Tuesday, 10 July 2012

Price discrimination

The Internet has been abuzz lately with rumours that on-line retailers are wringing extra cash from anyone judged to be rich, by sniffing through their data trail to work out whether they're a big spender. Are you using a Mac? OK, then you're obviously loaded so how about these more expensive hotels...

This article in The Economist gives a flavour of the debate: how deep are your pockets?

But price discrimination is all over the place and you can make yourself a much savvier consumer by opening your eyes to it, which is what I now attempt to do.

Suppose I run a widget factory, and each widget costs me £20 to make and sell. I have two customers: Alice who's willing to pay upto £30 and Bill who'll pay upto £50. What price should I charge? 

If I charge £30 I'll sell two widgets for a total of £60, minus £40 costs leaving me £20 profit. 

If charge £50 I'll lose the sale to Alice so I only sell one widget, but with only £20 costs I make £30 profit.

So £50 looks like the more profitable price, but I've lost a potential profitable sale to Alice. Charging £30 wins Alice's business but costs me £20 in lost profit on the sale to Bill. What I'd really like to do is charge Bill £50 while finding a way to sell to Alice for £30: that way I'd make both sales and come away with £40 profit. Get in! But how?

That is the art of price discrimination, and it's going on all around you. Here are some of the ways it's done.

Packaging. Bill's widget will come in a fancy "Neil's premium widgets" box and inside, the glossy instruction sheet will be full of colour photos of beautiful people gazing into the middle distance. Alice's widget will come in a plain white box marked "Basic Widget", the instructions will look like they were photocopied by a gibbon. There will be no beautiful people. Maybe the fancy box and instructions cost me an extra £2, but I'm happy to spend a bit on paper and cardboard if I can jack the price up by £20. There's nothing to stop Bill buying the Basic Widget, but he likes the shiny box and he wants to believe that the extra £20 he's paying is for more than just the box.

Environment. The premium widgets will be sold through upmarket retailers with fancy addresses, whose shops are immaculately appointed and staffed by yet more beautiful people. All of that costs money, but Bill's paying for it so that's fine. The basic widget will be sold in supermarkets or discount shops. Bill doesn't buy his widgets in those shops, if he even goes in them, so he never sees the Basic Widgets for £30. Even if he hears about them, he prefers the fancy shops and is happy to pay extra for what he considers a higher quality experience and/or product.

Coupons. Forget the premium/basic idea. Suppose I only sell one widget and it costs £50, but if you collect 14 coupons from the local newspaper, get them rubber-stamped at 5 different places then wave them above your head while standing on one leg I'll sell you one for £30. Alice is happy to do a bit of work to save £20 so she collect the coupons. Bill can't be bothered or he thinks there's social stigma attached to using a coupon, so he pays normal price. Since £50 is normal price he doesn't feel he's paying a premium.

Special discount. One widget, one price: £50. Everyone pays the same. Oh...except if you're a student, we have a student discount. Or over 60, we have an OAP discount, too. The game here is to guess why Alice is only willing to pay £30. If it's because she's in some identifiable group of people who're generally less willing to pay high prices, we can offer a discount to that group.  For this to work the group needs to be seen sympathetically by most people, since that's how we avoid a stampede of complaints from the customers left paying the higher price.

Premium product. My widget normally has a plastic on/off switch. It costs an extra £1 to install a fancy metal switch instead. Now it's not just a shiny box, the product has been made fractionally better! That'll be an extra £20, thank you.

Instant gratification. Bill's a busy commuter rushing to work, so I'll stand right in the most convenient spot on the train platform and sell him the widget for £50. He hardly has to break stride. If he cared to walk 2 minutes round the corner he'd find my other shop which is selling the same widget for £30. Here, customers are in less of a rush and are willing to price check a bit more, so I can't get away with the higher price.

Negotiation. The price is marked £50, but if you're willing to haggle you might find that I can be persuaded to offer a discount. Though if you look like a rich tourist you might find that I don't move very far.

Accessories. The widget costs just £30, but please do take a look at my exciting range of accessories. For example, this faux leatherette carry case for just £20: you want to be able to carry your widget, don't you Bill? The price sensitive shopper is likely to ignore this overpriced tat select range of enhancements, but Bill's just paid £30 for a widget when he was willing to pay £50 so he has some extra cash looking for a home, which I am happy to supply.

Shelf position. Neil's Premium Widgets enjoy a prominent shelf position on the end of the supermarket aisle or right at shoppers' eye level. My basic widget, in the plain box, is right down near your left ankle where you may not even notice it. This means I can have both products in the same shop practically next to each other, and still maintain the price difference. Supermarkets are brilliant at this, and they charge large sums of money to suppliers who want their goods positioned on the best shelves (around eye level). Even so, Bill's paying an extra £20 for the premium widget so that should cover the shelf positioning fee.

Social status. This cuts across a number of the tactics from shiny packaging to stocking the premium widget in fancy shops, but also includes money spent on advertising. The idea is to suggest that people who pay £20 extra for the widget in the fancy box are exactly the sort of people you want to be. The people with the basic widget are...well...they're not really your sort of people, are they? If you buy the basic widget you'll look like them, which means you won't be like the sort of people you want to be like. And you don't want that, do you? What would your friends think? Yes, naturally you want the premium widget, and it's just £20 extra, which people like you can easily afford.

In general, the game is to identify people who're willing to pay extra then find a fig leaf to justify your ruse to charge them more. Alternatively, you identify people who refuse the high price then you find a way of selling to them at a lower price while keeping the big spender locked onto the higher price. Preventing the big spender noticing the lower priced alternative, or preventing him from seeing it as a valid alternative, is the big challenge. 

If you're someone who likes to buy quality, someone who's willing to pay a premium for a superior product or a brand name, it's worth asking yourself how confident you are that the premium product actually is any better: have you tried the cheaper version? Sometimes you're paying extra for better quality, sometimes you're paying extra for the exact same thing in a shiny box sold by a beautiful person in a fancy shop. Only you can decide whether that's worth the extra. If you think it is, rest assured someone will be very happy to assist you.


  1. One of the requirements for a perfect free market is perfect knowledge. Therefore provided Bill is aware that he is paying £20 more than Alice for his widgets but is happy to do so because he will happily pay for the extra convenience, packaging, overprices tat, status etc than that is fine. However… if he is being deliberately denied the knowledge of what other people are able to purchase widgets for, then this is hardly a free market principal is it?

    This article is doing good work in itself by increasing the number of people aware of the practice and so creating a market for software that fools other software into thinking you’re a cheapskate who is in no hurry to buy. Yay!

  2. Thanks for the comment, Simon.

    One of the interesting aspects of Bill's purchasing decision is that he may, in theory, have access to all the relevant information but still believe that Neil's Premium Widget is better. Cognitive dissonance and the placebo effect are two fascinating ways in which he can fool himself into believing that the extra £20 is worth it. As Mr Feynman would said "The first thing is not to fool yourself, and you are the easiest person to fool."

    There is good evidence that people prefer expensive wines to cheap wines even when it's the same wine. Similarly, there is strong evidence that branded painkillers work more effectively than generics, even when they have the exact same dose of the same drug. People believe. They *believe*.

    On your second point, I think my main aim was to raise awareness that this idea of sizing up your customer and finding ways to extract more cash from people who appear more willing to spend, is not new. Doing it online is not a clever new trick, it's a new spin on an old trick. But your idea about countermeasures is also good, and I'm sure that will happen, just as it happens in real life.

  3. Also, for an amazing practical demonstration of how much information web sites can pick up about you, and therefore adjust what you see to fit, have a look at this comic:


    The specific cartoon you see is based on a huge number of possible variables. See this page, which tried to document them all:


    It's quite an amazing piece of work in doing so much work to customise the comic, which most viewers will not even notice. Which is the point: we don't notice that what we see isn't what others are seeing unless we get together and compare notes, which we almost never do.