How To Use Price Segmentation To Maximize Retail Profits

No two customers have the exact same Willingness to Pay (WTP) -- and your objective should be to capture as much of each of your customer’s WTP as possible, while still winning the business.  So do you charge different prices to different customers???  I hope so!!!  (This is price segmentation).   Imagine two customers, Mr. Rich and Mr. Middle Class: Mr. Rich is easily willing to pay $100 for your product. Mr. Middle Class is willing to pay only $75. What should you do? If you only get to set one price you either set it at $100 and only sell to Mr. Rich or you set your price to $75 and sell to both. You can easily do the math to figure out which price makes you the most profit. It turns out if your cost is over $50 you should set your price to $100. If it’s under $50 you should go for $75, but that’s not the point of the article.

What if you could set two prices? Charge $100 to Mr. Rich and $75 to Mr. Middle Class. Then, it doesn’t matter what your costs are, for (as long as they are less than $75) you will make more profit. This is always the case. Price segmentation is more profitable than setting a single price.

Once you start looking for price segmentation you will see it everywhere: Different prices for passengers in the same airplane. Student discounts at movie theaters. Senior coffees at fast food places. Early bird restaurant prices, especially in Florida. Coupons allow some people to pay less. Frequent buyer discounts. Sale events. These are all examples of price segmentation.

Two big issues are probably jumping into your mind – Is it fair? And how do you do it? I'll save the "how to do it" for a later blog, but is price segmentation fair?

In a word, yes! Think about each of the examples cited above. They are standard accepted practices for charging different prices to different customers. Rarely does anybody complain about it not being fair.

Before explaining what is fair, let’s give some examples of what people find unfair:

When retailers hike the price of bottled waters during a natural disaster, that seems unfair. When airlines started charging for checked luggage, an uproar ensued. When Apple dropped the price of the initial iPhone by $200 just two months after release, that was considered unfair to the earliest adopters. Finally, when Coke announced that they were going to increase the prices of a Coke from a vending machine on hot days, that was unfair.

What do all of these have in common? They are changes to the status quo. When companies change their pricing policies such that the outcome is unfavorable to the consumer, then people consider it unfair.

So how do you add price segmentation without upsetting your customers?

Follow this rule: Set list price as your highest price to target customers with the highest WTP. Then offer select discounts to customers with lower WTP.  How do you do that? I’ll show you four proven techniques -- in future blogs.

Let me have your thoughts on price segmentation. Thanks. Mark

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Mark Stiving, Guest Contributor

About Author

Mark Stiving is a San Jose, Calif.-based pricing expert with 15 years' experience speaking, writing, coaching and consulting to help firms increase profits through value-based pricing. He is the author of Impact Pricing: Your Blueprint for Driving Profits; he blogs at PragmaticPricing.com and shares pithy thoughts on Twitter using @MarkStiving.
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