what is Differential Pricing?
A differential pricing strategy allows a company to adjust pricing based on various situations or circumstances. The price variations come in different forms, from discounts for a particular group of people to coupons or rebates for a purchase. In a nutshell it means that certain customers pay less for the same product than others.
It's a strong and effective pricing strategy that takes advantage of a company's position and product offerings to maximize profit. It can be used by a variety of businesses but it works best for services, entry fees and restaurants. The targetted groups are generally thought of as deserving of the discount so those who won't qualify do not feel discriminated against. The discounted prices may come in the form of a temporary discount or a permanent lower price.
Price differentiation can also be seen where the requirement that goods be identical is relaxed. As an example, so-called "premium products" (including relatively simple products, such as cappuccino compared to a regular coffee with cream) have a price differential that is not explained by the cost of production. Some economists see this as a form of price discrimination, providing a means for consumers to reveal their willingness to pay.
Types of Differential Pricing
The most used option is to provide people from a certain group with a lower price. One example is an OAP or student discount on admission to a museum or entertainment facility.
Reduced pricing may come in the form of bulk discounting or bundling of multiple services or goods from your company. For example, your base price may apply for the purchase of one to five units, while a 10% discount applies for six or more units.
Allowing anyone to receive a discount if they use a coupon, apply for a storecard or wait for a sale.
What is essential before implementing a Differential Pricing Policy?
Firstly, your business must be able to identify market segments by their price elasticity of demand – and secondly, the firm must be able to enforce the scheme. This usually entails using one or more means of preventing any resale: keeping the different price groups separate, making price comparisons difficult, or restricting pricing information. The marketing boundary set up to keep segments separate is referred to as a rate fence.
As an example, airlines regularly use price differentiation by charging higher prices for customers with relatively inelastic demand (business travellers) and discount prices for tourists who have relatively elastic demand . The airlines enforce the scheme by making the tickets non-transferable, thus preventing a tourist from buying a ticket at a discounted price and selling it to a business traveller. Airlines must also prevent business travellers from directly buying discounted tickets. They accomplish this by imposing advance ticketing requirements or minimum stay conditions that would be difficult for the average business traveller to meet.
Benefits of Differential Pricing
Offering discounts allows your company to expand to customers who might not otherwise buy your product.
The lower price makes your business more attractive to the groups you target. The company's overall sales increase due to this expanded customer base.
In cases when strategies like coupons, sales or rebates are used, the initial discount gives the new customers a chance to try the product. If they like what they experience, they may continue buying the product at full price when the discount is no longer available.
Disadvantages of Differential Pricing
Your profits on the discounted sales drop since you won't receive the full amount you normally charge. For a permanent lower price such as an OAP discount or lower student rate, this means continued lower profits over time.
If the prices eventually go back up after a sale or the end of a coupon offer, you may lose those new clients who cannot afford to pay full price.
In the case of a physical product being purchased, someone who qualifies for a significantly discounted price could turn around and sell it to someone else for a higher price. This allows the consumer to profit from your product without your company receiving any of the money – they become in effect your competitors.
The end result of a successful differential pricing strategy is maximization of the profit by selling more products at the maximum price a customer is willing to pay. While pricing is only one element of the overall marketing mix, it is an area where there are possibilities to achieve significant differentiation and consumer connection.
The operation of a differential pricing policy provides major potential to seize a very real consumer opportunity. This is the age of the empowered consumer, and those companies that are best able to deliver genuine, relevant and more-highly tailored products and services are in the best position to guarantee real consumer engagement and satisfaction.
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