How Microsoft Became One Of The Most Succesful Companies in History.
We all know what is Microsoft and who Bill Gates is. But do we know the history behind it? Do we know how he became the richest man on earth for 19 years? Do you know how this man started from scrap…
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The Benefits and Perils of Price Differentiation
Price differentiation — that is, setting different prices for different customers — is typically positioned as one of the silver bullets in the arsenal of the pricing manager. In this blog, we will outline the justification for price differentiation. Moreover, we will show that there is a catch; if price differentiation is not done correctly, it will immediately hurt the bottom line. It turns out that price differentiation is like blowfish sushi — great if prepared correctly, but deadly otherwise — and most of the time.
Price differentiation is generally justified by some version of the following example. You sell a single product with unit costs of $50. Demand is linear with a maximum demand of 3,000 (at a price of $0), a price elasticity of -2 at a price of $100, and a maximum willingness-to-pay of $150.
If you could sell to each customer at their individual willingness-to-pay ( Graph B), then your profit would be 2,000*((($150+$50)/2)-$50) = $100,000. As a result, the profit under perfect price differentiation is twice that of the single-price scenario in Graph A. Hence, there is a considerable benefit in price differentiation.
To investigate this question, assume you still know the overall demand function shown in Graph B, but you have no knowledge of each individual customer’s willingness-to-pay. Specifically, the individual price you set for a customer and that customer’s willingness-to-pay are uncorrelated. If you then…
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