Indirect segmentation

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This article describes a pricing strategy used by sellers, typically in markets that suffer from imperfect competition, significant transaction costs or imperfect information.
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Definition

Indirect segmentation is a form of third-degree price discrimination where a seller uses covert methods to segment buyers into different prices for the same product. This is to be contrasted with direct segmentation and other forms of price discrimination such as first-degree price discrimination (individual-targeting) and second-degree price discrimination (volume-based targeting).

Examples of indirect segmentation

Ease and hurdles

Supermarkets and retailers may use indirect segmentation in product placement. For instance, as Tim Harford argues in his book The Undercover Economist, supermarkets often make the more expensive versions of a product more visible, for instance, by placing them on the top shelf, while the less expensive versions are less visible.

Discounting

Various forms of discounting can be used by retailers to discriminate. A discounting scheme is successful if people with high reservation prices, on average, do not benefit from the discounting, while those with lower reservation prices are made aware of the discounting and act upon it. For instance:

  • Periodic discounting: For instance, some stores provide discounts on one day of the week (often, a day that is not very convenient for most people). The less price-sensitive customers, who would have paid higher prices, are therefore quite unlikely to turn up at the store on a day of discounts. On the other hand, price-sensitive customers may make it a point to come on that day to save money. Note that this form of discounting, while it can be viewed as price discrimination, can alternatively be viewed as an attempt to spread the usage of the store better across the week by encouraging people to use the store on days when it is usually not crowded.
  • Random discounting: Here, prices are varied randomly and confusingly. Price-sensitive people are thus on the lookout for when the prices are low, and they defer purchasing a good till the time its price falls. People who value the good more are less likely to wait for the price to fall and are thus more likely to buy the good at its high price.

Other related strategies include coupons, which should require enough effort that price-insensitive people do not go to the pain of using them, but should not be too cumbersome for the price-sensitive people who would not have bought the good at a high price.

Sops to sense of luxury and conscience

In some cases, segmentation is made by the use of words that manipulate customer's behavior into revealing their preferences. For instance, some stores and restaurants have a high-priced and a low-priced version of the same product, with only a very negligible difference in the products. The main attraction of the higher price is certain connotations that go with the higher price. For instance, the lower-priced version may be labeled for the thrifty or for the money-conscious while higher-priced versions may be labeled luxury versions. This is closely related to the idea of conspicuous consumption and Veblen goods.

In other cases, the store or restaurant may use the higher-priced version as a sop to conscience. This may be done, for instance, by promising to donate a small fraction of the additional cost to a charity, or paying their suppliers higher wages (for instance, fair trade coffee) or other forms of psychological satisfaction (for instance, made locally).

In many of these cases, it might legitimately be argued that it is not price discrimination since buyers are buying a different product. It counts as price discrimination only if the difference in price is much greater than the difference in production costs as well as much greater than the difference in benefits to whichever third party they claim is being benefited.

References

Journal references

Expository book references

  • The Undercover Economist by Tim Harford, 10-digit ISBN 0345494016, 13-digit ISBN 978-0345494016 (paperback)More info, Page 31-59