Our final article in this pricing strategy series is on price segmentation. This strategy is when you offer the same product or services but at different (or unique) prices to different types of customers. This pricing strategy has proven to increase overall profit and revenue—especially in industries with high fixed-cost structures.
TL;DR
- Price segmentation (or price differentiation) is a pricing strategy that involves providing different prices for the same product or service, based on customer segmentation. Flexible billing software automates this process to ensure accurate billing every time.
- There are different types of price segmentation, such as channel-based, usage-based, and volume-based. No matter the approach you go for, it’s important to do market research before you implement price segmentation, otherwise, you may end up excluding price-sensitive customers and raking in lower profits than expected.
- While this pricing strategy can be very powerful, there are challenges to segmentation that can reduce its impact, such as dilution, backlash, or stagnation. That’s why it’s important to make sure it’s right for your company before selecting a pricing strategy.
What Is Price Segmentation?
Imagine you have a product priced at $10.
Some potential customers may see this price as too high and never convert. Other potential customers may be willing to pay $15. If you only set the $10 price, you lose $10 from the people who won’t buy, but at the same time lose $5 from the people who would have paid more, for a total loss of $15.
But if you have three prices—$5, $10, and $15—you get the $15 from the higher price segment, plus the $5 from the lower price segment, and you end up with a total of $20.
At first glance, it may seem there’s no way this can work. But think about the airline industry.
With price segmentation, a variety of prices are offered for the same seat on a flight; the seat is the same, but the price varies based on the type of customer making the purchase. This is pricing based on customer segmentation and the impact on the bottom line can be huge.
Will Price Segmentation Boost Profitability?
In just about any sales-driven customer acquisition, your sales team might have an array of prices it’s willing to offer customers for the same product depending on how negotiations go. Discounts can be applied over months or even years to secure customer loyalty and longer lifetime value (LTV).
Customers can be segmented by volume, attribute, service offering, time of purchase, time used, or more. From a billing perspective, your system will need to set different attributes for customers and apply price changes and discounts to specific segments.
Flexible billing software automates this process to ensure accurate billing every time.
Types of Price Segmentation
Before you implement pricing segmentation in your way of working, let’s take a look at some of the most popular types of effective pricing segmentation your business could use for different products and services.
Channel-based pricing segmentation
Prices for products can vary based on the channel via which they’re sold, which you might see in companies that sell products through both a physical storefront and online. Let’s say you run an eCommerce shop that also has brick-and-mortar locations: you could consider offering online-only products available at a lower cost since you wouldn’t need to account for the higher fixed costs involved with having a physical location.
Another example where you might see channel-based pricing segmentation is with restaurants that also provide delivery service. It’s often a few dollars cheaper to eat in or pick up an order, whereas if you order the exact same meal via a food delivery service app, it’s not uncommon to pay an additional fee—due to the additional incurred expenses the restaurant must front. In the SaaS world, you could offer a slightly cheaper price for customers who convert via online-only marketing funnels, as opposed to customers who are onboarded through in-person sales.
Usage-based pricing segmentation
Some might argue that this is the fairest pricing structure there is out there: charging customers for only what they use. Various SaaS companies may use this form of segmentation, which means that users will only pay for a certain value metric, whether it be gigabytes of data uploaded, API requests made, number of active users, or something else. For example, Slack offers pricing plans where they charge a fixed amount per person, with a discount if billed yearly.
The biggest advantage of consumption-based pricing is that there’s a clear correlation customers can derive between what they pay and the value received, which can lead to better customer retention. However, it’s important to factor in the possibility of unpredictable usage slumps, which can lead to a sharp decrease in your monthly recurring revenue.
Time-based pricing segmentation
In some cases, finding the right price for a product is nothing more than a matter of time. Take flight tickets for example: they vary wildly depending on when they are purchased. While they do generally get more expensive closer to the date, it’s not always predictable.
Conversely, the fashion industry is somewhat more predictable when its prices fluctuate. Seasonal clothes like winter jackets are generally less expensive towards the end of the season as spring starts to arrive.
Another example of time-based segmentation has to do not with when the product was purchased, but rather when it will be used. Traveling to an all-inclusive beach resort destination is often more expensive if booked for a winter escape in January, even if it was bought 6 months ago. Since many people will want to avoid the winter weather, the prices will usually be higher than if a customer booked for an April getaway.
If you offer a software product that’s more seasonal (such as tax preparation software), you could consider increasing the prices prior to tax filing season, although this could backfire if other competitors offer a discount to attract more customers at the same time.
Value-based pricing segmentation
A key customer-focused form of pricing segmentation is value-based pricing, which means the price points are based on a consumer’s perceived value of the price or product. This form of segmentation is also quite popular for SaaS companies but definitely requires a lot of market research.
It requires deep knowledge of the target audience, the competitor landscape, your unique selling point, and the market at large. Otherwise, you run the risk of charging too much and alienating certain target markets, or charging too little and devaluing your product from the get-go.
One of the best examples of value-based pricing can be seen in Apple products in general. Although it’s possible to get phones or smartwatches from other companies for a significantly lower price point, Apple’s brand image of providing products and services that just work is why they’re able to easily charge a premium for their products—and why consumers keep coming back again and again.
Volume-based pricing segmentation
With this form of segmenting prices, the prices are determined based on how much of a product or service is sold. Generally speaking, the rule of thumb is that the more units of a product sold, the cheaper the overall purchase is. A quick example of how this might play out in the supermarket could be that a bag of 6 tomatoes might cost $3, or 50 cents a pop, while a bag of 12 tomatoes might cost $5 instead of $6.
In the SaaS world, you can see this type of segmentation mostly with a monthly vs. annual subscription. Most software companies offer a discount if you lock in upfront for an annual contract instead of a monthly plan, which is a clever way to try to convince potential customers to stay in their ecosystem for longer.
Geographic pricing segmentation
For businesses with customers in different countries, segmenting prices by geographical region may be a necessary option if you wish to penetrate a certain region. For example, companies that sell staples like flour may charge more in more affluent countries and reduce the price for countries with lower salaries and purchasing power.
If you’re selling a software product that’s available globally, it may be worth considering offering a discounted price for customers in certain countries, although you would need to verify their location to avoid users spoofing their location to access the cheaper price.
However, not all businesses engage in this type of segmentation. Those that engage in value-based pricing, like Apple, often charge just as much or more for their iPhones in countries where the average salary is lower, like India.
To be clear, the above list of pricing segmentation strategies is by no means exhaustive! There are plenty of other methods of price segmentation that you could opt for, such as segmenting by demographics (which could involve charging students or teachers less than businesses), location (theaters and concert venues tend to charge more to sit up front), attribute (first class tickets cost more than their economy counterparts), or service offerings (non-refundable tickets are generally cheaper than refundable tickets).
No matter the approach you go for, it’s important to do market research before you implement price segmentation, otherwise you may end up excluding price-sensitive customers and raking in lower profits than expected (more on that in the next section).
How It Can Go Wrong and Some Things to Consider
While this pricing strategy can be very powerful, there are challenges to segmentation that can reduce its impact. Here are some things to watch out for.
- Dilution: It’s possible that customers who would pay your higher price will find ways to buy at your lower price.
- Backlash: If you’re not careful, higher-paying customers may not see the value they’re receiving from the premium price they’re paying and will feel taken advantage of. Make sure to keep perceived value in mind when creating and promoting your segmented prices.
- Stagnation: Don’t make the mistake of implementing your pricing strategy and forgetting it—iterate on your pricing. You should always be researching and exploring new ways to add value to your product or service.
Used properly, the segmentation pricing strategy can be very beneficial. However, it’s not the best fit for every business, so make sure it’s right for your company before selecting a pricing strategy.
To read more on our pricing strategies series, check out:
FAQs about Price Segmentation
Q: What is price segmentation in a pricing strategy context?
Price segmentation, often referred to as price differentiation, is a strategy that offers the same product or service at varying prices to different customer segments. The prices differ primarily based on the customers’ willingness and ability to pay. This strategy can considerably amplify the overall profit and revenue.
Q: What are the different types of price segmentation?
There are several types of price segmentation strategies, such as channel-based, usage-based, and volume-based segmentation. The choice of strategy depends on the company’s business model, the target market, and the type of product or service offered.
Q: How does price segmentation influence sales revenue?
Price segmentation can increase sales revenue by catering to distinct market sectors’ pricing expectations. By offering a range of diverse pricing options, companies can convert potential customers who may find one price point too high and, at the other end, raise revenue from those willing to pay a higher amount.
Q: How can the airline industry be an example of successful price segmentation?
The airline industry effectively uses price segmentation by offering a variety of prices for the same seat to different customer segments. Despite the seat’s value remaining unchanged, the price may vary depending on the customer purchasing it, significantly impacting the company’s bottom line.
Q: How can this pricing strategy be applied in my business?
Businesses can tailor their pricing plans to customer needs and desires to leverage this strategy. After conducting adequate market research, companies can implement price segmentation to maximize profit margins. However, being aware of potential challenges is crucial to ensure implementation success.
Q: What are the challenges associated with price segmentation?
While price segmentation can be advantageous, it’s important to recognize challenges such as dilution, backlash, or stagnation that might reduce its impact. Businesses must remain attentive to the perceived value of their offering and continue to seek ways to add value and refine their pricing strategy.
Q: What is channel-based price segmentation?
In channel-based price segmentation, prices vary based on the channel through which the products are sold. Examples include online-only products priced cheaper than those sold at brick-and-mortar stores due to lower fixed costs or different pricing for customers converted through varied marketing funnels.
Q: What is usage-based price segmentation?
Usage-based price segmentation allows customers to pay only for what they use. This approach is often seen in SaaS companies where pricing plans are tailored to data usage, the number of active users, and API requests, among other metrics.
Q: What is value-based price segmentation?
Value-based price segmentation offers price points based on the customer’s perceived product or service value. It requires a substantial understanding of the target market, competitor landscape, and unique selling propositions, or it might result in charging too much and alienating customers or too little, thus devaluing the product.
Q: How can volume-based price segmentation be leveraged in businesses?
In volume-based price segmentation, pricing depends on the number of units sold — generally, the more sold, the cheaper the overall purchase becomes. This strategy is prevalent in monthly versus annual subscriptions, where businesses often provide a discount for upfront annual payments.
Q: What is geographical-based price segmentation?
Geographical-based price segmentation involves different pricing strategies for regions based on economic factors such as salary levels and purchasing power. For global businesses, offering discounted prices for customers in specific countries might be beneficial to penetrate those markets better. However, this requires reliable location verification systems to prevent spoofing.
Q: Are there other methods of pricing segmentation?
As per the business needs, price segmentation can be based on other factors as well, including demographics (offering students or teachers lower prices), locations (more charges for front-row seats at concerts), attributes (premium tickets cost more), or service offerings (non-refundable tickets priced cheaper).
Q: Should every business engage in price segmentation?
While price segmentation can be beneficial, it is essential to ascertain if it fits your business. This decision depends on several factors, including the type of product or service, the target market, the company’s business goals, and available resources.
