“Discrimination” is a negative word. It is associated with age discrimination, discrimination based on race, etc. So, perhaps unconsciously, we tend to think that “price discrimination” is also an evil to be avoided.
But is it?
As I’ve already mentioned in this blog, price discrimination essentially means charging different customers different prices. That doesn’t sound terribly nefarious.
Before discussing the issue further, let’s note a few basic types of price discrimination (here, we’re talking about discrimination as to end-users or ultimate customers). In increasing order of individualization, we have:
Group pricing. Here, a company will charge different classes of customers different prices. Think about introductory offers for newspaper or magazine subscriptions, or for health club memberships.
Versioned or branded pricing. Here, a company will allow customers to essentially select a group themselves by selecting a version or a brand of a product. For example, a computer device manufacturer may sell a branded product at a higher price, and sell the exact same product under a generic name at a lower price. More technically-informed consumers can select the lower-priced product. More brand-conscious consumers can select the higher-priced product. The various brands or versions have greater or lesser attraction to various groups of consumers.
Individualized pricing. Here, a company will charge individual consumers different prices for the same product — and will presumably offer the product at the maximum price each customer is willing to pay. Professional services may be offered under such a pricing scheme. Large, complex, and expensive equipment sold to sophisticated buyers might also be priced uniquely for each customer. Car dealerships — although they of course have sticker prices — also to a large extent engage in individualized pricing.
As we move from group to branded to individualized pricing, transaction costs are likely to go up. That is, it is cheaper to set a single price for every bottle of soda that you sell than to set multiple pricing tiers or to haggle over soda pricing with individual buyers. Why, then, do companies ever engage in price discrimination?
The answer is that companies can sell to more consumers if they engage in price discrimination. For example, suppose a bottle of soda costs $0.50 to manufacture and transport to the point of sale. And suppose that the soda company’s profit-maximizing price for each bottle is $1.50. If the company sells to everyone at $1.50, it will lose some higher-priced sales, because some people will be willing to pay more than $1.50 for soda (e.g., people attending a baseball game and who are very thirsty). Secondly, the soda company will lose sales to people willing to pay more than $0.50 but less than $1.50. Price discrimination may allow the company to capture these otherwise lost sales.
Under this theory, price discrimination can actually increase consumer (and overall) welfare. By engaging in price discrimination, the soda company can sell to additional, thirsty customers who otherwise would not have soda to drink.
So why is price discrimination ever thought to be a bad idea, and why is it sometimes unlawful? I will address that question in an upcoming post.