Consider our small experiment. We used one iPhone and one Android mobile to book a one-night stay for the same date and the same type of room at a five-star hotel in Chennai. We reserved the room from the same place at the same time. The tax-inclusive price when booked via iPhone was around Rs 1,700 higher.
The hotel’s algorithm detected the type of mobile used to make the booking and concluded that the iPhone user to be wealthier and willing to pay more.
Does it sound unfair? It may at first glance. But while such pricing strategies undoubtedly increase a company’s profits, they also enhance overall consumer welfare.
Here is why.
What’s price discrimination—and who pays less?
Price discrimination is a strategy where a company charges different prices for the same product or service to different customers or groups, based on their willingness and ability to pay.
Have you ever taken advantage of student or senior citizen discounts, or booked early to get a cheap travel deal? Have you used coupons for discounts, bought a meal deal, or visited a restaurant during happy hours? All these are various types of price discrimination strategies, commonly called customer segmentation.
Let us first look at the history of the English word ‘discriminate’. It originated in the early 17th century from the Latin word ‘discriminare’, which means distinguishing or differentiating. Over time, people began to associate it with a negative outcome. But the word itself has no negative meaning. For example, you and I have discriminating tastes in music and food.
Now, if companies adopt price discrimination, who would they show lower prices to?
It is in the company’s interest to show a lower price to consumers with lower income or utility for the product. Otherwise, these potential customers would not buy the product. So, while price discrimination is done to raise company profits, it also tends to benefit relatively low-income consumers. Even offers such as happy hours and discounts are used more by price-conscious consumers. The company accepts a lower price from some consumers to widen market size and makes up for it by charging higher prices to others.
Tricks of the trade
How do companies know who has a higher income or wealth and who has a lower? Since they cannot directly ask consumers their income, companies have to resort to indirect methods. In the hotel booking case, the iPhone user was considered wealthier. In the cases of happy hours, discounts, or booking a flight in advance, it is about consumers self-selecting the time of purchase.
It’s true that not all iPhone users may have a higher income. Some may have bought their iPhones on credit to make a status statement, but that still reveals their preference for high status. What if their iPhones are gifts? In that case, indeed, price discrimination could go wrong.
What if richer iPhone users start using an Android mobile to book a room? If many wealthier customers find smart ways to sidestep higher prices, then companies will lose out since most purchases would happen at lower prices. In that case, the company is better off abandoning price discrimination and adopting a single average price. However, a single price would be higher than what relatively lower-income consumers pay when there is price discrimination.
Let us take another example where the seller can more easily verify people’s willingness to pay, making it difficult for buyers to mislead them.
Our campus—the Great Lakes Institute of Management— is near Mahabalipuram, a UNESCO world heritage site that includes the famous Shore Temple. The entry fee for Indian citizens is Rs 35, while for foreign tourists (excluding SAARC and BIMSTEC citizens), it is nearly 16 times more: Rs 550! Internationally, too, foreign visitors often pay higher entry fees. Why is that?
The monuments remain the same, but foreign visitors, having travelled a long way to visit the country, are generally more willing and able to pay higher fees. Verifying a visitor’s nationality is easy and quick using a passport, so there’s no dodging it. Without such price discrimination, a single uniform fee would need to be significantly higher than the current rates paid by Indian visitors.
Price discrimination is common in the healthcare sector too. For instance, Dr Devi Prasad Shetty of the famous Narayana Hrudayalaya Limited said in his chairman’s message in the 2019-20 annual report: “We also have an analytics programme to dynamically adjust the surgery package so that we try to match the patient’s ability to pay.”
Also Read: Why surge pricing can spark a brighter future for solar power
A win-win, but not always
With fast-developing new technologies, such as QR code pricing and even online shopping, price discrimination is easier. However, it can backfire and hurt consumer trust and brand loyalty if it leads to exclusion or if customers believe data is being manipulated.
When price discrimination occurs online, consumers do not have negotiating power. In bazaars, where it has been happening for centuries, consumers can negotiate with sellers, and hence, they do not mind.
Also, when surge pricing is used in emergencies or natural catastrophes—which is not on the ability-to-pay principle—it often triggers public outrage. Uber is among the firms that have lost goodwill several times because of such insensitivity.
In sum, firms need to be careful about when and how they use price discrimination. Equally, consumers should appreciate that it can be a truly win-win situation.
Shrivar Todi and Priya Kankariya are PGDM students, and Vidya Mahambare is a Professor of Economics at the Great Lakes Institute of Management, Chennai. Views are personal.
(Edited by Asavari Singh)
Great article! I really appreciate your in depth understanding of such categories & the insights showcased. Really helpful. It’s making me think I should now buy one android phone:)
Transparent pricing cannot be pushed under a rug to justify some warped sense of socialism or economic justice. Why would the authors even want to justify cross subsidising for private players? The Govt does that via different tax slabs. The silly example on healthcare, is just silly and shows that they haven’t really had the misfortune to step inside a hospital. Do they know that hospitals charges are substantially higher for a higher room category patient? Understandably to cross subsidise poor patients in general wards irrespective of what phone one uses.