What is price discrimination?

Price discrimination allows businesses to charge different people different amounts for the same product or service. Can you play this to you advantage?

Costco store front with the text “What is price discrimination?” and The Motley Fool jester cap logo

No one likes to feel that they are a victim of discrimination. However, price discrimination is perfectly legal. In fact, it’s one of the many methods businesses use to maximise profits and keep their customers happy.

There are different kinds of price discrimination. Here’s an explanation, and some examples of where you might find seemingly inconsistent prices.

Types of price discrimination

According to Economics Online, it seems there are three main types of price discrimination.

1. First degree

This form of price discrimination, also known as ‘perfect’ discrimination, is rare and happens only when a business charges each customer a different amount for every unit or service. It involves a seller, in a monopoly situation, knowing exactly what each potential buyer is prepared to pay.

For example, the child in the playground who is the only one with sweets to sell can maximise their profit by knowing how much each child will be willing and able to pay. Businesses can use this principle to determine prices according to location and circumstances.

2. Second degree

Second-degree price discrimination is very familiar. Consumers pay different prices according to the quantity of items they buy. For example, you may find that Sainsbury’s charges £2.10 for four apples, and £2.60 for six. Buy just four apples and you are paying ten pence more for each apple.

3. Third degree

This type of price discrimination divides consumers into groups and charges different amounts for the same product or service. For example, a hairdressing salon might charge students less for a haircut. And people travelling at off-peak times pay a much lower price for a train ticket.

Customers who are part of a membership scheme are also offered lower prices in this way. The most obvious example of this at the moment is different prices in Tesco for Clubcard members. There are two prices advertised on the shelves. Shoppers without a Clubcard must pay as much as double for some items.

The benefits for businesses

Businesses use price discrimination not only to maximise profits but also to enhance efficiency and to get to know their markets.

Discounts for off-peak travel spread the demand more evenly throughout the day, whilst making the maximum amount of money from people who have to travel at peak hours.

Economies of scale are also a factor leading to price discrimination.

By rewarding loyal customers, and changing purchasing behaviours through discounts and pricing structures, businesses can control their consumers. This cushions them against loss, and makes them even more money when demand is high.

Businesses can lure new customers away from competitors with attractive deals. A 0% credit card is a good example of this.

Is price discrimination good for consumers?

It may not be illegal, but price discrimination could be unethical or at least unfair, particularly in the financial and essential services sectors.

New broadband customers are frequently offered better deals than existing customers. Insurance can be vastly different according to age and gender. Vulnerable consumers may not be aware of how they are affected by price discrimination, or be in a position to change their situation to take advantage of lower prices.

Savvy consumers will always be on the lookout for a cheap deal, planning ahead to get the best discounts. This is not possible for everyone all the time, but those who do their homework will be rewarded with decent savings. Often, those paying more are subsiding these savings.

Certain groups of people, particularly students and seniors, will generally benefit from price discrimination. Large families will get better value from their weekly shop than a single adult household. Teachers always pay more for their holidays because they can’t book during school terms. There are winners and losers.

Ways to benefit from price discrimination

There are several ways in which you can benefit from price discrimination:

  • Be aware – keep an eye on prices and know how much things should cost. Otherwise, you won’t know if you are paying too much.
  • When travelling, plan ahead or be spontaneous – book a long way ahead or gamble on getting a last-minute deal.
  • Shop around – large supermarkets price differently. Also, use comparison sites regularly to get the latest deals on energy, broadband and insurance.
  • Be flexible – The most obvious way to avoid higher prices is to shop out of season, particularly for costly items such as boots and coats. Steer clear of prices aimed at tourists and the wealthy.

Price discrimination is here to stay. It’s wise to accept it, be on your guard and take advantage of it whenever you can.