E-Commerce

Price differentiation: types & information, simply explained

Fatih-Kağan Taşkoparan

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Price differentiation: you need to know these types

Prices in retail are the result of supply and demand. From the small corner store around the corner to the global conglomerate, this is one of the fundamental truths of retail. How much a store can charge for a particular product depends on how popular it is and how the other market participants set their prices.

However, not all target groups have the same willingness to pay for every product. For example, there are the technology freaks who always want the latest equipment and the bargain hunters who wait for price developments and specifically look for discontinued models. There are also the brand buyers who remain loyal to their favorite manufacturers and the price-conscious shoppers who look for the cheapest possible no-name products.

It becomes particularly exciting when stores charge different prices for the same products. What sounds strange at first is actually common practice - and it can also help you to maximize your profits.

How price differentiation works: an example

An online store sells a drill for 150 euros and ships it free of charge within Germany, but with a surcharge of 5 euros to Austria. If customers pick it up directly from the connected brick-and-mortar store, they receive a discount of 10 euros. New customers who sign up for the newsletter receive a further discount of 5 euros on their first order. The pricing looks like this:

  • 135 € - with newsletter discount for in-store collection
  • 140 € - without newsletter discount for in-store collection
  • 145 € - with newsletter discount for delivery within Germany
  • 150 € - without newsletter discount for delivery within Germany
  • 150 € - with newsletter discount for delivery within Austria
  • 155 € - without newsletter discount for delivery within Austria

Customers therefore pay different prices for the same drill, depending on their individual starting situation. The customer's destination, personal contribution, newsletter subscription and order history can result in price differences of up to 20 euros.

What types of price differentiation are there in e-commerce?

Price differentiation is a complex lever with which you can significantly increase your profits, depending on the target and product group. A basic distinction is made between the following types of price differentiation:

  • Price differentiation over time
  • spatial price differentiation
  • Factual price differentiation
  • personal price differentiation
  • Vertical price differentiation
  • Horizontal price differentiation
  • Quantitative price differentiation
  • Qualitative price differentiation

Price differentiation over time

Products and services can be priced differently at different times. This can be the case when a store offers discontinued summer collections at summer sale prices in order to make a profit on slow sellers and free up storage capacity before the start of a new season. Even with electronic items, you can still serve target groups for whom the cost price was too expensive a few months to years after market launch.

Spatial price differentiation

This refers to the concept of offering different prices at different locations or differentiating between online and in-store prices. A product that is offered at more remote locations without direct competition is usually noticeably more expensive - for example, drinks at petrol stations in rural areas. The costs of logistical processing usually play a certain role here, but the lack of alternatives to buying from the respective provider is also a price-driving factor.

Factual price differentiation

In contrast, product differentiation is not based on where the customer buys, but how the product is used. A common distinction is often made between private and commercial customers, or between bulk buyers and individual buyers. Because stores can usually sell large quantities of goods to commercial customers, they are happy to grant them discounts - this makes bulk purchases even more attractive for commercial customers.

Personal/horizontal price differentiation

This type of price differentiation is used when pricing is based on personal characteristics, the willingness and ability to pay of individual customers. For example, it is common practice for transport service providers to offer discounts to schoolchildren, students and senior citizens because they are less solvent than other groups of people. This rarely happens with online shopping. But all those who have a customer card also benefit from personal price differentiation.

Vertical price differentiation

It is similar to spatial price differentiation, although factors such as competition and location do not play such a dominant role. Vertical price differentiation occurs when companies divide the market for a product into independent submarkets and pursue their own pricing strategies for each of these submarkets. Each submarket includes all potential buyers in this market - they all pay the price intended for the respective market. One example is car brands that are sold at particularly high prices in certain countries because the manufacturer enjoys a high reputation there.

Quantitative price differentiation

If the final price to be paid depends on the quantity purchased, this is referred to as quantitative price differentiation. Discounts for larger orders or free shipping when a minimum order value is exceeded are common examples.

Qualitative price differentiation

Strictly speaking, this type is not actually a price differentiation strategy but a product differentiation strategy. In this approach, a product or service is offered in different quality levels or qualities. For example, customers can choose between a standard and a premium version of an item or service. The idea can be found, for example, in the different features of smartphone models, but also in first and second class train tickets.

What goals can you achieve with price differentiation strategies?

The primary goal of price differentiation is to maximize profits across all possible target groups. The different types of price differentiation help to ensure that customers with a high willingness to pay leave their money in your store just as much as customers with a low willingness to pay.

The various price differentiation measures can help you attract new customers by enticing them with discounts. Even if you want to establish yourself in new (sub)markets, price is a good lever to get your foot in the door.

In a world with perfect price differentiation, all customers pay what they are willing to pay for a certain product and what is still profitable for the retailer. This is also known as the First-degree price differentiation. In reality, of course, this only works in very few cases.

With the Second-degree price differentiation customers have the choice of accepting a few inconveniences and paying less in return. This is about discounts that are linked to conditions that customers can fulfill themselves. For example, a warehouse sale (spatial and temporal price differentiation) can help prospective customers to spontaneously become buyers of discounted products, while you benefit from the fact that your warehouse empties and frees up capacity for new attractive products.

In the event of a Third-degree price differentiation individuals can no longer decide for themselves which price group they belong to. This is the case, for example, with internationally differing delivery costs and discounts for business customers, from which private customers cannot benefit in principle.

Attention: Can types of price differentiation cause legal problems?

In principle, price differentiation means that certain buyers are given preferential treatment, while others are excluded from these price advantages. In this respect, price differentiation can also be referred to as price discrimination.

This is often the case with long-standing mobile customers who, despite their loyalty to the provider, do not receive the lower rates for new customers.

However, as an online retailer, you don't need to panic now: Under EU law, only unjustified unequal treatment in pricing constitutes a case of illegal price discrimination.

What this means must be clarified legally in each individual case, but you do not have to worry that you will be penalized because you reduce the prices of your products a few months after the market launch or only grant a certain discount to new customers.

However, it becomes critical if you exploit your market power and deliberately demand excessive prices from people who are urgently dependent on your products. At the same time, it is forbidden to systematically force your competitors out of the market with dumping prices that are even lower than the production costs.

Conclusion

Be sure to check the various instruments for price differentiation in order to assess how and to what extent you can optimally exploit the willingness to pay of different customer segments.

You have probably already used some types of price differentiation anyway, without having had their theoretical foundations in mind. Every discount code and every strike price is ultimately a form of price differentiation.

However, it is definitely worth strategically scrutinizing your pricing and taking into account the seasonal, demographic and individual factors of your target groups. However, be aware of the price sensitivity of all your customers, design price differentiations accordingly in an attractive and value-added way and, above all, avoid unjustifiably excluding customer groups.

In the case of critical feedback from people who feel disadvantaged, an unbureaucratic approach on your part can even contribute enormously to customer loyalty.

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