Pricing Segmentation

Price Segmentation Meaning

Price segmentation is used for many products. Price segmentation divides the market into different segments.

Market segments are created based on customers' willingness to pay.

Sometimes, a seller may accept a lower price for a good than what the customer is willing to offer. This concept is known as customer surplus.

Higher customer surplus means happy customers.

The purpose of price segmentation is to increase profits. Companies cannot employ a 'one-size-fits-all' pricing model, nor can they provide personalised prices for each customer. The best option is to divide customers into groups where each individual in a group is willing to pay the same price for a product.

Price Segmentation vs Product Segmentation

Even though the names are similar, price segmentation and product segmentation are different segmentation strategies.

Types of Price Segmentation

There are various types of price segmentation. They are as follows:

1. Customer-based segmentation

In this case, customers' social and economic status is the basis of segmentation. The customer is offered a price depending upon their characteristics. In physical stores, a seller places customers in price segments by asking a simple question: How can I help you? Or what is your budget? Digital stores are equipped with technologies that track customer behaviour, spending habits, past purchases, etc., to offer them deals.

2. Product bundle-based segmentation

Bundles usually cost less than purchasing each product individually. Product bundles cater to customer segments with a lower willingness to pay. Bundling increases buying intentions and customer loyalty.⁴

3. Product value-based segmentation

Customers' willingness to pay is proportional to the perceived value added to the product. If additional value is added to a product, businesses can charge extra. Businesses can add value via better packaging, fast delivery, etc. You may have observed on e-commerce websites that express delivery costs more than standard delivery. This is an example of price segmentation based on added value.

4. Purchase-time-based segmentation

Prices of products and services vary according to the time of purchase. This strategy is employed to target different customer segments. Common practices for such price segmentation are early bird discounts, peak time pricing, product auctions, and periodic discounts.

5. Purchase location-based segmentation

Businesses perform location-based segmentation based on the location of purchase or delivery of a product. Uber Eats charges you extra if you order food from a restaurant far from your location. Location-based pricing is also affected by competitors present in the area in addition to government regulations.

6. Purchase quantity-based segmentation

Some customers expect to pay less if they purchase a product in large quantities. The group of such customers are motivated to buy if they are presented with offers such as 'buy 2 get one free'.

7. Condition-based segmentation

Condition-based segmentation may be regarding the payment mode or service type. In many e-commerce companies, customers who make a single complete payment are rewarded compared to customers who choose an option to pay in instalments.

Price Segmentation Advantages and Disadvantages

Many businesses practice price segmentation to attract different customer groups. Let's evaluate the advantages and disadvantages of this strategy.

Advantages of price segmentation

The advantages of price segmentation are as follows:

1. Enhanced profits: A segmented pricing strategy approaches different customer groups. Thus, the firm makes profits from various customer groups.

2. Increased market share: The price segmentation strategy approaches customers with different pricing, meaning customers from various groups are willing to pay for the product. This can increase a company's overall market share.

3. Flexible pricing: Companies can study market response and modify pricing for segments that showed no profit. The company does not have to change the whole pricing strategy. Hence, it provides flexibility.

Disadvantages of price segmentation

The disadvantages of price segmentation are as follows:

1. Misunderstanding: If management fails to segment the market correctly and inform employees of the pricing strategy, it can create confusion and misunderstanding.

2. Confusion: Consumers may not understand pricing if not stated correctly. Confused customers avoid purchasing from said businesses.

3. Brand image: Consumers are concerned about how much they are paying and what others are paying. If not executed properly, consumers may feel cheated and avoid the brand. Customer distrust may tarnish the brand image.

Pricing Segmentation Strategies

Considering the advantages and disadvantages of the strategy, one may conclude that price segmentation might be necessary for the development of a business. However, marketers must conduct pricing segmentation with deep market research and perfect execution. Let's now observe how companies can implement price segmentation.

There are three types of segmented pricing or price discrimination. The types are:

1. First-degree discrimination: Each customer pays a different price for the goods or services according to their willingness to pay.

2. Second-degree discrimination: Different prices are offered to customers buying different product quantities. For example, free delivery if you spend more than £50 or buy two get one free.

3. Third-degree discrimination: Customers are divided into groups, and each group will pay different prices - for example, 10% off for senior citizens.

The company needs to assess the marketing mix and perform thorough market research before defining its strategy. Three primary conditions must be satisfied to implement segmented pricing:

1. The market must be segmentable with different degrees of demand in each segment.

2. The cost of segmentation must be less than the profits earned from segmentation.

3. Legal - unlawful segmentation can damage a business and incurs hefty fines.

Pricing segmentation strategy implementation

1. Market research

Market research is the most crucial step for segmentation strategy. Considering all the above conditions for price segmentation are satisfied, a business must segment customers and identify their willingness to pay.

2. Define segments

Once market research is complete, marketers implement market segmentation. Businesses identify different market segments and define their characteristics. It also helps companies understand their target customers better and identify what motivates them to pay.

3. Implement strategy

The last step includes offering segmented prices to customers and monitoring how they react to them. The company can change prices offered to different segments as per the feedback.

Price Segmentation Examples - Spotify

Spotify is a music-streaming service available for free with ads or premium without ads. Spotify uses pricing segmentation and offers four different pricing plans. Spotify has segmented prices based on the number of people using the service. As seen in the image below, the four categories are:

1. Individuals: Only a single person can use the service.

2. Duo: An account for two people who live together.

3. Family: For up to 6 family members living under the same roof in addition to a dedicated music app for kids.

4. Students: For individuals with high demand for music streaming but cost-sensitive

Comparison of different premium price offerings by Spotify, StudySmarter, Source: Spotify

All premium offers come with a free trial of a month for new users. It is essential to notice that Spotify sells the same service to all customers but at different prices. Spotify is an example of third-degree price discrimination. If we consider the types of price segmentation, it is a combination of bundle-based and customer-based pricing segmentation.