to divide customers into groups where each individual in a group is willing to pay the same price for a product.
Price segmentation is also referred to as price discrimination.
Price Segmentation vs Product Segmentation
Even though the names are similar, price segmentation and product segmentation are different segmentation strategies.
Product segmentation involves offering different products to different customer groups per their needs, while price segmentation includes offering the same product at different prices to different customer groups.
If you are a tech-savvy person, you might know about Samsung Galaxy watches. In 2021, Samsung launched the Galaxy Watch 4 and Galaxy Watch 4 Classic. Both watches have similar technical specifications, but the Galaxy Watch 4 Classic is bigger and has a physical rotating bezel. It is an example of product segmentation whereby marketers differentiate products based on the value they bring customers.
On the other hand, have you seen restaurants promoting 15% off takeaways? This is an example of price segmentation. Customers who do not want a dine-in experience receive a 15% discount. Hence, price segmentation includes offering the same or similar products at different prices for different customer groups.
Types of Price Segmentation
There are various types of price segmentation. They are as follows:
1. Customer-based segmentation
In this case, customers' social and economic status is the basis of segmentation. The customer is offered a price depending upon their characteristics. In physical stores, a seller places customers in price segments by asking a simple question: How can I help you? Or what is your budget? Digital stores are equipped with technologies that track customer behaviour, spending habits, past purchases, etc., to offer them deals.
2. Product bundle-based segmentation
Bundles usually cost less than purchasing each product individually. Product bundles cater to customer segments with a lower willingness to pay. Bundling increases buying intentions and customer loyalty.4
3. Product value-based segmentation
Customers' willingness to pay is proportional to the perceived value added to the product. If additional value is added to a product, businesses can charge extra. Businesses can add value via better packaging, fast delivery, etc. You may have observed on e-commerce websites that express delivery costs more than standard delivery. This is an example of price segmentation based on added value.
4. Purchase-time-based segmentation
Prices of products and services vary according to the time of purchase. This strategy is employed to target different customer segments. Common practices for such price segmentation are early bird discounts, peak time pricing, product auctions, and periodic discounts.
5. Purchase location-based segmentation
Businesses perform location-based segmentation based on the location of purchase or delivery of a product. Uber Eats charges you extra if you order food from a restaurant far from your location. Location-based pricing is also affected by competitors present in the area in addition to government regulations.
6. Purchase quantity-based segmentation
Some customers expect to pay less if they purchase a product in large quantities. The group of such customers are motivated to buy if they are presented with offers such as 'buy 2 get one free'.
In the UK, Costco charges customers to be members but offers many quantity-based discounts.
7. Condition-based segmentation
Condition-based segmentation may be regarding the payment mode or service type. In many e-commerce companies, customers who make a single complete payment are rewarded compared to customers who choose an option to pay in instalments.
Price Segmentation Advantages and Disadvantages
Many businesses practice price segmentation to attract different customer groups. Let's evaluate the advantages and disadvantages of this strategy.
Advantages of price segmentation
The advantages of price segmentation are as follows:
1. Enhanced profits: A segmented pricing strategy approaches different customer groups. Thus, the firm makes profits from various customer groups.
2. Increased market share: The price segmentation strategy approaches customers with different pricing, meaning customers from various groups are willing to pay for the product. This can increase a company's overall market share.
3. Flexible pricing: Companies can study market response and modify pricing for segments that showed no profit. The company does not have to change the whole pricing strategy. Hence, it provides flexibility.
Disadvantages of price segmentation
The disadvantages of price segmentation are as follows:
1. Misunderstanding: If management fails to segment the market correctly and inform employees of the pricing strategy, it can create confusion and misunderstanding.
2. Confusion: Consumers may not understand pricing if not stated correctly. Confused customers avoid purchasing from said businesses.
3. Brand image: Consumers are concerned about how much they are paying and what others are paying. If not executed properly, consumers may feel cheated and avoid the brand. Customer distrust may tarnish the brand image.
Pricing Segmentation Strategies
Considering the advantages and disadvantages of the strategy, one may conclude that price segmentation might be necessary for the development of a business. However, marketers must conduct pricing segmentation with deep market research and perfect execution. Let's now observe how companies can implement price segmentation.
There are three types of segmented pricing or price discrimination. The types are:
First-degree discrimination: Each customer pays a different price for the goods or services according to their willingness to pay.
Second-degree discrimination: Different prices are offered to customers buying different product quantities. For example, free delivery if you spend more than £50 or buy two get one free.
Third-degree discrimination: Customers are divided into groups, and each group will pay different prices - for example, 10% off for senior citizens.
The company needs to assess the marketing mix and perform thorough market research before defining its strategy. Three primary conditions must be satisfied to implement segmented pricing:
1. The market must be segmentable with different degrees of demand in each segment.
2. The cost of segmentation must be less than the profits earned from segmentation.
3. Legal - unlawful segmentation can damage a business and incurs hefty fines.
Pricing segmentation strategy implementation
1. Market research
Market research is the most crucial step for segmentation strategy. Considering all the above conditions for price segmentation are satisfied, a business must segment customers and identify their willingness to pay.
Surveys and questionnaires can identify customers' willingness to pay. These results may help businesses decide the degree of price discrimination. Needless to say, it is highly dependent on the product and size of the business. A company producing daily essentials cannot afford first-degree price discrimination.
2. Define segments
Once market research is complete, marketers implement market segmentation. Businesses identify different market segments and define their characteristics. It also helps companies understand their target customers better and identify what motivates them to pay.
3. Implement strategy
The last step includes offering segmented prices to customers and monitoring how they react to them. The company can change prices offered to different segments as per the feedback.
Price Segmentation Examples - Spotify
Spotify is a music-streaming service available for free with ads or premium without ads. Spotify uses pricing segmentation and offers four different pricing plans. Spotify has segmented prices based on the number of people using the service. As seen in the image below, the four categories are:
1. Individuals: Only a single person can use the service.
2. Duo: An account for two people who live together.
3. Family: For up to 6 family members living under the same roof in addition to a dedicated music app for kids.
4. Students: For individuals with high demand for music streaming but cost-sensitive
Comparison of different premium price offerings by Spotify, StudySmarter, Source: Spotify
All premium offers come with a free trial of a month for new users. It is essential to notice that Spotify sells the same service to all customers but at different prices. Spotify is an example of third-degree price discrimination. If we consider the types of price segmentation, it is a combination of bundle-based and customer-based pricing segmentation.
Pricing segmentation - Key takeaways
- Price segmentation is a strategy in which prices are freely adjusted based on "fences" like time of purchase, place of purchase, customer characteristics, product characteristics, etc.
- Consumer surplus is the difference between the price a consumer is willing to pay to buy a product and the price they end up paying.
- Product segmentation involves offering different products to different customer groups per their needs.
- Second-degree price discrimination is when different prices are offered to customers buying different product quantities.
- Third-degree price discrimination is when customers are divided into groups, each paying different prices.
References
- Haws, K. L. and W. O. Bearden (2006). "Dynamic pricing and consumer fairness perceptions." Journal of consumer research 33(3): 304- 311.
- Breidert, C. (2006). WPT in Marketing. Estimation of Willingness-to-Pay. Springer, 27
- Mankiw, N. G. (2014). Principles of economics, Cengage Learning.
- Ahmetoglu, G., Furnham, A., & Fagan, P. (2014). Pricing practices: A critical review of their effects on consumer perceptions and behaviour. Journal of Retailing and Consumer Services, 21(5), 696-707.
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