Differential pricing: What it is and how to use it?

When you start to dive into the pricing strategies, it soon becomes a bottomless hole with new strategies popping up one after another. Since you seemed to be pretty interested in our blog post about dynamic pricing, we decided to explain another pricing strategy that is very closely related to it – differential pricing. 

Read on to find out how to use and benefit from this pricing strategy! 

What is differential pricing?

Differential pricing is a sophisticated pricing strategy that can often be confused with dynamic pricing. Truth be told, differential pricing is a part of dynamic pricing, but they’re still not the same thing. But we’ll come back to this in a bit.

The great thing about this pricing strategy is that it can benefit almost all businesses if implemented correctly. What’s the secret of such universality? Well, differential pricing refers to setting a product’s price based on the customers’ characteristics such as buying patterns and purchasing behavior. Additionally, this allows you to charge different prices for the same product to different customers. By applying it, you’ll be able to reach a wider audience, but be careful – it needs to be done very carefully, otherwise, you may end up losing revenue. 

Differential pricing relies on a fluctuating pricing system therefore, it can’t be done without repricing. 

What types of differential pricing there are? 

Like other pricing strategies, this one also has a few types, but we’re going to focus on the most important ones.

Since the bottom line of this strategy is customer segments, the different strategy types will depend on that factor. 

Brand image in different markets

Do you know that the same brand can have a different brand image in different geographical locations? For example, one brand can have an established position in one country, but outside of it not so much. Therefore, different locations will require a different set of prices. 

If you’re following us regularly, then we’re sure that you’re connecting this to penetration pricing. And you’ll be right. Differential pricing can be extremely helpful when entering new markets.

Geographic location

Different geographic locations mean different prices. Do you know why that is? Well, if you are supposed to sell the product within your area, and on the other side of the country, the price can’t be the same, right? Therefore, the customers who live close by will fall into one price range, while the ones who are further into another. 

Having this in mind, it’s not strange that differential pricing is used by multinational companies who by nature require this type of market and customer segmentation. 

Product variations

If you are a company that sells only one product, that doesn’t need to mean that you have to use only one price. Product variations can require different prices. Even though the products’ essence can be the same, the dimensions/size, color, material, additional features may differ. This allows you to set different prices and to use special offers or discounts for customers who decide upon e.g. a bigger size product. 

Isn’t differential pricing the same as dynamic pricing? 

We’ve promised to come back to this question. The answer is no, it’s not. Differential pricing can be understood as a part of a dynamic pricing strategy, but the main difference is that it relies much more on customer characteristics and buying behavior. On the other hand, dynamic pricing is focused on market conditions. Looking from that perspective, we can say that differential pricing is a more narrowed and focused approach. 

Dynamic pricing, as the name suggests, will require a more frequent price change. The change can happen in a matter of days, or even hours and minutes, depending on how competitive a certain market is. Due to that, repricing is a must-have feature for all the businesses that are using these types of strategies. 

When price changes are occurring so frequently, it’s almost impossible to keep track of them manually. Thus, most companies rely solely on an automated approach. Since the majority of businesses don’t have a developed in-house solution, they’re looking for the help of price monitoring tools. 

In general, repricing will help you define whether your price is too low or too high, and is there any room for price changes. Your pricing strategy can’t be defined without having an insight into competitors’ actions, and repricing can easily help with that task. When deciding on which price monitoring tool to use the smartest thing would be to check if they’re offering custom repricing options. 

Differential pricing examples

As we said, airlines are a well-known example of using this kind of pricing strategy. But let’s show a few more ways in which you can make use of differential pricing.

Volume discounts – businesses can use differential pricing when offering volume discounts. Book stores and fashion stores can be a good example – usually, you can notice that they are having special offers – if you buy one item, you get the other one in a different color at half price. 

Seasonal discounts – airlines and the travel industry, in general, are great examples of seasonal discounts. They are using differential pricing in the following way – prices will drop during the period of low demand, and vice versa. For example, you can expect to pay less for a room reservation in the off-season or during the week. But, if you’ll be most likely paying much more for the same room during the peak of the holiday season or over the weekend. 

Group discounts – group discounts are usually present in the entertainment industry. Besides restaurants or movie theaters that can offer group discounts, small businesses can benefit from differential pricing too. If you have a small bookstore, maybe you can consider offering discounts to students, teachers, or librarians. A very useful way of using differential pricing! 

Remember how we said that price monitoring tools can help you with differential pricing? Well, here is an example of one travel company. As you can see, their prices are divided into a few categories – passenger type, departure port, days before departure, and competitor groups. 

With the help of Price2Spy, they can easily get all the needed information and use it to make further pricing and strategic decisions. 

Advantages of differential pricing 

Since price is one of the most important points in your marketing mix, there’s no need to explain how much a business can improve by setting the right pricing strategy. 

One of the most important advantages that differential pricing will bring you is an increased market reach. If you take the time to understand customer segments, you’ll be able to set different prices for each segment and enlarge your overall customer base. That’s the beauty of differential pricing – people get the opportunity to try out your products, and if that’s what they’re looking for, they will be more likely to pay even more than they’ve previously intended. 

Additionally, this will lead to increased revenue. It’s well-known that the prices go up when the demand is also higher, and vice versa. For example, companies such as Uber operate on that model. The rides are more expensive when the demand is higher. Thus, eCommerce pricing works in the same way. 

Another area where differential pricing comes helpful is when it comes to inventory reduction. If you have already checked all the other aspects that can cause poor sales, then a high price is most definitely the reason for low results. Differential pricing will enable you to lower the prices of certain products while keeping a higher price for the ones that customers are more interested in.

Finally, all of this sounds nice in theory, but the most important question is how to implement a differential pricing strategy?

How to use it? 

If you have been reading carefully, you can already tell that the first step is to create the right market segmentation. Initially, this can seem like a time-consuming task, but it will pay off in the long run. Your business will function more efficiently and you’ll witness time and resource savings. 

Market segmentation will help you to understand the price elasticity. However, this can’t be done unless you fully understand your customers’ wants and needs and developed a tailored pricing strategy. 

What should you pay attention to?

• Identify who are your potential customers
• Get to know them better – what they need and want, like and dislike, how they spend
• What is their lifestyle? Where do they live? How old are they? What do they do for a living?
• Focus on the potential risks that a price change can cause 

Once you have all this information, you should use it to define a solid strategy. First and foremost is to understand whether the products have elastic or inelastic demand. It’s vital to also understand the “Rate Fence” method. This method is used to strictly separate market segments, and it’s pretty common in the airlines’ industry. Airline companies are well-known for using differential pricing to set different pricing for tourists and business travelers. 

As we have already mentioned, things can get complicated when it comes to repricing, so it would be a smart move to look for the help of a price monitoring tool.

Conclusion

Even though differential pricing can be a time-consuming task, it will help you get a better understanding of your customers and in the end, bring more success. As you can see, there are different ways of approaching this pricing strategy and they all require time and effort. 

If you haven’t had success with pricing strategies so far, maybe differential pricing is just the right solution for you. Be sure to share your experiences with us! We would love to hear them!