How to Avoid Looking Like a Villain When You're Price Discriminating
Companies that are able to vary pricing without upsetting customers in the process stand to gain quite a bit.
Uber recently came under fire for the widening gap it's allowed to occur, between the fares riders pay and the money drivers earn. The company says it’s charging what users are “willing to pay,” but this practice could be more aptly described as price discrimination.
Semantics aside, Uber’s pricing system charges customers based on what it predicts they might be willing to pay for a certain route. This sophisticated system considers where and when people use the app -- as well as the demand at that moment -- to compute a unique price for each Uber ride based on perceived value.
While some might decry this practice as greedy, it’s a shrewd business move for the ride-hailing service. It’s also an incredibly common business practice, even if people don’t realize that's the case. Why else would the same bottle of ice-cold water cost $1 at your local gas station and $5 at a football stadium? It ends up being a win-win scenario: Customers believe that they've received adequate value from a transaction, and businesses turn a profit while also not running out of products.
Entrepreneurs who are able to walk this precarious tightrope and set prices much higher than cost can rake in far more capital than founders who stick with a flat pricing structure. Here's how that works:
Related: Nailing Down the Perfect Price Point
How to increase prices without provoking consumer outrage
So, if price discrimination is so great, why doesn't every company price-discriminate? It largely boils down to the inherent difficulty. Imagine the owner of a 7-Eleven scrambling to adjust prices on the fly for every walk-in customer. If the price of every Slurpee and roller-grill hot dog were based on a host of situational, data-driven and economic indicators, business would grind to a halt.
The key is to get as close to price discrimination as possible without making your customers feel as though they’re being two-timed. Business leaders who want to dip a toe in the price discrimination waters should carefully consider these five strategies:
1. Differentiate your products.
Differentiation involves offering unique versions of the same base product at varying prices. It isn’t pure price discrimination -- you’re not charging different prices for the exact same product -- but it does help avoid the problem of customers feeling that your pricing model is unfair.
The automotive industry is rife with differentiation. Most cars use the same frames, engines and basic components, but auto manufacturers create various bundles to achieve price discrimination on the sly. A standard model might feature a cloth interior while the deluxe edition includes leather seats. This allows salespeople to use different models to see how high consumers will go on price.
You could convey solutions that are different enough to warrant unique names and prices. You might also allow customers to customize their products, adding on various elements the way you do with an order at Chipotle. A report by Podium claimed that 68 percent of consumers surveyed were willing to pay up to 15 percent more for a better experience. In fact, customers get so excited about tailoring their orders that they will pay extra for the "trouble."
2. Find ways to subdivide your business.
Many brands, especially clothing stores, offer lower-priced selections in dedicated outlet locations. Consumers get great deals, but they have to travel to the outlet and wrestle with fellow bargain hunters. People who value the goods more highly can still pay premium prices for the convenience of buying them in traditional retail establishments, but outlet stores offer a palatable alternative.
Interestingly, research at the University of Texas at Dallas and Northwestern University indicates that outlet centers attract new customers, who often buy full-price products once their income increases.
Any business can respond to this scenario by creating subsets of its production with different customer reputations and valuations. If Walmart wanted to compete with Whole Foods, it wouldn’t simply increase the quality of its goods; Walmart would create separate brands that resonate with affluent customers. Focus on branding, and make sure each audience segment understands the brand you've created. The products might be the same, but the customer experience should be different.
3. Mark down prices.
Stores use sales to lower prices temporarily and attract consumers who are unwilling to pay regular rates. Black Friday and Cyber Monday are great examples of events designed to attract budget-conscious customers. A jaw-dropping 154 million consumers shopped in stores and online this past Black Friday, according to a National Retail Federation survey.
Customers are largely unfazed by sales even though they're a clear example of price discrimination. Retailers might try to spin sales as ways of clearing out old merchandise or rewarding customers for their loyalty, but those promotions are often far from the truth. These perceptions play on customer beliefs, and managers can move more product for a slightly smaller profit. Find a way to make your customers feel that they’re capitalizing on your hardship, and they’ll be eager to do business.
4. Vary prices based on location.
Stores routinely charge different prices for the same goods. You might pay $3 at Whole Foods for an avocado that you could buy for significantly less at your local ALDI: After all, the U.S. Department of Agriculture reports that the average Hass avocado retails for less than $2. The avocado hasn’t changed as a commodity, but the price differential reflects the perceived value to different customers.
Managers should have no qualms about tweaking the prices of their products based on different markets. Your only goal should be establishing the right ambiance to sell merchandise for higher or lower amounts. The notion that an ALDI avocado is less valuable than a Whole Foods avocado is absurd, but consumers accept this reality. Whole Foods displays its avocados in a beautiful arrangement with nary a rotten fruit among its offerings. Because ALDI gives less attention to aesthetics, customers see those avocados as less valuable.
5. Try different prices at different times.
Restaurants are the king of this tactic. Happy hours and early bird specials are designed to fill seats when establishments are usually empty. Restaurateurs would rather make a little profit than none, so they lower prices to entice customers. Data from integrated-point-of-sale provider Cake indicates that bars that offer happy hours enjoy 33 percent higher transactions than those that do not.
To adopt a similar approach, managers must first identify their off-season or off-peak business hours. A pool salesperson in the Northeast could offer a major sale on in-ground pools in December and January to keep inventory moving, setting up a schedule of installs well ahead of the busy spring and summer seasons. Use these slow seasons as justification for lower prices, allowing you to keep sales in the pipeline at all times and cover your fixed costs.
Whether you see it as highway robbery or smart business, Uber has the right idea when it comes to price discrimination. Business leaders in every industry can learn a few lessons from Uber’s approach of catering to customers on their terms.
Companies that are able to vary pricing without upsetting customers in the process stand to gain quite a bit. Look past the naysayer headlines into the economics of the process, and you’ll see a treasure trove of opportunity to increase your company’s reach, value and reputation.
Entrepreneur Leadership Network Contributor