Amazon Price Discrimination Done Well

I wrote a while back about price discrimination and its bad rep. It is actually not all bad. My attempt to rebrand it as price harmonization did not catch on. The right kind of price discrimination is offering multiple versions at different price points so customers will self-select themselves to the version they want to pay.

Like you pick retina display with MacBook Pro or SSD disk over HDD. This is second degree price discrimination. With price discrimination, as long as you do not restrict customers from choosing certain versions and let them choose any of your versions then it is perfectly acceptable.

The success of second degree discrimination also depends on packaging and pricing the cheapest version such that it helps bring-in low-end of the market without being attractive to those who would gladly pick the higher priced version had there not been the cheaper version.

Amazon has a product that very nicely executes second degree price discrimination, while also capturing a little bit extra consumer surplus from one of the genders. (Yes, pure gender based price discrimination is bad but I will show you why in this case it is not the case.)

Take a look at the 3 versions of the same model of GPS watch.

The first version

The base model without heart rate monitor costs you $147.35 (at a discount of $52.64). If you want heart rate monitor to go with the black model, it is sold separately for $45, bringing the total to $192.35.

Now the second version

It is the red model with included heart rate monitor, priced at $184.91. That is $7 cheaper than black base model plus heart rate monitor add-on.

Why is the drab base model priced such that its combo price is more than buying bundled red model? Because they are targeting the base model  at low-end customers with lower willingness to pay.  And if some of those insist on heart rate monitor with that color they likely value it more hence have higher willingness to pay and should pay $7 extra over the bundled red model.

Also note the list prices of the base and red models – $199.99 vs. $229.99 – a difference of $30. But how they are discounted is much different from the $30 difference. You would expect discounted price of red model to be just $30 over black base model. Instead it is $37.56 over base model. In other words the amount Amazon has to discount to make the sale goes down as they move up the model.

That is $7.56 in profit from effective pricing.

Finally, the pink one

The pink model, arguably a choice targeted only at women, is $1.22 more than the red model. But still cheaper than black combo.   Nothing prevents men from buying it so the pink model pricing is not at all a gender based price discrimination. But helps to capture additional consumer surplus from women who most likely will buy it. (I am succumbing to stereotype here! Sorry!)

So is $1.22 a big deal? For the razor thin per-product margin Amazon operates at and the volume it does, it most likely does. The $1.22 flows directly to their net-income.

Overall a very fine management of pricing.

But don’t attempt this at your business – most businesses, especially small businesses and startups do not have the volume, data and computational wherewithal to fine tune pricing to this level. Worse, most are not even in the right zipcode to attempt any such fine tuning.

Ask me what your business should do instead!