Variable Pricing and Price Discrimination Meaning

Variable Pricing

Variable pricing is a pricing strategy for products. Traditional examples include auctions, stock markets, foreign exchange markets, bargaining, electricity, and discounts. More recent examples, driven in part by reduced transaction costs using modern information technology, include yield management and some forms of congestion pricing.

Due to advances in technology, another variant of variable pricing, called “real-time pricing”, has arisen. In some markets events occur so fast that there is insufficient time to either set a fixed price or engage in lengthy negotiations. By the time one has all the information to determine a price, everything has changed. Examples include airline tickets, stock markets, and foreign exchange markets. In each case prices can change in less than a second. By linking all the market participants through internet connections, price changes are disseminated instantly as they occur.

A variant of real time pricing is online auction business model (such as eBay). All participants can view the price changes soon after they occur (technically this is not quite real time pricing because there is a delay built into the eBay system). Traditional auctions are inefficient because they require bidders (or their representatives) to be physically present. By solving this problem, online auctions reduce the transaction costs for bidders, increase the number of bidders, and increase the average bid price.

Sales are a traditional example of discriminatory pricing. During the Christmas shopping season prices are high. Come the new year there are sales. Other examples of sales occur on various goods such as appliances and cars. Electronics, clothes washers/dryers, etc. typically have a season of the year where sales occur. Cars are sold at discounts before the new model year. Discriminatory pricing is not always bad. It helps people who will/cannot pay “list” or even street price an opportunity to buy at a better price if they are willing to wait and/or to buy older models. At the same time it helps merchants clear out old stock and/or items for which they misjudged the market.

This kind of price discrimination is largely and widely used by rental car companies. Usually, those firms need to know their customers’ country of residence so they can adjust the price. Depending on the answer it is possible to get significantly different quotes for the same vehicle, date and time of rental. It is also true when accessing the rental car site through the .com main site.

Electricity real-time pricing allows charging higher prices when demand is highest, which is expected to reduce actual use during peak demand periods, which increases production costs because it drives the expansion of costly equipment.

Models

Variable Pricing based on Location:

Now, this pricing model works on the basis of the location of the store. Stores which are located at the central or mainstream location of the town. Whereas the same store located at the less popular place might sell the same product at lower rates.

The reason behind adopting this model is to increase the foot traffic in those stores. For example, a store of the same brand might sell the same product at high prices than a store located in suburban areas.

Variable Pricing Based on demand:

This model of variable pricing is designed based on the demand for the product. Some products and services are more in demand during a certain period.

During the demand period, the prices of the products raised and are lowered when they are not in demand to let new customers try that product.

For example, the price of hotel rooms at tourist places peak up during the rush season, and another example of this variable pricing model based on demand is the sale on off-season clothes. Usually, stores sell clothes of the winter season on heavy discounts during the summer season.

Variable Pricing Based on Groups:

This is a smart variable pricing model. In this model, the consumers of a product or service are divided into different groups based on their location, type, and demographic information, etc. Then the same product is sold to these different groups at different prices on the basis of their categorization.

However, this model is not liked by most consumers, and there have been many lawsuits filed against this model of variable pricing.

Price Discrimination

Price discrimination is a microeconomic pricing strategy where identical or largely similar goods or services are sold at different prices by the same provider in different markets. Price discrimination is distinguished from product differentiation by the more substantial difference in production cost for the differently priced products involved in the latter strategy. Price differentiation essentially relies on the variation in the customers’ willingness to pay and in the elasticity of their demand. For price discrimination to succeed, a firm must have market power, such as a dominant market share, product uniqueness, sole pricing power, etc. All prices under price discrimination are higher than the equilibrium price in a perfectly-competitive market. However, some prices under price discrimination may be lower than the price charged by a single-price monopolist.

The term “differential pricing” is also used to describe the practice of charging different prices to different buyers for the same quality and quantity of a product, but it can also refer to a combination of price differentiation and product differentiation. Other terms used to refer to price discrimination include “equity pricing“, “preferential pricing“, “dual pricing” and “tiered pricing”. Within the broader domain of price differentiation, a commonly accepted classification dating to the 1920s is:

• “Personalized pricing” (or first-degree price differentiation): Selling to each customer at a different price; this is also called one-to-one marketing. The optimal incarnation of this is called “perfect price discrimination” and maximizes the price that each customer is willing to pay.
• “Product versioning” or simply “Versioning” (or second-degree price differentiation): Offering a product line by creating slightly different products for the purpose of price differentiation, i.e. a vertical product line. Another name given to versioning is “menu pricing”.
• “Group pricing” (or third-degree price differentiation): dividing the market into segments and charging a different price to each segment (but the same price to each member of that segment). This is essentially a heuristic approximation that simplifies the problem in face of the difficulties with personalized pricing. Typical examples include student discounts and seniors’ discounts.

Different Types of Price Discrimination

First Degree Price Discrimination

Also known as perfect price discrimination, first-degree price discrimination involves charging consumers the maximum price that they are willing to pay for a good or service. Here, consumer surplus is entirely captured by the firm. In practice, a consumer’s maximum willingness to pay is difficult to determine. Therefore, such a pricing strategy is rarely employed.

Second Degree Price Discrimination

Second-degree price discrimination involves charging consumers a different price for the amount or quantity consumed. Examples include:

• A phone plan that charges a higher rate after a determined number of minutes are used
• Reward cards that provide frequent shoppers with a discount on future products
• Quantity discounts for consumers that purchase a specified number of more of a certain good

Third Degree Price Discrimination

Also known as group price discrimination, third-degree price discrimination involves charging different prices depending on a particular market segment or consumer group. It is commonly seen in the entertainment industry.