Pretend you’re sitting on an airplane. You purchased your ticket two weeks ago for business and are sitting in the middle seat. Do you turn to the person on the aisle and ask them how much they paid for their ticket? Probably not. We’re comfortable with the idea that people pay different amounts for the same flight. So why aren’t we comfortable paying different amounts in retail?
Retailers have long struggled with setting prices. How much are customers willing to pay? Are some customers willing to pay more? Prior to the 1870s, a shopper and a clerk would haggle over how much an item was worth, ultimately ending up at a value that was advantageous to both—or walking away from the sale. The invention of the price tag simplified shopping but also created uniform margins, leaving retailers with the question: Could I be making more?
What Would Personalized Pricing Mean?
As technology gets smarter, the amount of information companies have about each of their customers is steadily growing. This information has turned us into a society where personalization is already the status quo. The banners popping up on on your Facebook page, the suggested items on Amazon, the ads on your YouTube videos—these things are already tailored towards you. If a retailer knows what you’re likely to buy and how much you’re likely to spend, why shouldn’t the price of an item be individualized, as well?
What’s Wrong with the Price Tag?
While a set price makes for an easy checkout, the work that goes into deciding how much an item costs is harder than one would think. As a retailer, would you rather sell one hundred items at a profit of $5, or 50 items at a profit of $100? The lower the margin, the more people buy, the larger reach your product has etc. The higher the margin, the more money you ultimately make.
Research has shown that personalized pricing could maximize revenue for many businesses. If it was possible to know the most a customer was inclined to pay for any good or service, a company could sell to the highest number of people while also increasing profit.
Personalized Pricing in Practice
In a study done by two professors from the University of Chicago’s Booth School of Business, personalized pricing was found to increase the profits of one company by 84%. The company, a B2B tech startup, initially charged a flat fee of $99.00 per month. By collecting a large amount of information about each potential customer (location, company size etc.) and crossing it with historical data, the company was able to use an algorithm that could predict the maximum amount a customer was willing to pay for their services. After this study was concluded, however, the company returned to a traditional model of pricing (although it now uses tiered pricing, as opposed to the single price approach).
Personalized Pricing Now
Many decision makers are wary of personalized pricing because it’s a shift away from the norm. According to David Reiley, principal scientist at Pandora and an adjunct professor in the School of Information at the UC at Berkeley, “If you’re making decisions at a firm and you decide to do an experiment, you have to admit that you don’t know the right thing to do….[if it works]...the question becomes: ‘Why were you doing the wrong thing this whole time?’”
There are other flaws in the targeted pricing system. What if a customer purchases a product at a low target price, and sells it to customers being targeted at a higher price? What if consumers learn to cheat the system by purposely looking at discount stores before shopping? What if large giants like Amazon simply decide to match your lowest price? There’s also potential for unfair discrimination based on factors like race, income, etc.
Most importantly, how do you pioneer a tactic that many consumers will view as inequitable? While discounts, though technically a form of price discrimination, are acceptable (buy one get one, first 50 sold are half off, etc.), individual pricing is a tough sell for many people. Implementing a system like this could actually be detrimental to a business, purely because it’s not what consumers know.
What’s The Answer?
On one side, research has shown that personalized price discrimination increases the size of the potential market and allows all those who want a product to purchase it. While people may not want to pay more than the person next to them, it can be argued that equal is not always fair. On the other side, we get into the weeds of true execution. How would a company deal with implementation from a PR standpoint? Would people learn to hack the system? The potential upside is massive, but will it ever become a reality?