What are the main conditions necessary for price discrimination to work?
Here are the
main conditions required for discriminatory pricing:
Differences in price elasticity of demand: There must
be a different price elasticity of demand for each group of consumers.
The firm is then able to charge a higher price to the group with a more
price inelastic demand and a lower price to the group with a more
elastic demand. By adopting such a strategy, the firm can increase total revenue and profits
(i.e. achieve a higher level of producer surplus). To profit maximise,
the firm will seek to set marginal revenue = to marginal cost in each
separate (segmented) market.
Barriers to prevent consumers switching from one supplier to another: The firm must be able to prevent "consumer switching" –
i.e. consumers who have purchased a product at a lower price are able
to re-sell it to those consumers who would have otherwise paid the
expensive price.
This can be done in a number of ways, – and is probably easier to achieve with the provision of a
unique service such as a haircut, dental treatment or a
consultation with a doctor rather than with the exchange of tangible
goods such as a meal in a restaurant.
Switching might be prevented by selling a product to consumers at unique moments in time
– for example with the use of airline tickets for a specific flight
that cannot be resold under any circumstances or cheaper rail tickets
that are valid for a specific rail service.
Software businesses often offer heavy price discounts for educational users providing they give an academic email address
Students may be required to show proof of identification using secure ID cards
Price discrimination is easier when there are
separate and distinct markets for a firm's products and when price elasticity of demand varies from one group of consumers to another
Summary of the main conditions
Conditions for price discrimination to take place
What is 1st degree (perfect) price discrimination?
Perfect Price Discrimination is charging whatever the market will bear
Sometimes known as optimal pricing, with perfect price discrimination, the firm separates the market into each individual consumer and charges them the price they are willing and able to pay
If successful, the firm can extract the entire consumer surplus that lies underneath the demand curve and turn it into extra revenue or producer surplus.
This is hard to achieve unless a business has full information on every consumer's individual preferences and willingness to pay. The transactions costs
involved in finding out through market research what each buyer is
prepared to pay is the main barrier to a business's engaging in this
form of price discrimination.
If the monopolist can perfectly segment the market, then the average revenue curve becomes the marginal revenue curve.
A monopolist will continue to sell extra units as long as the extra revenue exceeds the marginal cost of production.
In reality, most suppliers and consumers prefer to work with
price lists and menus from which trade can take place rather than having to negotiate a price for each unit bought and sold.
Pure price discrimination2nd degree price discrimination
What is Second Degree Price Discrimination?
This involves businesses selling off packages or blocks of a product deemed to be surplus capacity at lower prices than the previously published or advertised price.
Price tends to fall as the quantity bought increases.
Examples of this can be found in the hotel industry where spare rooms are sold on a last minute standby basis. In these types of industry, the fixed costs of production are high. At the same time the marginal or variable costs are low and predictable.
If there are unsold rooms, it is in the hotel's best interest to offload spare capacity at a discount prices, providing that the extra evenue at least covers the marginal cost of each unit.
There is nearly always some supplementary profit
to be made. Firms may be quite happy to accept a smaller profit margin
if it means that they manage to steal an advantage on their rival firms.
Peak and Off-Peak Pricing
Peak and off-peak pricing and is common in the telecommunications industry, leisure retailing and in the travel sector.
For example, telephone and electricity companies separate markets by time:
There are three rates for telephone calls: a daytime peak rate, and an off peak evening rate and a cheaper weekend rate.
Electricity suppliers also offer cheaper off-peak electricity during the night.
At off-peak times, there is plenty of spare capacity and marginal costs of production are low (the supply curve is elastic)
At peak times when demand is high, short run supply becomes relatively inelastic as the supplier reaches capacity constraints. A combination of higher demand and rising costs forces up the profit maximising price.
Ansoff's Matrix is a key part of most courses where competition is discussed and on the face of it is an easy model for students to understand.
The model was created by Igor Ansoff and was first published in 'Strategies for diversification' in 1957.
The basic premise of the matrix is that there are 4 different
strategies that a business can adopt with each one carrying a different
degree of risk. At first glance this is simple to apply. For example, a
business launching new products into new markets is a high risk strategy
because it consists of both product and market development and the
business may be operating outside of its comfort zone.
Where Ansoff can become tricky is correctly classifying which strategy the firm is adopting.
For example, when Cobra launched a draft version of its bottled beer.
Is this actually a new product? The beer is the same the only difference
being its available on draft. Is it a new market? Could the market for
bottled beer be classed as different to the marker for draft beer?
However, the most common area I find with students is that they miss perhaps the most important aspect of Ansoff which is the degree of risk. Most students can argue that diversification is a high risk strategy however, not many students go on to classify the degree of risk attached to diversification.
For example, take a hypothetical situation whereby a large supermarket
aims to launch a chain of DIY stores. This would be classed as
diversification as the move is a new product in a new market. Lets look
at an actual example to compare and contrast. In the 1990's Nokia moved
from being a producer of car tyres to become a major player in the
mobile phone market. Again, this is diversification. However, which one
has the greater degree of risk? One could argue that the supermarket
moving into the DIY sector is less risky. The supermarket already
operates in the retail sector and can transfer many of the skills and
systems to its new strategy. Therefore this strategy would be perhaps at
the top left hand corner of the diversifciation 'box' whereas in the
case of Nokia, this might be placed in the bottom right hand corner of
the diversification 'box'.
The Ansoff Growth matrix is another marketing planning
tool that helps a business determine its product and market growth
strategy.
Ansoff’s product/market growth matrix suggests that a
business’ attempts to grow depend on whether it markets new or existing
products in new or existing markets. The output from the Ansoff
product/market matrix is a series of suggested growth strategies which
set the direction for the business strategy. These are described below: Market penetration Market
penetration is the name given to a growth strategy where the business
focuses on selling existing products into existing markets. Market penetration seeks to achieve four main objectives:
Maintain
or increase the market share of current products – this can be achieved
by a combination of competitive pricing strategies, advertising, sales
promotion and perhaps more resources dedicated to personal selling
Secure dominance of growth markets
Restructure
a mature market by driving out competitors; this would require a much
more aggressive promotional campaign, supported by a pricing strategy
designed to make the market unattractive for competitors
Increase usage by existing customers – for example by introducing loyalty schemes
A
market penetration marketing strategy is very much about “business as
usual”. The business is focusing on markets and products it knows well.
It is likely to have good information on competitors and on customer
needs. It is unlikely, therefore, that this strategy will require much
investment in new market research.
Market development
Market
development is the name given to a growth strategy where the business
seeks to sell its existing products into new markets. There are many possible ways of approaching this strategy, including:
New geographical markets; for example exporting the product to a new country
New product dimensions or packaging: for example
New distribution channels (e.g. moving from selling via retail to selling using e-commerce and mail order)
Different pricing policies to attract different customers or create new market segments
Market development is a more risky strategy than market penetration because of the targeting of new markets.
Product development Product
development is the name given to a growth strategy where a business
aims to introduce new products into existing markets. This strategy may
require the development of new competencies and requires the business to
develop modified products which can appeal to existing markets. A
strategy of product development is particularly suitable for a business
where the product needs to be differentiated in order to remain
competitive. A successful product development strategy places the
marketing emphasis on:
Research & development and innovation
Detailed insights into customer needs (and how they change)
Being first to market
Diversification
Diversification is the name given to the growth strategy where a business markets new products in new markets.
This is an inherently more risk strategy because the business is moving into markets in which it has little or no experience.
For
a business to adopt a diversification strategy, therefore, it must have
a clear idea about what it expects to gain from the strategy and an
honest assessment of the risks. However, for the right balance between
risk and reward, a marketing strategy of diversification can be highly
rewarding.
(The Guardian 6th December) Britain could be set for a fully privatised rail line, as transport secretary Chris Grayling outlines plans for a new line connecting Oxford and Cambridge. “What we are doing is taking this line out of Network Rail’s control,” Grayling told BBC Radio 4’s Today programme. The transport secretary said the new private line, to be funded by
“private finance, in a form to be decided”, would provide “a degree of
comparison with Network Rail to say, ‘can we build lines quicker and
cheaper than we are at the moment?’.”
This amounts to a state regulated private monopoly
On the plus side a fully integrated rail system owned by one
organisation will surely create efficiencies, on the minus side, there
surely is nothing more economically deleterious than a complete 100%
private monopoly.
At least with a public monopoly, the profit motive does not extract
resources away from the particular public service, and health and safety
concerns are paramount. I wonder what the competition and markets authority will think of
this state regulated private monopoly? Even if the contract is put out
to tender every ten years or so, whilst in operation, it is still a
monopoly.
We will see higher fares
Given that all passenger train operating companies (TOCs) operate on
the franchise model and that most franchises are between seven and ten
years, what happens when a TOC, in the last year or two of their
franchise, knows they won't get a franchise renewal? Are they going to
keep spending their own money to maintain a network they know they'll be
handing to a competitor in the near future or are they going to
maintain it on a shoe string budget to maximise their own profits? Also, what happens to operators who run trains on more than one
company's section of line? Cross Country for example? Suddenly they are
going to have to pay a premium to several other operators, rather than
the current single access charge to Network Rail. You can guess how thry
are going to recoup the cost.
Let them raise their own capital
If private companies really are so wonderful at owning, providing and
managing infrastructure, why not let them rise their own capital and
take care of crossrail, HS2 and Heathrow? Oh right, they couldn't. Why spend billions from the public purse one one rail line only to
allow private companies to cream off the profits from an existing one?
There will still be subsidies
Does fully privatised mean that the government will give them no
subsidies, that there will be no special tax breaks, that they will
actually stand on their own two feet as no other privatised industry
seems to be able to do?
Rail requires a monopoly - state or private
Deutsche Bahn runs practically everything in Germany. So yes it works
as long as there is no competition. You can only run a railway if
everything is under the control of one organisation. Which should be
either the state or a heavily regulated and accountable monopoly.
At least with a public monopoly, the profit motive does not extract resources away from the particular public service, and health and safety concerns are paramount.
I wonder what the competition and markets authority will think of this state regulated private monopoly? Even if the contract is put out to tender every ten years or so, whilst in operation, it is still a monopoly.