Price segmentation involves charging different prices to different customer groups. It allows firms to improve profitability by setting higher prices for customers with a higher willingness to pay, while also capturing larger volumes from customers willing to pay less. For price segmentation to be effective, products must have limited transferability between segments. Segmentation hedges are also used to separate customer groups and prevent those willing to pay more from purchasing at lower prices.

1. Tim J. Smith
Pricing Strategy: Setting Price Levels,
Managing Price Discounts, &
Establishing Price Structures
PowerPoint by
Tim J. Smith, PhD
Managing Principal, Wiglaf Pricing
Adjunct Professor of Marketing & Economics, DePaul University
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

2. Chapter 6
Price Segmentation
How Customer Differences Can Lead
to Price Differences
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

3. Agenda
• What is price segmentation?
• When does price segmentation work?
• Is price segmentation a good or bad?
• How do segmentation hedges enable a firm to
price-segment the market?
• How should an executive design a price
segmentation policy?
• Stretch Question: If a firm price-segments the
market, what is the optimal set of prices and
market shares for the different price segments?
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

4. Price Segmentation
• Pricing the same or similar products
differently for different customer segments.
• Different customers value products differently
• This diversity is a form of market
heterogeneity.
• When we are describing differences between
individuals in their willingness to pay, we are
describing a form of heterogeneity in demand.
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

5. Goal of Price Segmentation
• Align prices to demand heterogeneity in an effort
to extract a greater portion of the consumer
surplus from the market in the form of profits.
• Align prices to factors that drive (or undermine)
value for customers can be used to create a price
segmentation policy in that the firm
automatically charges more (or less) when and
where the product delivers more (or less) utility.
• Align prices to cost factors to discourage profit-
destructive behaviors.
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

6. Limited Transferability
• Price Segmentation requires limited
transferability of the product or service
• Once sold to a customer, that customer should
find it difficult to resell it to another customer.
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

7. Results of Price
Segmentation
It can improve the
firm’s profits.
It can improve the
number of customers
served by actually
lowering the market
entry price for some
customers.
Quantity
Price
Demand
Revenue
P*
Q*
Profit
Contribution
Variable
Costs
Quantity
Price
Demand
PL
QL
Profit
Contributions
Variable
Costs
PH
QH
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

8. 1st, 2nd,& 3rd Degree
Price Discrimination
• Perfect price discrimination, or first-degree price
discrimination, is charging every customer at the
price that matches their willingness to pay.
• Second-degree price discrimination is charging
different customers different prices according to
the quantity purchased.
• Third-degree price discrimination is charging
different markets or market segments different
prices.
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

9. Complete, Direct, and Indirect Price
Segmentation
• Complete price discrimination requires complete
information of all customers’ willingness to pay in
all situations, a feat that is likely to cost more to
achieve than would be rewarded through profit
increases. Direct segmentation defines price
variances based upon specific attributes of the
customer, such as age, gender, or location
• Indirect segmentation defines price variances
based upon a proxy that correlates to customer
segmentation based on willingness to pay
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

10. Strategic or Tactical
• Tactical price segmentation approaches are
those that are used to capture marginal and
sometimes even specific customers in unique
situations
• Strategic price segmentation approaches are
those in which the definition of the price
structure itself enables different customers to
pay different price
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

11. Segmentation Hedges
• Segment hedges are barriers that prevent customers
who are willing to pay a higher price from paying a
lower price
• If the segmentation hedge acts as a sieve rather than a
barrier, it can actually damage profits
• Requirements
– Correlate with customers’ perception of value
– Minimal information needed for implementation,
– Enforceability,
– Cultural acceptability.
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

12. Summary
• Price segmentation is charging different prices to different customers or groups of
customers.
• Willingness to pay varies between individual customers. This heterogeneity in
willingness to pay creates the opportunity for firms to improve profitability
through price segmentation. In addition to heterogeneity in willingness to pay,
price segmentation strategies require that products sold to one segment of the
market have limited transferability to another segment in the market. Price
segmentation improves profits by enabling the firm to capture a higher price from
those customers who value the product higher and capture higher volumes at a
lower price to customers with a lower willingness to pay.
• Segmentation hedges are used to separate customers who must pay more from
those who will pay less. Good price segmentation hedges should be highly
correlated with customers’ perception of value, require minimal information from
customers, be enforceable based on objective criteria, and be culturally
acceptable.
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.