What is differential pricing? (with examples)

What is a differential pricing strategy?

Differential pricing strategies, A.K.A., price discrimination, is when you charge different prices for the same product to different customers.

“A pricing strategy in which a company sets different prices for the same product on the basis of differing customer type, time of purchase, etc; also called Discriminatory Pricing, Flexible Pricing, Multiple Pricing, Variable Pricing.” — Monash Business School

You can make this decision by basing yourself on a variety of factors, such as purchasing behavior, timing, demand, and competition.

But is this strategy better than any others, like prestige pricing or loss leader pricing?

Why do companies use differential pricing?

This strategy may seem odd at a first glance (charging different prices for the same product?) but there are many benefits to it:

Maximize your revenue

You can get more revenue from customers willing to pay (w.t.p.) more while still attracting people who prefer to pay less, leading to you maximizing your revenue.

Serve multiple markets

You can do this by tailoring your offerings to better meet the needs of each segment.

Undercut competitors

Differential pricing can be used to undercut competitors, helping you to increase market share without sacrificing profit.

Secure revenue

Offering lower prices for early purchases can help you to secure revenue in advance and manage demand better. Examples include early bird discounts.

Product versioning

Differential pricing helps with product versioning. If you create different versions of a product or service with varying features and prices, you can appeal to different customers, allowing you to offer a basic version at a lower price while charging more for more features/services.

Geographic location

Orgs may also have different prices based on geographic location to account for different marketing conditions, costs, etc.

Perceived value

Price discrimination helps to manage customers’ perceived value of your products. You can make them appear more accessible and attractive to people without devaluing it for other segments.

Speaking of value, Paul Maguranis, Senior Pricing Manager at Covetrus, discusses pricing in this podcast episode, including how the pricing process for SMEs and large enterprises works. Give it a listen.

How is price discrimination different from other strategies?

Here’s a comparison table to help you decide which strategies are best suited for you and your company.

	Price discrimination	Dynamic pricing	Prestige pricing	Loss leader pricing
Definition	Charging different prices to different customers based on their willingness to pay.	Adjusting prices based on real-time supply and demand conditions.	Setting high prices to signal high quality or luxury status.	Pricing items below their market cost to attract customers and boost sales of other items.
Objective	Maximize profits by capturing consumer surplus.	Maximize revenue or profit based on fluctuating market conditions.	Create a high-value perception and target wealthier consumers.	Drive traffic or increase sales volume; often used in promotional or competitive contexts.
Price sensitivity	Based on differences in customers' price sensitivities.	Reflects changes in market conditions like demand spikes or inventory shortages.	Assumes low price sensitivity; customers are willing to pay more due to perceived value.	Targets price-sensitive customers.
Market segmentation	Essential for identifying and charging different segments.	Less about segmentation, more about timing and market conditions.	Generally targets a narrow, affluent segment.	Broadly targets the market to increase foot traffic or cross-sell higher-margin items.
Price variability	Prices vary between customer segments but are generally stable within each segment.	Prices are highly variable, often changing from day to day or hour to hour.	Prices are stable at a high level to maintain a luxury image.	Prices are temporarily reduced; usually stable outside promotional periods.
Data dependency	Moderate; requires data on customer demographics and buying habits.	High; relies on algorithms and real-time data analytics to adjust prices.	Low; based on brand positioning and market perception rather than real-time data.	Low to moderate; depends on inventory management systems.
Legal and ethical issues	Must be managed carefully to avoid discrimination accusations or breaching regulations.	Needs careful handling to avoid customer backlash over perceived fairness.	Few concerns unless pricing is misleadingly high compared to product cost or quality.	Must ensure it does not lead to unfair competition as per local laws.
Customer perception	Risk of negative perception if customers feel unfairly treated.	Risk of alienation if customers see prices as unfair or manipulative.	Enhances brand prestige and exclusivity; positive if aligned with customer expectations of luxury.	Generally positive if customers feel they are getting a good deal; can be negative if seen as bait.

What conditions do you need to meet to implement differential pricing?

Price discrimination can be a beneficial strategy for companies seeking to maximize profits, but you must meet certain conditions in order to implement it effectively.

You must have some control over the prices you charge, since you need the ability to adjust pricing based on buyer segments.

Your customers must differ in their sensitivity to price changes, which allows you to charge higher prices to those less sensitive.
The ability to segment markets is crucial, since you need to know who’s willing to pay what, buyer consumption habits, etc.
Mechanisms must be in place to prevent or limit the resale of products from lower-priced to higher-priced markets. If consumers could resell, price discrimination doesn’t work because products would be sold at the lowest possible prices.
You must comply with local and international laws and remain ethical.

As Robert Phillips, in his book Pricing and Revenue Optimization (2005), says:

“If price differentiation is such a powerful way for sellers to increase contribution, why don’t all of them do it? The reason is that there are powerful real-world limits to price differentiation.

“1. Imperfect segmentation. The brain-scan technology required to determine the precise willingness to pay of each customer has not yet been developed. The best that can be done is to create market segments such that the average willingness to pay is different for each segment.

“2. Cannibalization. Under differential pricing, there is a powerful motivation for customers in high-price segments to find a way to pay the lower price. In the widget example, there is a strong motivation for high-willingness-to-pay customers who are being charged $8.75 per widget to ‘masquerade’ as low-willingness-to-pay customers and pay only $6.00 per widget.

“3. Arbitrage. Price differentials create a strong incentive for third-party arbitrageurs to find a way to buy the product at the low price and resell to high-w.t.p. customers below the market price, keeping the difference for themselves.”

Types of price discrimination

First-degree

This type of price discrimination means that sellers charge customers the maximum price they’re willing to pay. For example, imagine an auction – the highest bidder will always win by paying the maximum bid.

This strategy is often found in industries with high fixed costs.

However, a downside of first-degree price discrimination is that it takes a long time to implement and perfect, since you need detailed information about your customers, which can be challenging info to gather.

Second-degree

The second-degree price discrimination is all about charging different prices based on quantity consumed or version of the product. This includes bulk discounts, coupons, and product versioning (e.g., software with basic and premium versions).

This type of price discrimination can lead to a boost in sales by encouraging bulk buying, and it’s also easy to implement and manage, since you don’t need an in-depth knowledge of how much your customers are willing to pay.

Of course, a con of this strategy is that selling more for less reduces the profit margin on individual units. Buyers may also not purchase from you for a while if they do buy in bulk, leading to uneven sales patterns.

Third-degree

As for this type of differential pricing, as a seller, you’d charge different prices to different customer groups based on identifiable characteristics.

As an example, think about student and senior citizen discounts, as well as geographic pricing.

Some of the benefits of this strategy include the ability to tap into different market segments and maximize sales across diverse groups, as well as making products more accessible to people on lower incomes.

However, some customers may feel alienated (i.e., feel like they also deserve a discount and be upset if they don’t get it).

How to use differential pricing effectively

Understand your market and segment your customers

It’s important that you first identify different customer groups based on their willingness to pay, location, buying behavior, purchasing history, buying power, and other elements.

Also, you should conduct in-depth research to understand what each segment values in your product or service.

Determine your pricing strategy

This means choosing between strategies like:

Cost-based pricing: The price covers things like production and delivery, including profit margins.
Value-based pricing: Set prices based on the perceived value of your product to different customer segments.
Competitive pricing: Consider your competitors’ pricing strategies and where your product is positioned in the market.

Prevent arbitrage

What does this mean? That you should use strategies like time-based offers to stop customers from buying products in a low-price market and reselling them in a high-price market.

Communicate value

Your customers should be aware of why you have different prices, including benefits, premium features, or loyalty rewards, which helps to ensure that the value of your brand isn’t diluted—and that you’re not alienating customer segments.

Monitor the market

It goes without saying that you should keep an eye on your pricing strategy—particularly, how effective it is. This way, you can adjust it based on feedback and market changes.

For example, you may have to lower prices temporarily to be able to enter the market or raise them if your competitors aren’t valuing products right.

Make sure to use analytics to measure the impact of this strategy on your sales, acquisition, and retention.

Competition map, courtesy of Simon Kucher

5 real-life examples of differential pricing

1. Amazon

Amazon relies on several differential pricing tactics to maximize their revenue, which includes dynamic pricing. This means the algorithm adjusts prices in real-time based on factors like time of day and customer browsing patterns.

Another factor is Prime membership – Prime members have benefits that others don’t, including free shipping, next-day delivery, access to Prime Video, and other services.

Depending on where you live, Amazon will show different prices as well (A.K.A., geographical pricing). For instance, the same book might be priced differently in the USA and UK, reflecting local markets, competition, and purchasing power.

It’s also worth mentioning events like Black Friday, Cyber Monday, and Prime Day, which sees prices reduced for a limited time to drive sales. This is a time-based pricing strategy.

2. Uber

This company uses dynamic pricing by adjusting fare rates in real-time based on the demand and supply in a specific area.

What’s more, Uber also experiments with personalized pricing based on the user’s ride history and their willingness to pay. For example, frequent riders on specific routes may sometimes see tailored offers or promotions.

Prices may increase around large public events when the demand for rides increases as well, which is called event-based pricing.

3. Starbucks

Starbucks employs geographic pricing, with variations in the pricing of their coffee and other products based on the location of the outlet. Prices in urban and high-cost living areas are typically higher than in suburban locations.

The company also offers different sizes and customizations (product versioning) which allow for a range of pricing options that cater to different customers and their willingness to pay.

Another thing to consider is seasonal pricing. Limited-time offers and seasonal products often come at a premium price, such as special holiday drinks or summer specials.

4. Apple

Apple uses product versioning and customer segment pricing for its products, as it offers different prices for products like iPhones and MacBooks in different countries. Often, the company also tiers their pricing structures depending on storage capacities on their products.

This means they can capture people who are a bit more conscious of their budgets, as well as people who seek high-end features and are willing to pay more.

In addition to this, Apple strategically prices older models lower once a new model is released (product lifecycle pricing) and sells refurbished models at lower prices – these strategies cater to price-sensitive consumers without undercutting more high-end sales.

5. Adobe

Adobe offers its products at different prices based on user segments, since students and teachers, for example, receive a significant discount compared to other users.

Prices also vary depending on the business buying the company’s products. Enterprise pricing often includes volume discounts and bundled products.

Switching to a subscription-based model allows Adobe to offer a lower entry price point, targeting a broader market and ensuring a steady revenue stream.

TL;DR

Pricing can be tough. Price your product too low, and you leave money on the table. Price it too high, and you might not sell as much. This is why the right pricing strategy is so important.

Differential pricing is one of many strategies you can use to align the price of your products with customers’ value perception, market demand, and competitive dynamics. It allows you to cater to a diverse customer base, adapting prices based on things like location, time, buyer behaviors, etc.

Products aren’t made in a vacuum. Pricing is one of the many elements of product positioning, so it’s crucial you keep it top of mind.

For more about positioning your product just right, download your free copy of our Competitive Positioning Playbook, where you’ll learn:

👷 How to blend competitive intelligence and customer research for a rock-solid positioning strategy.

🙅‍♀️ The three steps you must take when crafting competitive positioning.

🪛 A top-to-bottom tear down of the positioning process, and how competitive intelligence fits in.

🏹 How to use competitive positioning to shatter your org’s revenue ceiling.

Everything you need to know about differential pricing strategies (with examples)

Teresa Garanhel