Assessing the Potential of Differential Pricing Strategies
- Analysis of the Benefits and Pitfalls
Marketing Week Conference
28 May 2002
Through the Loop
Assessing the Potential of Differential Pricing Strategies
Assessing the potential of differential
pricing strategies
Analysis of the benefits and pitfalls
Martin Payne
Strategic Projects Director
Through the Loop
Structure
• A contextual analysis.
• Defining the elements of a differential pricing
strategy.
• The consumer perspective.
• Geographic pricing.
• Future scenarios.
• Summary.
A contextual analysis
A contextual analysis
• Differential pricing is not a new issue.
• However, it has come to the fore as a result of
substantial changes in the marketing environment:
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Marketers undertaking more consumer segmentation.
Pressure on the entire value chain.
Pricing has become a major media issue.
Transparency is more important than ever.
Marketing tools are evolving fast.
• Every element of the marketing mix is being
questioned under the new marketing scenario.
Good afternoon ladies and gentlemen. Over the
course of the last two days you have heard about
many different aspects of pricing. My brief is to
analyse the issue of differential pricing and to
develop some ideas of where it is heading. The
principal focus of this talk is consumer marketing
although some aspects of business to business will be
relevant at some stages.
There are a number of areas that I will be covering.
After a brief contextual analysis, I will define some of
the areas where differential pricing is currently
operating. The consumer perspective will view the
subject from the other side to identify a number of
issues that should be taken into account when
developing a differential pricing strategy. Geographic
pricing looks at how prices may vary across regions
and countries. There are three future scenarios that
show ways in which differential pricing is developing
and the summary shows some of the issues that will
be faced in the future.
The most important factor when analysing
differential pricing is to recognise that it does not
exist on its own. The pricing policy for a company or
brand is part of the overall marketing mix.
Furthermore, there is nothing especially new about
differential pricing. Haggling has been around for
ages. Nevertheless, the marketing environment is
changing so rapidly that the issue has come to the
fore.
Marketers are rethinking their entire value change in
order to focus more on the final consumer. Target
market segmentation has been used as a way to
develop tighter marketing strategies. The consumer
has changed and is far more aware of prices that are
being charged in different areas. Furthermore,
marketing tools are evolving fast and are becoming
more sophisticated to enable pricing to be
undertaken in different ways.
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Assessing the Potential of Differential Pricing Strategies
The state of the economy also plays an important
role and I will return to that subject.
Defining the elements of a differential
pricing strategy
Defining the elements
Straightforward
supply & demand
Promotional activity
Differential pricing
Geographic pricing
Consumer focused
Defining the elements
Supply & demand
• Prices and determined by supply and demand for the
product or service.
• Widely used in some product and service sectors:
– Utilities.
– Travel.
• Higher prices tend to be charged at peak times for
essentially the same product or service.
– Flexible pricing policy may provide a range of service options
for travel.
Defining the elements
Promotional strategy
• Pricing may be used frequently as a promotional tool.
– Use a low price to increase sales volume during a promotion.
– Low price for a limited period to attract customers to the offer.
• The value of retailer sales can be questioned:
“Shoppers now wait for the sales and that’s the fault of retailers.
The old idea that discount sales were there to get rid of shopsoiled goods has gone. Sales of regular merchandise are
crazy.”
Professor Gary Davies, Manchester Business School
As I said, differential pricing is nothing totally new.
There are a number of ways in which it is being
undertaken at present. I have identified four main
areas although these are not necessarily exhaustive.
The key area is straightforward supply and demand
where economic forces dictate the price. Promotional
activity is the second area where prices are subject to
change. Geographic pricing refers to where different
prices may be charged in different areas at the same
time and, finally, consumer-focused means the
pricing is more dynamic and could even be varied by
the consumer.
The first area is where the price is dictated by supply
and demand. Under this mechanism a higher level of
demand for the product or service raises the price
although the product or service itself may not
change in nature.
Examples of where this approach is used includes
utilities such as telephones and electricity that have
peak time and off-peak rates. Travel tickets are
typically less expensive in off-peak periods for the
same journey. In this case, the lower price for offpeak travel may be looking to encourage greater
utilisation during these periods.
The use of price as a promotional instrument is more
controversial. Price-led offers such as buy one-get
one free or extra product are used commonly. A low
price may also be used during an introductory period
after product launch or to attract new consumers.
Good in theory maybe but the overuse of price as a
promotional tool has had the effect of turning
brands into commodities. A long-term low-price
strategy changes the brand values. A brand can no
longer be viewed as a premium product. Using low
price as a key element of the brand is fine, EasyJet
seems to be successful, but it cannot work if the
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Assessing the Potential of Differential Pricing Strategies
brand positioning is intended to focus more on
premium aspects. This helps to explain the difficulties
that Sainsbury’s and British Airways have
encountered when trying to compete in the price
arena.
Defining the elements
Geographic pricing
• Pricing will often vary in two different regions.
– Within one country.
• Regional pricing model may be used to target less and more
affluent parts of the country with the appropriate price level.
– Across different countries.
• What price will the market pay in each country? More complex
than a regional pricing model and cultural and product use
differences will be greater.
Defining the elements
Consumer focused
• An area that may be more common in business-tobusiness marketing than in the consumer sector.
• Price is charged according to the depth of the
customer relationship:
– Better customers may receive greater discounts.
– Pricing is dynamic and varies as consumers cross-purchase
more products and services.
• Price is charged according to access/delivery
method.
Geographic pricing is another area that is frequently
controversial, receiving regular negative media
coverage. A different price could be charged in
different regions or in different countries. This is
based on the assumption that different areas are able
to afford different price levels or that the costs of
marketing a product or service can vary by area.
Under customer-focused I am including prices that
vary according to the actual customer. This is a
common b2b scenario but is becoming more
widespread in consumer marketing. A couple of
examples here are rebates given to consumers who
are important customers such as Tesco’s Clubcard
vouchers or Sainsbury’s Reward points that
effectively reduce the cost of the shopping basket.
Cashback for existing customers, for example on a
software purchase, may also fall within this category.
The price could also vary according to the “access
method.” This could mean a lower price for
somebody booking a ticket via a Web site as the
marketer’s costs are lower. British Airways and
EasyJet are examples of companies that adopt this
approach.
The consumer perspective
These four elements take the marketer perspective on
differential pricing. However, in order to be
successful it is vital to consider the issue for the
consumer. The consumer perspective is a crucial
element, even more so with the increased
transparency of pricing.
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Through the Loop
The consumer perspective
• Any differential pricing strategy has to be effective
from the consumer angle.
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Should work in both the long term and short term.
Has to be understood.
Should add to not undermine brand equity.
Needs to be effectively communicated.
Assessing the Potential of Differential Pricing Strategies
A differential pricing strategy will not work if it
cannot work from the consumer side. This means
that long-term considerations are equally important
as short term. An uplift in sales or the number of
new customers has little worth if the brand value is
undermined or existing customers are
disenfranchised.
Communications play an important role here. A
differential pricing strategy can no longer be hidden.
The media has seen to that. Therefore, the pricing
options need to be communicated as something
positive for the consumer. If lower prices are
available then the consumer should be made aware
of them prior to the purchase.
Consumers also know about stealth pricing, a recent
example being the extensive media coverage about
last minute holidays that seem to have so many
necessary extras increasing the overall cost.
The consumer perspective
• Increased pricing transparency.
– Consumers are far more price aware than previously.
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•
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Price pressure from (perceived) economic slowdown.
Influence of the media.
Government action.
Cross-border shopping.
Launch of the Euro.
Consumers have become more price aware although
this does not necessarily mean more price sensitive.
An anticipated economic slowdown has made
consumers, not just marketers, question price more.
The media has played a crucial role in this with
effective PR from price-led companies such as
EasyJet and Ryanair but also media “exposés” of
issues such as rip-off Britain.
Cross-border shopping has become more widespread.
For example, the DVD of Harry Potter costs £16.99 at
amazon.co.uk (a reduction of £6) but at amazon.com
the price is just $19.95, equivalent to £13.73.
Consumers now find it easier to shop where the price
is lowest, even if means ordering overseas. This has
implications for the government that is losing out on
tax revenue and it has now investigated some
product categories such as cars and forced the UK
manufacturers to lower prices to nearer the
European level.
The launch of the Euro is an area that is expected to
lead to greater price harmonisation in Europe
although there are doubts as to whether this is
actually happening. I will return to this subject later.
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Assessing the Potential of Differential Pricing Strategies
The consumer perspective
• The use of pricing as a promotional strategy has become an
increasingly hot topic.
– Sales promotion activity uses numerous tools where the price is
temporarily reduced:
• Two for one offers.
• More product.
– However, overuse of such a promotional activity has the ability to
cause long-term damage to the brand.
“Some brands are considered to be over-promoted, and if this is the
case then no consumer ever knows what they really stand for.”
Andrew Marsden, Category Director, Britvic
The consumer perspective
• A new value equation:
– Consumers have been taught to buy on price in many
sectors.
– Overused promotional activities based on price redefine the
“value” of the brand in the consumer’s perception.
– Ultimate consequence is that the brand becomes a
commodity.
Net: Dangerous to mess with your price/value equation.
The consumer perspective
• The use of differential pricing to acquire potential
consumers may be effective but also contains a
major pitfall.
– Provides a reward for promiscuous consumers while
penalising existing consumers.
– Long-term customers may be subsidising disloyal
customers.
The consumer perspective
• The Paradox of Loyalty
– Too frequently marketers’ efforts are focused on “disloyal”
rather than loyal consumers.
– Is there a tendency to reward disloyal rather than loyal
consumers?
– Loyal customers may be prepared to pay for a product or
service but should receive a higher level of value.
– A more focused product or service can mean premium
pricing through greater customer satisfaction.
– Recognition of genuinely loyal customers can help to
encourage trading-up.
In this case we are talking about the damage that
could be caused to a brand by a misuse of
promotional pricing. Brands normally command a
price premium, indeed that is one of the key factors
that differentiates a brand from merely a product.
This price premium has to be continually reinforced
and justified but overuse of promotional pricing is
more likely to damage this premium so that
consumers start the question the validity of the full
priced product. The brand starts to lose its identity.
Furthermore, consumers may be conditioned to
buying on price and will actively search out current
offers. This may have the effect of promotional
activity merely shifting sales rather than helping to
increase them. Such a strategy may be useful,
though, for shifting unsold inventory. It is interesting
to note here that retailers take different approaches.
Some do not like to discount ends-of line while
others prefer to sell discounted merchandise through
a controlled environment such as a factory outlet
and maintain some control of brand values.
In addition, the use of promotional pricing has the
ability to isolate existing customers where it is being
used to attract new users. Why should long-term
loyal consumers pay more than those whose
patronage may be fleeting and are not loyal, even
promiscuous? Those consumers who transfer their
credit card balances every few months could pay
nothing while the loyal consumers pay high rates of
interest. This is what we are calling The Paradox of
Loyalty.
Too frequently, there appears to be too much
attention focused on gaining new customers while
longer-term loyal customers are seemingly almost
forgotten. This extends beyond pricing although the
use of differential pricing or other incentives such as
Air Miles is one of the elements that shows how new
customers could be rewarded while existing
customers are not. While loyal consumers may be
prepared to pay a higher price premium, they should
receive greater value. Maybe the service they receive
can be better if they have a genuine engagement
with the company or brand.
However, rather than operate a differential pricing
policy there is clearly potential to encourage
consumers to trade up or cross-purchase additional
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products and services. This is where added
profitability should be generated, not by simply
charging more.
The consumer perspective
• The operation of a differential pricing strategy can be
fraught with pitfalls.
– Consumers are price-aware (and aware of what others may
be paying.)
– Potential for highly negative media coverage if differential
pricing is seen.
The consumer perspective
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By this stage it should have become clear that the
operation of a differential pricing policy could be
fraught with difficulties. Price is only one element of
the marketing mix and should work in relation to the
other variables. Furthermore, charging different
prices to different consumers for what may be
perceived as an identical product or service has the
potential to generate unfavourable media coverage.
A few recent examples of where the press has
reported in a negative way on this issue.
Interestingly, a vending machine that raises prices in
hot weather is presumably the same machine that
lowers the price when it is cold.
The Halifax Bank received extensive negative
coverage when the banking ombudsman ruled that it
had two standard variable rates, one for new and one
for existing customers. The bank received further bad
publicity when it stated that it would compensate
those existing customers who had complained about
the dual rates prior to the ombudsman’s decision and
would pay £100 goodwill only to other customers.
The Nationwide, on the other hand, decided to
compensate all customers but through reducing their
mortgage commitments rather than by refunding
payments already made.
I would like to return to the issue of geographic
pricing for a while.
Geographic pricing
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Through the Loop
Assessing the Potential of Differential Pricing Strategies
Geographic pricing
• This refers to charging different prices in different
countries or regions.
• Currently receiving extensive media attention:
– Car pricing in the UK versus overseas.
– Grey imports (Tesco versus Levi’s)
– The launch of the Euro “could” herald price equalisation.
• However, an EU report has indicated that
manufacturers are continuing to operate differential
pricing across Europe.
This is where the price differential depends on the
region of the country or the country itself. This is an
area that has been much in the news recently. There
is the issue of the differential in car pricing between
the UK and Europe. While the car manufacturers may
argue that like-for-like is not being compared, the
consumer perception, which may be media-driven, is
that they are being ripped off. Difference or not, the
consumer perception is that there is an issue.
Grey imports have also been receiving intense
coverage with the most high profile example the
case of Tesco and Levi’s where Tesco had been buying
Levi jeans outside the UK and selling them lower
than the Levi’s recommended price. Again it is the
company looking to enforce differential pricing that
has to deal with the problem. This is not a case of
Levi’s against Tesco, this is Levi’s against consumer
perception. Guess who is likely to lose here at the
end of the day.
The recent launch of the Euro in many European
currencies has been widely expected to lead to price
harmonisation across the EuroZone as a common
unit of currency will effectively hide and pricing
differential. But what is happening so far?
Geographic pricing
Brand
Highest Cost
Evian Mineral Water
Finland
189 France
44
Barilla Spaghetti
Sweden
138 Italy
59
Heinz Ketchup
Italy
138 Germany
66
Kellogg’s Cornflakes
Greece
152 UK
71
Mars Bar
Denmark
143 Belgium
73
Coca-Cola
Denmark
139 Germany
73
Fanta
Sweden
146 Netherlands
77
Nivea Shaving Foam
UK
142 France
81
Colgate Toothpaste
UK
126 Portugal/Spain
76
Nescafé
Italy
133 Greece
77
Note:
Source:
EU average = 100
EC Internal Market Scoreboard
Index
Lowest Cost
Index
The truth, albeit after five months only, is that
differential pricing is being maintained. This recently
published EU study shows that that there are
substantial differences in price for some well-known
brands. However, even on the basis of the limited list
of brands shown, we can conclude that it is the laws
of supply and demand that are determining some of
these prices.
Take a look at Barilla pasta which is substantially less
expensive in Italy compared with Sweden. Could this
be due to intense competition in the home of pasta?
Equally Nescafé is priced relatively high in Italy, a
roast and ground coffee market where, presumably,
demand for instant coffee is fairly low. Similar
reasoning can be applied to Evian mineral water in
France and Kellogg’s Cornflakes in the UK.
Conclusion: it is not as straightforward or linear as
the press coverage would have you believe.
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Assessing the Potential of Differential Pricing Strategies
Geographic pricing
• Within a single country there is an argument that
prices should be fixed on a regional basis to account
for variations in disposable income.
– Retail Week reported that Sainsbury’s is considering a
value-led offer and distinct merchandising style for Northern
stores.
– Tailors its offer more to shoppers on a regional basis by not
appearing to be too expensive (negative impact of Jamie
Oliver campaign).
– Is there a danger that Sainsbury’s will undermine its
price/value relationship with such a strategy?
Geographic pricing
• What affects regional pricing?
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Level of disposable income.
General level of retail prices.
Unemployment rate.
Type of employment.
Household composition.
• However, how does this affect the national brand
positioning.
– Marketing is more than price alone.
Differential pricing on a regional basis within one
country is likely to be driven by different factors.
The retail chain Sainsbury’s was reported to be
looking at adopting a regional pricing policy for its
northern stores so that has more of a value offer
than it may have in the south. However, there is the
possibility that it would compromise its brand
positioning by such a move. Sainsbury’s problems in
the mid-1990s may have partly resulted from this
type of approach nationally as the chain undermined
its core value of quality by moving towards a lower
price offer when discount chains were making gains.
The factors that impact on regional pricing may be
different to those operating across countries. A
marketer may choose to run differential pricing to
reflect varying levels of disposable income or general
regional price differences. They may reduce prices in
areas of higher unemployment or where the type of
employment varies. Equally the local household
composition could affect the prices that consumers
are willing or able to pay.
Pricing may also be established according to the level
of local competition. In this case a retailer may
reduce a price to match the competition. This may be
more applicable to commodity products where the
price cannot be higher than the competition.
However, it cannot be classed as marketing initiative
but more one of survival. Adopting a “follow the
competition” policy will at best achieve parity rather
than any significant competitive advantage.
This has been an overview of some of the important
elements and issues in differential pricing currently.
Future scenarios
The next stage is to consider where differential
pricing is heading. We have analysed the different
driving forces in the market together with
indications of the pricing policies of some leadingedge companies to distil three possible scenarios for
differential pricing.
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Assessing the Potential of Differential Pricing Strategies
Future scenarios
New forms of
differential pricing
Dynamic supply &
demand
Consumer
aggregation led
Consumer value
demand led
Future scenarios
• Dynamic supply and demand:
• The ability to provide differentiated pricing according
to fluctuating levels of consumer demand, e.g.,
– Perceived value of a “refreshing” or cooling/warming product
changes according to the weather.
– Road pricing that varies according to the level of demand.
– Retail prices that can vary according to the time of day.
– Insurance pricing that varies according to the degree of risk,
e.g. higher premiums for higher mileage drivers.
Future scenarios
• Consumer aggregation led:
– Consumers are able to reduce prices through an
aggregation of demand similar to industrial bulk buying.
– This may use an auction process where consumers state the
price they are willing to pay.
– Marketers are given the opportunity to bid for a consumer’s
business at their defined price level.
– Recognises the power of the consumer.
– Reverse auctions already operating through priceline.com
and Comet.
These possible future scenarios are dynamic supply
and demand, consumer aggregation and consumer
value demand. These are not meant as an exhaustive
list but an illustration of some potential ways
forward.
Let us consider each in turn.
The dynamic supply and demand model moves
forward from existing pricing based on supply and
demand. This makes the assumption that consumer
demand is not static and that the value of a product
and brand can change according to different criteria.
This could include factors such as the weather where
a sunny day raises the value of an ice cream or a cold
drink. Cooler weather has the opposite effect
naturally. Road pricing could be used to charge a
higher toll at peak periods thus discouraging driving
at these times. Retail prices could vary according to
the time of day, higher in peak periods but lower
when the store is quieter. Finally should insurance
risk be calculated according the driver’s mileage or
the time of travel rather than where he or she lives?
Progressive Insurance in the US has already
developed a system where a car is tracked by satellite
and the insurance charged according to mileage or
time of journey. It is said to be possible at a later
stage to adjust the premium according to the driver’s
behaviour behind the wheel. While this system would
almost certainly face a number of implementation
difficulties, it does illustrate that differential pricing
could be used to define the premium for the
individual user.
The second scenario is where consumer aggregation
applies industrial bulk buying to the consumer sector.
This enables groups of consumers to buy in bulk to
force down prices. Such an approach is being used by
so-called “reverse auctions” such as priceline.com or
letsbuyit.com. Priceline.com allows consumers to
state the price they are willing to pay and suppliers
have the opportunity to bid for that consumer at
that price. An answer is expected to be provided
within fifteen minutes!
Letsbuyit.com enables consumers to sign up for a
product with the price falling as the number of
buyers increases. An example of this from the
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Future
Future scenarios
scenarios
S o n y T V & D V D P ackag e
S o n y T V & D V D P ackag e
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£ 8 00
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6 00
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letsbuyit.com Web site yesterday shows that you can
purchase a Sony widescreen TV and Toshiba DVD for
£1,055 compared with an average retail price of
£1,499.
This really is a buyer’s market.
A ve ra g e re tail
A ve ra g e re tail
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Future scenarios
• Consumer value demand led:
– Under this scenario the price is set for an individual
consumer based on their buying behaviour and other factors.
– Potential to identify individual key price points.
– Recognises individual customer profitability.
– Potential to reward loyal consumers.
– Examples include retailers that can alter the price for regular
customers or “redirect” them to higher value/profit items.
– Financial services could vary interest rates according to
individual credit risk/financial history or level of investment.
The third scenario is based on the value of individual
customers and again brings b2b pricing into the
consumer arena. It uses the assumption that
different consumers have different buying behaviour
and price points. Loyal customers can be treated
accordingly. An example of where this could be used
would be to reduce the price of a product where the
consumer is clearly expressing an interest but not
buying. Over time the marketer is able to build a
complex picture of the individual’s purchasing
behaviour and develop an appropriate pricing policy.
Such an approach may also be used to encourage
consumers to trade up to higher value or higher
profit items. As the consumer’s buying behaviour is
known, perhaps through a reward scheme, he or she
can be offered products and services appropriate to
previous behaviour but in higher profit areas.
So what can be learned from this analysis? Firstly,
the issue of differential pricing is, like the pricing, a
dynamic area in itself.
Summary
Summary
• The issue of differential pricing is gaining in
importance as marketers recognise the value of
individual customers and consumption occasions.
• It has become possible to develop new models of
differential pricing.
– Reflect individual consumer behaviour.
– Identify how the value of a product or service may change
with time or other factors.
– Use differential pricing to alter consumer behaviour.
With the move away from purely mass marketing to
a model where the importance of individual
consumers is being increasingly recognised,
differential pricing takes on a whole new perspective.
Pricing is an essential element of the integrated
marketing mix. Its role is different for different
consumers and at different times. In addition, tools
are now available that allow marketers to develop
innovative pricing models that reflect the nature of
consumers as individuals and the dynamic nature of
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Assessing the Potential of Differential Pricing Strategies
the price-value equation. Pricing elasticity should be
measured on an individual customer basis not for the
market as a whole.
Summary
• How should a differential pricing strategy be
communicated?
– Impact of pricing transparency.
– Potential for immense PR (positive or negative).
– Identify and emphasise the benefits for consumers of flexible
pricing.
•
•
•
•
•
Product or service gives you more flexibility.
Possibility of exploiting off-peak rates.
Shop off-peak and save money.
Regular customers have lower prices.
Stimulate demand through price reductions at “low value”
times.
However, the issue also brings a number of factors
that should be taken into account when considering
a differential pricing policy. Prices cannot be hidden
or disguised so assume that prices are generally
known.
There is a potential for massive PR both ways. The
marketing communications need to emphasise
genuine consumer benefits of the policy such as
greater flexibility or ability to save money by
shopping off-peak.
Further to this, differential pricing may be used to
encourage a shift in the pattern of demand.
Tesco.com is testing a new way of charging for its
delivery fee based on the time of delivery with higher
charges at peak times. This gives the customer the
opportunity to save money and helps to make the
Tesco system more efficient. The store claims that the
system is already proving popular with pensioners.
Lower off peak transport fares are typically used to
encourage greater utilisation of transport
throughout the day. Would it make more sense to
have lower fares for rush hour periods to firstly
reward the “loyal” consumers who use public
transport more often or to encourage use of public
transport for travel to work? At present, higher peak
time fares may act to encourage driving to work by
car rather than taking a bus or train.
In conclusion, I have looked to outline some of the
future directions in differential pricing that take
advantage of a shift towards consumer power and
control, new marketing tools and perceived failings
of current models. While pricing is only one element
of the overall marketing mix, it is an area where
there are possibilities to achieve significant
differentiation and consumer connection.
The operation of a differential pricing policy provides
major potential for marketers to seize a very real
consumer opportunity. In the age of the empowered
consumer, those marketers that are best able to
deliver genuine, relevant and more-highly tailored
products and services are in the best position to
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Assessing the Potential of Differential Pricing Strategies
guarantee real consumer engagement and
satisfaction.
Through the Loop Consulting
155 Lichfield Court
Sheen Road
Richmond
Surrey TW9 1AZ
020 8334 6300
020 8940 1447 (fax)
www.throughtheloop.com
info@throughtheloop.com
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