Price segmentation

A business that employs price segmentation sets different prices for different groupings of customers.

The practice involves dividing customers into groups based on various factors such as age and shopping behaviour. That might mean catering to someone who wants the cheapest airfare or hotel or is willing to spend more on additional services.

Ajay Sirsi, Director at the Centre for Customer Centricity at York University’s Schulich School of Business, says price segmentation means setting different prices for the same offering.

“Some customers want more amenities, more services, and are willing to pay for it,” he says, adding that serving those needs requires the company to raise prices. “It costs us more to serve that premium customer.”

The opposite is true, too. The value customer, looking for a bargain, is often willing to accept fewer services and is therefore less costly to your company.

Examples of segmented pricing

Sirsi explains that your company can set different prices for different customer groupings based on criteria such as age (like seniors and students) or occupational status (for example, part-time workers).

“Your company may realize that to attract more of these specific customers, you need to offer them some kind of incentive,” says Sirsi. That incentive usually takes the form of a discount on the price.

Price segmentation can apply to several types of services and products. Here are a few examples:

• Movie tickets: Children and seniors often pay less than adults. 
• Airline tickets: Different prices are offered for the same seat depending on the time of booking and class of service.
• Streaming services: Tiered pricing models, like basic, standard and premium, allow customers to choose a plan that fits their needs and budget.

How price segmentation can help your business

• Increased revenue: By capturing more of the market's willingness to pay, businesses can increase overall revenue.
• Improved profitability: Charging higher prices to customers willing to pay more can lead to higher profit margins.
• Enhanced customer satisfaction: Offering tailored prices can make products and services more accessible to different customer segments.

What are the risks with price segmentation

If you plan to use price segmentation, Sirsi implores you to protect your profit margins.

“The key to making money with value customers is we have to keep our cost-to-serve low,” he says, referring to the financial tool that calculates the profitability you earn from a specific customer.

“But the mistake I see many customer companies making is that they offer all kinds of freebies to value customers. But in trying to attract them, their margins get narrower and narrower.”

He often sees this in B2B markets, with companies trying to serve some price-sensitive segments

“What they do is they add services in the hopes of not losing this segment to the competition but they're losing track of how much they're actually giving away.”

Look at what you’re charging

Sirsi says your company needs to look at the transaction price, which is the actual price the customer pays you and comprises the incentives you’ve offered.

“The salesperson might have given the customer, for example, free engineering drawings,” he says, adding that the company sometimes fails to factor in this kind of expenditure. “A company could be losing money with some customers and not even know it.”

He says the key to effective price segmentation is good data. Analyze the numbers to understand the profit made on heavily discounted customers. He suggests doing this with a customer profitability analysis.

Next step

Take the guesswork out of business planning by downloading BDC’s free guide, Monitoring Your Business Performance.