The Hidden Power of Differential Pricing

Conventional wisdom suggests you charge one price for your products and services, and that's what customers pay. But smart companies actually do something called price segmentation, a pricing method that has been in existence for hundreds of years.

Same Service, Different Prices

Price segmentation basically means selling the exact same product to two different people at different prices. The example you're probably most acquainted with is airline travel. Virtually everyone in coach has paid a different price for essentially the same service and experience.

One of the most common (and most subtle) forms of price segmentation involves product differentiation. This involves selling different levels of products to different people at dramatically different prices. And this occurs in every marketplace.

I went through the Burger King drive-through the other day and ordered a Whopper for $2.39. They asked if I'd like cheese,and of course I said yes. My Whopper with cheese was $2.69. The cheese was 30 cents! For a slice of CHEESE!

So how is this price segmentation?  People who are very price sensitive would never pay 30 cents for a slice of cheese. But people who aren't so price sensitive would, especially if they see a huge value in the marked up price. (In this case, most people love cheese.)

The Power of Price 'Versioning'

This type of price segmentation is frequently called versioning. As the name implies, we create different versions of a product for customers with different "willingnesses" to pay.

I still remember shopping for my first brand new car about 20 years ago. After I picked out the car, it was time to decide on the options. The radio option for this car was $1,000! At the time I could buy a radio with speakers at an electronics store for less than $100, which I did and installed it myself. What a ripoff.

Today the same concept is evident in on-board GPS systems. You can buy the manufacturer's version for $2,000 or just get a Garmin for a lot less.

Mini, owned by BMW, is another great example. Check enough option boxes and you can turn a $20K Mini Cooper into a $33K Mini Cooper, often paying for a lot of features that are standard on the most basic Hyundai (like a USB port).

The less price-sensitive the buyer, the more egregious versioning becomes. All Porsches come with leather seats, but customers often pay thousands more to get "leather on everything". Ferrari charges roughly $9,000 for paint options because it knows customers want unique paint colors. Since all car manufacturers get paint from third party companies, there's a good chance that same paint is also available on lesser car makes, maybe even at no additional cost.

In all these examples car dealers and manufacturers are simply using price segmentation, and their customers willingly pay. In the case of mainstream cars, dealers offer entry-level models, oftentimes without air conditioning or even power windows, for price sensitive buyers. But they know few buyers will take that option.

Action: What products do you currently sell with different versions? Are you charging enough for the highest level? Are you charging too much for the lowest level?