B2B International
B2B International

May 23, 2007

Following on from part one that was published last Thursday.

The first is what economists call “first-degree price discrimination”, but we could call it the “unique target” strategy: to evaluate each customer as an individual and charge according to how much he or she is willing to pay. This is the strategy of the used-car salesman or the estate agent. It usually takes skill and a lot of effort: hardly surprising, then, that it is most often seen for items that have a high value relative to the retailer’s time – cars and houses, of course, but also souvenirs in African street stalls, where the impoverished merchant will find it worth bargaining for some time to gain an extra pound.


Now, however, companies are trying to automate the process of evaluating individual customers to reduce the time it takes to do so. For instance, supermarkets accumulate evidence of what you’re willing to pay by giving you “discount cards”, which are needed to take advantage of sale prices. In return for getting a lower price on certain items, you allow the stores to keep records of what you buy and then in turn offer you vouchers for discounts on products. It doesn’t work perfectly, because supermarkets can only send “money off” vouchers, not “money on” vouchers. “Money on” vouchers have never been a success.

The second approach, the “group target” strategy, is to offer different prices to members of distinct groups. Who could complain about reduced bus fares for children and the elderly? Surely it must be reasonable for coffee shops to offer a discount to people who work nearby, and for tourist attractions to let locals in for a lower rate? It often seems reasonable because people in groups who pay more are usually people who can afford more, and that’s because people who can afford more are usually people who care less about the price. But we shouldn’t forget that this is a convenient coincidence. Companies trying to increase their profits and get the maximum value out of their scarcity are interested in who is willing to pay more, rather than who can afford to pay more.

For instance, when Disney World in Florida offer admission discounts of more than 50 per cent to local people, they’re not making a statement about the grinding poverty of the Sunshine State. They simply know that for a reduced price, locals are more likely to come regularly. But tourists will probably come once, and once only, whether it is cheap or expensive.

Disney World Florida

This example gets to the heart of things, and tells us what we really mean by “price sensitivity” or “being lavish” or “being cavalier about prices”. The important concept is this: when I raise the price, how much do my sales fall? And when I cut the price, how much do my sales rise? Economists tend to call this “own-price elasticity”. I prefer “price sensitivity”.

Tourists visiting Florida are less price-sensitive than locals, which means that if Disney World raises its prices, locals are more likely to skip a day at the park. By the same token, if the admission price falls, locals may make repeat visits in a way that tourists probably won’t. Being rich is sometimes connected with being insensitive to prices, but not always. Business-class air travel is expensive, because companies are willing to pay and airlines have the scarcity power to take advantage of that fact.

The same is true of discounts at coffee bars for local workers. The AMT bar in Waterloo station will knock 10 per cent off the cost of your coffee if you work locally. This isn’t because the local workers are poor: they include top Whitehall mandarins and the extravagantly remunerated employees of the gigantic oil company, Shell. The discount reflects the fact that local workers are price- sensitive despite being rich. Commuters who pass through Waterloo in a hurry see only one or two coffee bars and are willing to pay high prices for convenience. Local workers pop out of the office at 11am for coffee and could walk in any direction. They can buy from several cafes, all equally convenient, all of which they will have had a chance to sample. They are bound to be more price-sensitive, even if they are rich.

The “individual target” strategy is difficult, partly because it requires a lot of information and partly because it tends to be very unpopular. Despite the difficulties, however, it’s so profitable that companies always explore new ways to do it. The “group target” strategy of discounts for students or locals is less effective, but easier to put into action, and usually it’s socially acceptable. Either will deliver more profits than simply treating all customers as a homogenous mass.

The cleverest and most common way to persuade turkeys to vote for Christmas is the “self-incrimination” strategy. To get customers to give themselves away, companies have to sell products that are at least slightly different from each other. So they offer products in different quantities (a large cappuccino instead of a small one, or an offer of three for the price of two) or with different features (with whipped cream or white chocolate or fair trade ingredients) or even in different locations, because a sandwich in a station kiosk is not the same product as a physically identical sandwich in an out-of-town superstore.

Coffee bean

It’s reasonable to ask how common this tactic really is. Because the products are different, you never quite know whether the company is using a price-targeting trick or merely passing on added costs. It could be that it really does cost 10p more to put fair trade coffee in a cappuccino; maybe cans of whipped cream are expensive to refrigerate and troublesome to clean and the staff hate using them; perhaps large cups of coffee take longer to drink, and so the charge is for table-space not coffee – in which case, charging a higher price is not a strategy to get me to incriminate myself, but simply the coffee shop passing its costs through to me. But I think it’s safe to say that companies are always alert for ways to squeeze the maximum advantage out of whatever scarcity power they have, and price-targeting is the most common way to do that. If it looks like price-targeting, it probably is.