Price Segmentation: A Crucial Tool For Improving Pricing Strategy

Prices of goods and services never stay static. People think companies dictate the price of their offerings; it is actually the customers who have the final say. After all, they are the ones who decide what an offering is worth and whether they are willing to buy it.

Yet, many sales teams falsely believe they know the customer well enough to set prices based on gut feeling. While it may increase sales volume in the short term, it will invariably lead to compromised revenue and profit.

Now, this is not to say that prices should be based on each customer’s willingness to pay, given each customer has a unique value perception. Excessively using willingness to pay to set prices can lead to thousands of prices for the same offer. Here is where price segmentation comes in.

What Is Price Segmentation?

Price segmentation is a pricing strategy where you charge different prices to different types of customers based on their ability and willingness to pay. With Price Segmentation, you make higher profits from customers who pay the most and lower profits or even losses from customers who pay the least. For example, an occasional traveler may have a higher price sensitivity and not be willing to splurge on first-class seats whereas someone traveling for business will have a lower price sensitivity.

Types Of Segmentation

By Offering: What is being sold. For example, airplane tickets that are fully refundable are higher priced than non-refundable tickets.

By Attribute: What is included. For example, concert ticket prices often vary based on the seating area, where seats closer to the stage cost more than those in the nosebleeds.

By Volume: How much is being sold. For example, shoppers looking for travel-size shaving lotion can expect to pay a much higher price per ounce versus buying bulk packs.

By Time of Purchase:  When is it being sold. For example, skiers wanting to save money on ski passes may choose to purchase them in advance to avoid the high costs during the season.

By Channel: Where it is being sold. For example, customers who have become accustomed to buying groceries online may be willing to pay more due to the increased convenience.

By Customer: Who is it being sold to. For example, some customers may be first-time buyers while others have been loyal customers for decades. In this case, each customer requires a completely different price structure.

By Location: Where is it being sold. For example, hotels by the airport are more expensive than in rural locations.

What Can Go Wrong?

While leveraging segmentation to improve your pricing model can be very effective, it is not easy to execute. Here are a few things to keep an eye out for:

Backlash: Before increasing prices for certain customer segments, firms may pay little consideration to perceived value. If the higher price does not justify the offer quality, brand image, or cost it can cause backlash from customers.

Dilution: Sometimes introducing price tiers aimed at certain customer segments can lead to cannibalization. For example, if you offer a discount on a full-year subscription versus monthly, it could cause your loyal buyers to choose the discounted option. Your loyal buyers are happy to commit to staying for a year, but if this offer was not available, they would have stayed a likewise term and paid a higher price.

Stagnation: Successful segmentation is an iterative process and requires constant updating. Unfortunately, many companies find updating their segmentation model too difficult (due to outdated software, complex modeling, and lack of resources) and do not update annually. In such cases, price segmentation ends up becoming price stagnation. Leaving a pricing strategy untouched for too long can result in inactivity and inefficiency.

How To Implement?

Understanding your potential buyers is the first step toward effective price segmentation. You’ll need to be able to divide potential purchasers into groups depending on their demographics (age, gender, etc.), psychographics (values, attitudes, motivation, etc.), geographics (country, area, urban, etc.), and behavior (spending habits, loyalty, order patterns, etc.). For optimal results, it’s best to segment by behavior as it can help companies understand customer purchase habits which can then be used to predict and influence future behavior.

Now, this is easier said than done. Price segmentation requires subtlety since you cannot explicitly state that less price-sensitive customers pay more than more price-sensitive ones.

Enter data and analytics. It provides companies with the right granularity to establish pricing strategies without having to do any guesswork. To create highly accurate segments, companies must rely on a blend of business expertise and detailed data sets.

Final Thoughts

Too many companies rely on intuition rather than data to set pricing strategies. The bottom line is that if you do not segment effectively, you’re leaving money on the table.

Price segmentation is a challenge and many companies do not know where to start. At Revenue Management Labs, our team of pricing experts can help you segment your customer base to maximize sales potential. Reach out to find out more.


ABOUT THE AUTHOR Avy Punwasee is a Partner at Revenue Management Labs. Revenue Management Labs help companies develop and execute practical solutions to maximize long-term revenue and profitability. Connect with Avy at [email protected]

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