Differential Pricing: Many important industries involve technologies that exhibit increasing returns to scale, large fixed and sunk costs, and significant economies of scope.
Two important examples of such industries are telecommunications services and information services. In each of these cases the relevant technologies involve high fixed costs, significant Joint costs and low, or even zero, marginal costs. Setting prices equal to marginal cost will generally not recoup sufficient revenue to cover the fixed costs and the standard economic recommendation of “price at marginal cost” is not economically viable.Some other mechanism for achieving efficient allocation of resources must be found. The outcome of this investigation is that (i) efficient pricing in such environments will typically involve prices that differ across consumers and type of service; (it) producers will want to engage in product and service differentiation in order for this differential pricing to be feasible; and, (iii)differential pricing will arise naturally as a result of profit seeking by firms.It follows that differential pricing can generally be expected to contribute to economic efficiency Thus differential pricing is the practice of selling the same product to different customers at different prices even though the cost of sale is the same to each of them. More precisely, it is selling at a price or prices such that the ratio of price to marginal costs is different in different sales” TYPES OF DIFFERENTIAL PRICING First-degree price discrimination means that the producer sells different units of output for different prices and these prices may differ from person to person.
This is sometimes known as the case of perfect price discrimination. Second-degree price discrimination means that the producer sells different units of output for different rices, but every individual who buys the same amount of the good pays the same price. Thus prices depend on the amount of the good purchased, but not on who does the purchasing.
A common example of this sort of pricing is volume discounts. Third-degree price discrimination occurs when the producer sells output to different people for different prices, but every unit of output sold to a given person sells for the same price.This is the most common form of price discrimination, and examples include senior citizens’ discounts, student discounts, and so on. Why Differential pricing in Telecom: Suppose that there are two classes of consumers for a particular telecommunications service: those with a high willingness to pay and those with a low willingness to pay. The telecommunication service in question exhibits a technology with high fixed costs (of, e. g. , building and maintaining a network), but low marginal costs (of, e.
g. , providing additional service to existing customers).In this case, the two-part tariff described above is a very natural pricing scheme. Consumers are charged an attachment fee to connect to the network; the revenue from these attachment fees tself is pegged to incremental cost.
The attachment fee is set so that the firm’s total cost is recovered and the necessary condition for Pareto efficiency is satisfied. The basic requirement is that the marginal willingness to pay must equal marginal cost. The long-distance telecommunications market in India involves many different forms of differential pricing.Firms give quantity discounts to both large and small customers; charge business and individuals different rates; and offer calling plans that offer discounted rates based on individual characteristics and usage patterns.
Steps for differential pricing: The five steps a firm must take to achieve a differential pricing policy are as follows: 1 Select the target market: The target market is already selected when the product is positioned. For differential pricing,divide the target market into smaller segments. Divide the target market into smaller customer segments: Developing a service strategy is an essential step towards choosing an optimal mix and level of service for different customer sets. The essence of any customer service strategy is to segment the customers to be served.
As with classic market segmentation, the goal is to isolate a reasonably homogeneous set of consumers that an be served at a profit. Thus, the target market is divided into several narrow customer segments. Customer service segments differ from the usual market segments in significant ways.For one thing, customer service segments tend to be narrower. Also, the narrower the segments the more homogeneous they tend to be, making it easier to estimate the demand of the consumers.
Markets can be subdivided by usage situation. Market segmentation requires an understanding of the what, when, where, how and why of demand. As demand results from the interaction of a person with his or her environment, a segmentation perspective that ncludes both the person and the situation is needed to explain the demand and target the marketing strategy.Distinct lines of demarcation can be drawn to divide the different types of customers. 3 Estimate demand for each customer segment: Customer demand can be estimated by a method suggested by Oren, Smith and Wilson (1984). According to this method, there are many customers in the target market, each with different characteristics summarized in an index, say, t indicating the customer’s type. Presume that there is a continuum of types with indices arrayed in an interval t[sub]O