Price Segmentation Yields More Profit At High End

Last month, we discussed price segmentation and how to charge different customers different prices based on customer characteristics, their behaviors, and transaction characteristics. These are all techniques on how to charge different prices for the same product. This month, let’s look at the most powerful price segmentation tool of all, your product portfolio:

The Example

A commonly-experienced example of price segmentation is in the airline industry. First class seats cost between 5 and 20 times the price of a coach seat on the same flight. (Go ahead and look some up.) There is no way it costs an airline five times more to service a first-class passenger than a coach passenger. Why such a large disparity?

It’s because someone who can easily afford a first-class ticket will happily pay the price for the easier travel. Meanwhile, those of us who cringe when we pay the seemingly high prices for coach tickets are happy to get to our destination.

Notice that everyone makes their own choice. We choose coach because we don’t think the difference in service (or seat size) is worth the much higher price. But wealthy people think paying for more comfort is easily worth it.

Now look at this from the airline’s perspective. They simply created two different products (classes of service) targeted at different audiences and priced according each market’s willingness to pay. This is price segmentation using products.

In Retail

As a retailer, you can and should do the exact same thing to maximize your profits. For now, let’s think of having two classes of products, entry level and high-performance.

Entry level: You want to establish your entry level product so it attracts the most price-sensitive market you are willing to service. If you are a high-end retailer, you are not trying to capture all customers. For example, if you are a high-end watch retailer you may say TAG Heuer at $1,000 is the lowest priced line you will carry. But if you’re Watches R Us you may want to carry some watches around $10 or less.

Your entry level products attract and capture your most price-sensitive customers.

High-performance: These are the products you offer to make more profit from the customers who are less price sensitive. You should have a higher gross margin percentage on these, so not only are they more expensive, but you are getting a much better return. Back to our watch example, these might be Rolex’s at $10,000 per watch for the high end retailer, and they might be Fossil watches at $79 for Watches R Us.

The point is to use your aggressive pricing on the entry-level products to attract customers, essentially telling everyone you have low prices. Then make decent money when you upsell the less price-sensitive customers.

Your higher end products provide much more profit.

Summary

You likely already have a product portfolio. Now it’s time to take a look at how you priced it. Price your lowest end as aggressively as possible. Price your upper end with more cushion, and focus on upselling customers who are less price sensitive. You will win more customers and make more money.

I’d like to hear 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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