Why do brands charge different prices for different customers for nearly identical products\/services? Is the higher-priced product really significantly better than its lower-tier option?<\/p>\n\n\n\n
It’s no secret that companies can charge different prices for different customers. Once you realize that sellers base their prices in part on what they think you\u2019re willing to pay, you can make better decisions<\/a> about what you buy, where you buy it, and how much to spend on it.<\/p>\n\n\n\n In this article, we’ll explore how companies can charge different prices to different customers, and what it means for you as a buyer.<\/p>\n\n\n\n\n\n\n\n While individuals and companies can look to profit from scarcity, they don\u2019t have ultimate power over their consumers. No matter how scarce their resource are, if a company sets its price too high, the customer won\u2019t buy what they\u2019re selling. What they can do, though, is employ the strategy of price targeting, <\/em>or setting different prices for different customers.\u00a0<\/strong><\/p>\n\n\n\n A typical Starbucks menu illustrates how companies can set unique price points: They have regular coffees, cappuccinos, or hot chocolates priced at a fairly low rate\u2014let\u2019s say $2. But if you want a larger size, or a special bean, or even a blend of two different types of coffee, you pay more\u2014maybe $3. Customers know it doesn\u2019t cost Starbucks an extra dollar to manufacture these \u201cfancier\u201d items, but some customers are still willing to buy them. The customer who just wants her coffee and is money-conscious might go for the $2 coffee. But the customer who cares less about what her coffee costs and is curious about a particular blend will go with the more expensive option. Businesses are constantly looking <\/em>for the latter customer or the one who doesn\u2019t care as much about the price. <\/p>\n\n\n\n One way for companies to find customers that care less about the price is to rent storefronts in prime locations. For example, storefronts for coffee shops in train stations are desirable. Customers getting a coffee on the way to catch a train are likely to be less discerning about the price, given that they have a train to catch and don\u2019t have time to leave the station and look for a lower-priced option. <\/p>\n\n\n\n However, even storefronts in prime locations need to practice price targeting. If the coffee shops in train stations sell their coffee at too high a markup, even though they\u2019re the only coffee shop in the area, people will just forgo their coffee. But if they sell coffee at too low of a price, they won\u2019t make enough money to turn a good profit, because their rent is so high due to the desirable location. This is why setting different price points, <\/strong>so that people who are willing to pay more will, and people who aren\u2019t won\u2019t (but will still buy something<\/em>), works so well. <\/p>\n\n\n\n There are three ways that businesses go about finding desirable customers: <\/p>\n\n\n\n 1. The first strategy is to think of every customer as a \u201cunique target.\u201d <\/strong>The sellers in this scenario attempt to sell each of their products at the highest price that each customer is willing to pay. However, it requires a lot of time, energy, and skill as a salesperson to ascertain exactly what each customer is willing to pay. This wouldn\u2019t work for a coffee shop, for example. Generally, it\u2019s salespeople renting homes or selling used cars who will employ this strategy. The items sold have to have enough value that it\u2019s worth the time of the salesperson to figure out their customer\u2019s price.<\/strong> While this strategy is time-consuming, it\u2019s also theoretically how salespeople can make the most money, because they\u2019re charging each one of their customers exactly how much that customer is willing to pay. <\/p>\n\n\n\n Because it can be so profitable, companies have started attempting to automate this process. Some supermarkets, for example, will give you \u201cloyalty\u201d or \u201cdiscount\u201d cards, which lets them track what you are purchasing (and thereby what you are willing to buy). It\u2019s not a perfect system, because the data only lets them provide individual customers with coupons to lower <\/em>the price of some goods, but it\u2019s still an attempt to understand each customer\u2019s individual preferences. In the past, large internet companies like Amazon have experimented with charging some customers more money for the same product than others based on their purchasing history, but when customers found this out, they were angry, and Amazon had to stop the practice. <\/p>\n\n\n\n 2. The next strategy is to split customers into groups and charge each group different prices. <\/strong>While people were angry at Amazon for charging different prices based on individual purchasing tendencies, they don\u2019t tend to get upset about group discounts or price hikes. Think about how museums will charge less money for students and the elderly, who likely have less disposable income, and the grand majority of people find this fair. <\/p>\n\n\n\n We should remember, though, that companies doing the group strategy are not truly concerned with what their customers can afford. Rather, they\u2019re concerned with what customers are willing to pay. At Disney World, they have a 50 percent discount for locals. This isn\u2019t because everyone who lives near Disney World is poor, but because they\u2019re less willing to pay full freight given that they live in the area and are not on vacation, a time when many people are more careless about money. The people who live near Disney World might come four times a year if Disney World reduces prices, while vacationers will almost certainly go only once a year at most, no matter the price. Essentially, what every business should ask themselves is how much less are we selling when we raise the price, and how much more are we selling when we lower the price? <\/strong>We\u2019ll call this question price sensitivity. <\/em><\/p>\n\n\n\n 3. The final strategy is to let customers tell <\/strong>you <\/em><\/strong>how much they\u2019re willing to spend on a good or service. <\/strong>This is called price targeting<\/em>. <\/strong>This is what coffee shops like Starbucks do: By offering goods that are just slightly different from one another, they\u2019re basically asking customers how much they would like to pay for their coffee. Obviously, this is a simplification. When two products are similar (but not the same), it\u2019s difficult to know whether a company is trying to price target or whether one product is simply more expensive for the company to produce. However, companies are attempting to make as much money as they can, so it\u2019s probably more likely that if two products are similar but one costs a decent amount more than another, the company is price targeting. <\/p>\n\n\n\n This doesn\u2019t just happen with similar products. As we described in the introduction to this section, where a store is located will likely change how they price their goods as well. For example, if they\u2019re closer to a major transportation hub, products will be more expensive. Customers could always walk to a less expensive place a ways away, but it\u2019s not worth the walk for enough customers that these places continue to make money. <\/p>\n\n\n\n Generally, successful businesses<\/a> also do some virtue signaling<\/a>. Think back to the example of charging children and the elderly less for admission to a museum. It\u2019s hard to object to a decision like this, as it looks like a public good. The most widespread example of this in recent years has been the proliferation of organic or fair trade goods. People who are less concerned about how much money they\u2019re spending on their groceries are generally much more willing to buy goods labeled organic or fair trade because they believe these products to be better for themselves and for the world. They are likely correct. But these products are also marked up a lot, <\/em>and supermarkets make a lot of money off of the markups. Rarely will stores put the organic and non-organic versions of the same product right next to each other, because customers would be too shocked by the price disparity. <\/p>\n\n\n\n People think Whole Foods is an expensive grocery store. But compare the prices of regular onions at a Whole Foods to the prices of regular onions at an \u201cinexpensive\u201d grocery store like Safeway. They\u2019re the same. The reason that most customers think Whole Foods is so expensive is that when they\u2019re there, they\u2019re buying expensive goods. A sense of what is \u201cluxurious\u201d is different between Whole Foods and Safeway. Whole Foods stocks more expensive goods, so the scale shifts. While buying seltzer at Safeway might be luxurious, at Whole Foods, it looks more like a basic because of all the more expensive goods around. While the price of regular onions at the two stores is the same, Whole Foods has the option of many more varieties of more expensive onions. Bargains don\u2019t come from \u201cinexpensive stores\u201d but from buying inexpensive goods. <\/strong><\/p>\n\n\n\n As we\u2019ve demonstrated, power in the market comes from scarcity. <\/strong>However, businesses often achieve greater scarcity more from consumers\u2019 laziness than from any unique place they have in the market. Coffee shops or grocery stores next to train stations can charge huge markups not because they\u2019re the only business of their kind in a two-mile radius, but because they\u2019re the only business of their kind in a quarter-mile radius, and people are too lazy or in too much of a rush to search further afield. <\/p>\n\n\n\n These businesses will often even charge wildly different prices within <\/em>their stores, sometimes marking up a vegetable, for example, by a factor of three every few weeks. The people who notice likely won\u2019t buy that particular vegetable the week it\u2019s much more expensive, but a lot of people simply aren\u2019t paying close attention. <\/p>\n\n\n\n While it seems like companies have great power over consumers, there are two major ways where this can go wrong for companies. Here are the potential problems and how companies solve them:<\/p>\n\n\n\nMultiple Price-Points<\/strong><\/h2>\n\n\n\n
Finding Good Customers<\/strong><\/h3>\n\n\n\n
What Does \u201cExpensive\u201d Mean?<\/strong><\/h3>\n\n\n\n
Companies\u2019 Power<\/strong><\/h3>\n\n\n\n