If you are a manufacturer, you have the opportunity to choose how your products are delivered to the market. Is selling directly to the consumer the best approach? Do distributors and/or dealers provide you with greater market access? Is a combined approach the best solution for YOUR Company? There are many considerations when choosing the most beneficial channel, and a lot of manufacturers utilize a blend of the above options because they sell into varied market segments. A common mistake, though, is that the manufacturer does not know the target consumer group(s) well enough to know whether or not they should implement a Price Discrimination strategy. The result is that they do not realize as much sales revenue and gross profit as they otherwise could have. Money is left on the table - a lot of money.
Price Discrimination can be loosely defined as selling products/services at different prices in different markets. Companies use a Price Discrimination strategy to take advantage of the fact that there is a measurable willingness to pay more by some groups of customers. This strategy efficiently skims off the consumer's willingness to pay, and it ALWAYS leads to more profits if the marketplace is understood.
Price discrimination comes in several forms and assumes different names. We are all exposed to it daily, in one form or another. From grocery coupons to airfare classes (first, business, coach) to choices at the gas pump, there are prices set based on our willingness to pay. Another common example is known as "Bundling", where a manufacturer will pair two or more items together and sell the bundle at a price somewhat less than the sum of the individually priced items. They do this because they realize that some consumers value the first component more than the second, while others will value the second component more than the first. Regardless, the consumers will pay what they perceive as a discounted price for the bundle. They may not have as much utility for the lesser valued product, but the discounted price wins out and the manufacturer is quite pleased with the higher sell price.
For a Price Discrimination strategy to work, it is absolutely necessary that the manufacturer understands their target market segments and their respective price elasticity of demand. That is, are there market segments that will have a willingness to pay more than others, and if so, how much more? Without this understanding, a Price Discrimination strategy will not work.
Where this gets interesting for the manufacturer is in the scenario where their product is being sold into two or more distinct market segments. For one market segment (A), the manufacturer may choose to sell through distribution, using a discount structure. Let's assume that the distributor receives a 50% discount from the manufacturer, and they pay $50 for a $100 list price item. In our example, the distributor resells the product to the consumer at a price that is 10% less than the list price, or $90. In this scenario, the manufacturer realizes a respectable gross profit (let's say $25), the distributor makes a gross profit of $40, and the customer understands that he received a 10% discount off of the list price.
The same manufacturer has identified another market segment (B) that is unique enough from (A) in that there is no conflict with their distribution channel. Not only can the manufacturer choose to sell directly to the consumers in (B) at the same $90 consumer price and realize a much healthier gross profit of $65, but the manufacturer can use a different list price all together. Let's say that the (B) market understands the list price for the item to be $120. If the (B) consumer is content with the same "10% discount" off of this elevated list price and pays $108, now the manufacturer has realized a gross profit of $83.
These opportunities absolutely exist, yet so many manufacturers fail to capitalize on these highly profitable scenarios. The reason for this is that they fail to understand the differences in the markets, and they generally use the same list price from market to market. A comprehensive market analysis will highlight these opportunities, and the time and money invested in having that market analysis conducted has a very significant ROI for the manufacturer.
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