There Is Not Just One Price

Customer and Product Segmentation

One of the biggest popular misconceptions I run into is that there is just one fair price for a given product.

You can see why people think this way. If you have just one product, which takes a specific amount of work for you to produce, then surely it should have just one price, right?

However, this is looking at only one side of the equation that defines a price. A price is how the value which the product delivers to the customer is turned into value for the seller. But since there are many different customers, and the same product may have different values to those different customers, there are many different possible prices, though each of those prices might capture a different number of customers.

You’ve probably heard the classic examples: You can sell umbrellas for more on a rainy day than when it’s sunny outside. You can sell water for more in a desert than you could in the supermarket.

Those examples, however, often sound exploitive. Why, people ask, should you charge the person in the desert more just because he’s desperate? (One answer might be that it’s harder to get water out to the middle of a desert.)

It might make things clearer if we consider variation on the selling side. Picture an artisan-made shirt, hand sewn by a skilled tailor and made from hand-woven cloth and on the other hand, a standard mass-produced shirt. Perhaps the artisanal shirt is priced at $1000 while the mass produced one is $40. In today’s economy, only a collector with an interest in artisan-made shirts would pay the $1000 while everyone else who just wanted something to wear would buy the mass-produced shirt.

But in a world before mass production, everyone had to buy the time (and thus cost) intensive shirt. Tailors and weavers weren’t taking advantage of people by charging what today would be high prices. Indeed, they were much poorer than people today. But it was only the advent of mass production and its lower prices which allowed the sorting out of who cared about artisan production and who just wanted something to wear.

These are extreme examples, but within a given company’s range of customers, there are different customers who buy the company’s products for different reasons, and as a result, they place different values on the same product.

Sometimes it’s the arrival of new competition which reveals those different customers.

Picture a company which sells circular saw blades. The blades are of medium quality, and they are the only company selling such blades. Everyone from do-it-yourselfers to job-site professionals buys the same saw blades. Some people use them to cut 2x4s and plywood. Some people use them to cut rebar or sheet metal as well.

Then a new competitor enters the market. They sell carbide tipped metal cutting blades, specifically for cutting sheet metal and rebar. The blades cost three times as much, but they last longer for the pros who often have to cut metal. So those customers leave for the higher end specialty product.

Yet another competitor arrives, but this one is selling super basic steel sawblades. They’re not as well made as the original companies, and if you’re cutting construction debris which might have nails or screws in it, they’ll jam up instead to cutting through. But if all you’re cutting is new 2x4s and plywood, they’ll get the job done, and they’re half the price. This company strips away most of the do-it-yourself customers.

Our original saw blade company didn’t realize that within their customers they had multiple groups: some didn’t value all the quality they provided, and others were actually willing to pay significantly more if they could get even more quality for specialized purposes.

But importantly, while they could perhaps recapture the low-end customers if they dropped their price down to match the low-end product, they can’t recapture the high-end customers who left unless they produce a different, higher quality product. If they wanted to keep all customers profitably, they would need to produce three different products which fit the three different customer needs.

In another business segment, the lines might be a little fuzzier. Picture a fast food restaurant. Some of their products sell because they’re quick, cheap calories. Value menu items often fit this niche. Others sell because they are indulgent, like a double bacon cheeseburger or an ice cream sundae. And yet other products sell because they fit specific needs: healthy options or meatless options.

You can much more easily increase price on an “indulgent” product than a “quick calories” product. But you need to test your customers to see which type they are. And it may be that a mix of “cheap calorie” and “indulgent” customers are buying the same product. In that case, a company might need to split them out, offering the “cheap calorie” customers a more basic product at a low price, while encouraging the “indulgent” customers to buy a new, more premium offering.

While these are just a couple simple examples, all companies have differing segments of customers who are all buying the same product, and those different segments of customers will respond differently to changes in price or features. This is why customer segmentation is an essential part of pricing.

By figuring out what different types of customers are all buying the same product, and what different things they value about the product, companies can work to satisfy all of their customers while adjusting their pricing to reflect the value they are delivering to each customer group. Whereas, if they simply increase prices across the board when they need to increase their margins, they risk losing their most price sensitive customers while some of their customers who value their products most are still paying significantly less than the maximum price they would willingly pay.