Are discount coupons just a perk for customers? Discover the intent behind price discrimination strategies and explore how they leverage consumer characteristics and behavior.

 

Pricing dilemmas and coupon secrets

There is an element of price discrimination in product pricing. Who they discriminate against is ‘people with money’!

I’ve been a chef for 10 years, working my way up to the position of executive chef. Recently, I opened a small restaurant for my own business, offering dine-in as well as delivery through a delivery application. I priced it very cheaply, almost at cost, because I thought it was important to get customers first.
But it didn’t work out that way. My food tastes better and the quality is much better than the restaurants around me. I have good reviews on the delivery app, and my prices are 20% lower. But why are there so few customers? Especially since my strategy of offering good food at a low price doesn’t seem to be working, and I’m not getting many return visits or repurchases.
So the manager of the delivery application took a look at my store one day and suggested that I raise my prices a little bit and use coupons to discount them to what they are now. It was a little bit of a hassle, but I thought I’d give it a try anyway, and I’m happy to report that my delivery sales have really increased.
But I have one question: why raise the price and then use a coupon? Customers actually have to download the coupon to use it, and it’s a hassle, so why not just drop the price of the product right away? And some customers don’t even know that coupons exist, so how do I make them aware of them?

 

Coupons are a form of price discrimination

Menu pricing is a very important part of running a store. If your prices are too high, you won’t be able to attract customers, and if they don’t come in, you’ll have fewer customers. If your prices are too low, you’ll only be able to make a limited amount of food each day, so even if you do get a lot of customers, you’ll only be able to serve some of them, and you’ll have to give up more profit.
If you balance your prices well, you can keep the influx of customers moderate. Customers also want to come back for more if they’re satisfied with the food at a good price, so finding the right balance is key. So how should you price your menu from a business perspective?
Have you ever visited a fast food restaurant like KFC or McDonald’s in the past and used coupons to get discounts? Nowadays, many business applications issue and use e-coupons. Why do merchants use coupons? Why not just lower the price of the product and attract more customers? Why go through all this trouble?
The truth is, it’s a hassle for both merchants and customers, but there’s a reason why discount coupons have been around for so long.

You’re selling ice cream, and you have two left in stock, and they only cost $0.2 each. Two people come in to buy ice cream. Customer A is willing to pay $0.7, and Customer B is willing to pay $0.5. What price should you set?

If you price it at $0.7, you’ll only sell one and earn $0.5. You won’t sell the other one. If you price it at $0.5, you can sell both of them and keep $0.6. So $0.5 is the right price, right? Yes, but there’s a catch. Because Customer A was originally willing to pay up to $0.7, and you sell them for $0.5. Of course, they’re grateful. They feel like they’ve saved $0.2, which is free money.
In economics terms, that $0.2 is “consumer surplus”. The more consumer surplus, the happier the customer, of course. But as a seller, you feel bad. The customer was originally willing to pay more, but because you underpriced, that money went into their pocket instead of yours.
So how do you make sure that the customer who was willing to pay $0.7 still pays $0.7, and the customer who was willing to pay $0.5 still pays $0.5?
You set the price at $0.7 and apply a $0.2 off coupon, but you put a little bit of a catch on how the coupon is applied. What happens?
Customer A was originally planning to pay $0.7 for the product, so they accept that price and make the purchase. Customer B realizes that even though it’s only $0.7, the coupon allows them to save as much as they want. The feeling of saving money overrides the slight complication, so he downloads the coupon and happily pays for the item.
Each consumer has a different elasticity of price demand. In other words, they have different sensitivities to price. Some people will never buy the product without a coupon, while others don’t mind a discount coupon. So if a seller lowers the price right away without applying a coupon, he loses some income.
In economics, this strategy is known as “price discrimination,” but discrimination in this context is not a bad thing, and certainly not a positive thing: it’s not the people who use coupons who are being discriminated against, but rather the people with money who don’t. By definition in economics, price discrimination actually creates a price differential of some sort. When the same product is sold at different prices to different buyers, it creates different selling prices or consumption standards among those who accept it.
Price discrimination occurs because managers sell the same goods or services at different prices to different buyers without a justifiable reason. Price discrimination is a type of pricing strategy that monopolists choose to maximize profits.

 

First-degree price discrimination: Haggling

Throughout the history of business, price discrimination has been the subject of numerous examples and a rich theory. Economists categorize it into three types based on the degree of price discrimination.
The first is first-degree price discrimination, also known as “perfect discrimination,” where all units of a good are priced differently. The premise of first-degree price discrimination is that the seller knows exactly how much consumers are willing to pay for the product, so they set the price, and the price they set matches the price consumers demand for the product, thus capturing all of the consumer surplus.
In first-degree price discrimination, the seller charges a different price for every unit of a product that a customer buys. In what situations does this happen?
A common example is a street vendor: they initially quote a very high price, and through haggling, they find out the “psychological price” in the consumer’s mind. They then sell the product at the highest psychological price the consumer is willing to pay. This kind of consumption usually applies to ‘informal products’. This is because they don’t have a standardized, official market price, so the psychological price is based on individual judgment.

I was at a resort on a scenic beach and wanted to buy a souvenir to remember my trip. The beach was lined with small shops and the shelves were filled with all kinds of souvenirs. They were all locally made and handcrafted, and you wouldn’t find them in other cities.
You looked around and found one souvenir that caught your eye and asked for the price. The owner looked you over and said, “I’ll give you up to $60 for it.” You realize that’s a lot of money, so you start haggling. The price came down to $40, and you gladly opened your wallet.
Not long after, a woman came in looking for the exact same souvenir as you. The boss took one look at her. She was wearing a designer bag, a designer bracelet, and a designer dress. “It’s handmade, I have just this one. It takes me days to make one of these. You’ll have to pay me $40.” She promptly paid the $40 and went home happy.

It doesn’t matter how much that souvenir cost. That’s first-degree price discrimination, which means “cut your coat according to your cloth.

 

Second-degree price discrimination: Set different prices for different quantities

Different consumers need different amounts of the same product. For example, if you live alone, you only need one set of cutlery, or maybe two or three extra in case you have company over. If the seller offers to give you half off if you buy a set of 100, you’ll probably just buy a set for two at full price, because you don’t need that many.
But if you’re opening a restaurant, you might need 100 sets. This is what we call consumer “demand price elasticity”. It’s when you set a different price per unit based on consumer demand.
This is where second-order price discrimination comes in. The seller knows the demand curve of the consumer and sets different prices for different quantities. This way, they can increase their sales volume and capture the “consumer surplus” that comes from buying different quantities.
In second-degree price discrimination, the seller doesn’t have perfect knowledge of each customer’s characteristics, but they understand the diversity of customer preferences, so they offer an offer with multiple prices and ancillary terms.
From the buyer’s point of view, it’s up to them to decide and choose, so they can pick and choose which of the seller’s offers fits their consumer demand curve. The end result is a consensus between the seller and the customer that maximizes both volume and price. Here’s an example.

You’ve traveled hard to relax. You want to buy a few more gifts for your coworkers in addition to the souvenirs you just bought, so you stop at a store that sells magnets to stick on refrigerators. The owner offers to sell them to you for $3 each, but you knock it down to $2.
“If I buy 10, will you give me a little more off?”
He said he’d take $5 off the price and give you $15. Now the price per magnet is $1.50. I paid for them, and as I was putting them away, he said.
“If you buy 10 more, I’ll only give you $10.”
You started to think: the more you bought, the better the deal. If you just bought 10, the unit price would be $1.5, but if you bought 10 more, the price would drop to $1. Feeling good about the idea that you could buy more gifts for your coworkers at this price, you buy 10 more, for a total of 20.

When prices are based on quantity, it pays to buy more, which is why many stores run promotions like “buy two, get 20% off, buy three, get 50% off.” This is what we call second-degree price discrimination.
But in economics, there’s also the concept of “reverse second-degree pricing,” where the “forward” is what we just saw, where the more you buy, the cheaper the price, and the “reverse” is literally where the more you buy, the higher the price.
Mobile data is a classic example. Those of us who used smartphones when they were just coming out know that we all had a “data plan” and we’ve all had the experience of using more than the amount of data allowed on our plan and then getting hit with a bill. As a college student at the time, I didn’t have a lot of money to live on, so I was always scrambling for data usage. Once I used up all the data on my plan each month, I had to wait until the first of the next month to get more. But I had a friend in my dorm who had a lot of money, and I remember looking at him and being jealous of how he used his data without worry. The essence of this “reverse” second-class pricing discrimination is to extract the most profit from consumers with the most purchasing power.
It’s all about segmenting and managing your customers, because you can generate a lot of “consumer surplus” from consumers with high purchasing power, so you can create product kits or sales models that target them exclusively and make money off of “people with money.” So it’s wealthy people who get price discriminated against.

 

Third-degree price discrimination: Different for different targets

Third-order price discrimination is also known as “selection by indicators.” It involves dividing a market into several segments based on consumer characteristics and setting different prices in each segment. This allows you to extract the most profit from the market with the highest prices. At the same time, resources can be ‘steered’ by price signals to maximize profits in each market. This price discrimination strategy is often utilized when deploying public resources.
Electricity is an example of this. Typically, the peak time for electricity use is during the day. In the evening, especially after dark, electricity usage plummets, which is why there are shortages and even blackouts during the day. But in the evening, demand plummets again, forcing power plants to shut down some of their generating capacity for a while.
That’s where electricity progressive pricing comes in. It maximizes profits by providing electricity to those who need it, while “shifting” the demand of those who don’t necessarily need it to the evening, so that resources are used more equitably.
This “shifting” of demand during peak periods to off-peak periods has positive implications for both the seller and society, as it not only maximizes profits, but also ensures that the facility’s resources are fully utilized.
In third-degree price discrimination, once the characteristics of the buyer are accurately identified, the company sets different prices based on information about the customer, specifically the customer’s willingness to pay for the product and how much they are willing to pay for it. Examples include product pricing in certain countries, membership discounts, campus-specific software pricing, and student discounts.
Third-degree price discrimination is the most common form of price discrimination. Sellers categorize their buyers into groups, so they create different prices for those specific groups. This behavior is called “market segmentation.” Let’s look at an example.

After some time, I revisited the same beachfront resort I visited last time and stopped by the same souvenir shop again. The owner was the same, and the store was the same. But the selection was much larger. There were over thirty different types of fridge magnets.
Curious, you asked the owner what was different about these products. He replied that they were all different, from the materials to the craftsmanship.
Finally, you asked, “So how much do they cost, Mr. Boss?” He said a very high price, which was completely different from before.

The same product means different things to different people. Some people buy it just to keep it as a memento, while others buy it for its exquisite quality and unique feel. The reason there are so many different types of magnets is to cater to the needs of different consumers.

 

Knowing your buyers is key

To make good use of price discrimination, sellers need to effectively segment their buyers’ characteristics. These differences arise because different buyers have different needs, buy different amounts, and want different prices. The key is for sellers to effectively differentiate between these differences.
Airlines often run deep discounts on tickets, but no matter how much of a “bargain fest” they have, there will always be a segment of business travelers who are not bound by this: they are not price sensitive, and they have to go on their planned business trip no matter what the price is.
But the seller doesn’t know if the customer is an ‘entrepreneur’ or a ‘personal traveler’ – so how do airlines segment these passengers and markets?
As you know, discount tickets always come with strings attached: “must be redeemed within two weeks,” “round-trip tickets can only be used on weekends,” “must spend a week or two at the destination,” etc. But business trips, which are often organized by the boss, are more rushed. Not many people plan and buy tickets two weeks in advance, so it’s hard for business travelers to qualify for discounts.
The most outrageous is the requirement to spend a weekend at the destination. If I’m traveling for work, I’m probably staying in a nice hotel and my travel expenses are covered, but if I’m traveling for a weekend, I have to stay in a hotel for at least two nights, which increases the cost of my accommodation and travel support, and I’m coming back from a weekend, which means I’m missing a few days of work. The support you’d get would far exceed the discount you’d get on the ticket, so smart entrepreneurs don’t get hung up on that “pennies” discount. That’s why business trips usually don’t last more than a weekend, and very rarely more than two weeks.
By setting the terms of the discount, the airline is able to tap into latent demand and weed out a group of customers who don’t need this kind of discount, which is why the parent airline’s “fly as much as you want on the weekend” promotion was such a huge success.
In many cases, discrimination is a low-cost, risk-averse strategy. Employees at luxury stores see a customer’s demeanor and instantly come up with a response. Of course, many people are repulsed by this approach to customer service, but when you look at it another way, there’s nothing wrong with it: employees have limited time, and when multiple customers come in for service at the same time, they have to choose between them, and the natural inclination is to choose the customer with the most purchasing power.

 

In the internet age, price discrimination is more covert

With the development of the internet age, information between consumers has become increasingly transparent, so has price discrimination become less and less common? The internet is very efficient at transmitting information – misleading fake news or “fluff” can be circulated very quickly through private media, making discrimination more costly and less visible. But in a sense, this also means that discrimination is becoming more covert.
Online sellers can’t take the “price by sight” approach of traditional price discrimination – if one consumer pays $0.4 for 500 grams of apples and another pays $0.1, it leaves a trail across the internet, and once it’s discovered by a consumer, it’s immediately followed by comments and reviews that say things like “unfair,” “the seller is unscrupulous,” and “I’ll never buy from them again.
How can merchants capture more “consumer surplus” while staying in the minds of consumers?
In the age of the internet, the answer is to make consumers take the initiative and go through a relatively complicated process to reap the benefits, such as downloading a coupon. It’s a concept of “user labor.” This creates a psychological balance between consumers who buy at full price and those who get a discount, while the merchant reaps high profits – a true “win-win” situation.
Let’s take a look at one of our favorite events in social commerce: Consumer A wants to buy a certain product. He thinks the price is a bit high, so he invites his friends, family, or acquaintances to buy the product together and lower the price. The consumer gets a discount and the seller gets “free advertising” at no cost, so it’s a win-win situation.
Consumer B, who wants to buy the exact same product, isn’t price sensitive, so he pays full price. The seller gets a higher profit margin.
In this way, social commerce is a labor-saving and mutually beneficial way of price discrimination, giving price-sensitive consumers a discount and non-sensitive consumers the opportunity to buy comfortably at full price. This ultimately benefits the merchant, just like the above example of having to download a coupon to redeem a discount.
Some of the biggest social commerce breakthroughs have been due to the use of this price discrimination strategy. The price drops as soon as a group of people buy together, and it drops again once a certain number of people have bought. In this way, the exact same product can be priced differently depending on how much “labor” the customer is willing to put in, attracting potential customers who are willing to buy. Even consumers who weren’t ready to buy can be caught in the “same net”.

 

Price discrimination for everyone

A bakery launched a new cake for $39. After a period of time, sales started to dwindle. To boost sales, the owner dropped the price to $29. That’s a $10 drop in price for the exact same product in a short period of time. While this may bring in a lot of new customers, it also means losing the customers who originally bought it for $39, which is $10 in profit.
That’s why experienced store managers don’t drop the price right away. They set a special price and add strings attached. For example, they might offer $29 for a $39 regular price if you upload a photo of a cake to social media and get 100 likes. This “user labor” naturally distinguishes their pricing policy.
In the case of hotels, when you book on an online booking site, the price changes depending on how far in advance you book. But for customers who are not price sensitive, especially those who need to stay in a hotel in a hurry, what matters is that the hotel is available as soon as possible, convenient, clean, and time-saving. Price-sensitive customers, on the other hand, will plan their trip well in advance and lock in their dates to take advantage of discounts, even if it’s a bit of a hassle.
Regular promotional offers do the same thing: they indirectly price their products differently to make a higher profit.
If a cafe runs an event where they sell an Americano, which normally costs $0.4 a cup, for $0.2 every weekend, price-conscious consumers will wait until the weekend to buy it, while others will just buy it when they feel like it.
Malls have huge sales every weekend. It’s a strategy to get the “salarymen” out of the house on the weekends, otherwise they’d stay home and not spend. The reason your local grocery store has sales every weekend is to get the “mothers” out of the house. Otherwise, they’d all be shopping at the big box stores.
Why don’t young people see these ads? Because they are too busy every day. But young people who like to go to the supermarket don’t care about promotions. Of course, they know that the price of vegetables in the traditional market is much cheaper, but they feel more comfortable buying them at the supermarket at full price without going through the complicated process. The supermarket is maximizing profits through such promotions.

 

Some consumers enjoy price discrimination

In some cases, consumers willingly enjoy being “discriminated against. Human behavior and decision-making often deviates from rationality, and merchants can take advantage of this irrational behavior to make consumers feel like they’re not getting ripped off. They can even make consumers enjoy the ‘discrimination’.
Institutional economists, including Veblen, have pointed out that “when people buy something, they pay attention not only to its use value, but also to its ability to demonstrate their wealth, status, and class.” According to this argument, goods have two kinds of value: actual functional value and status value. The latter value is linked to market pricing, which is why the more expensive a luxury item is, the more desirable it is. In economics, this phenomenon is known as the Veblen effect. It refers to the phenomenon where the demand for a product does not decrease as the price goes up, due to the ostentatiousness or vanity of some people.
Sellers see the best results when they combine “price discrimination” with the Veblen effect. Airlines differentiate classes of seats on an airplane based on economic status to provide special service. It’s this sense of superiority that makes consumers willing to “discriminate.
Price discrimination, which is applied differently to different people, sometimes causes consumers to complain about issues such as “discomfort” or “equity”. Here’s an example of a great example of removing this ‘discomfort’ and ‘equity’ by taking advantage of a consumer’s irrationality.
Have you ever heard of an online game called ‘Wildrift’? In the game, there are various paid items called ‘skins’. They’re very popular with users because they have a cool effect when you equip them. In the game, a designated store runs a sale on skins.
At the event, all players will be given one chance to win a free skin through a lottery. If you win, you will receive a corresponding benefit when you purchase the skin.
The first thing to note is that the ‘skins’ specified here are usually for the characters that players play the most in the game, which makes them more motivated to buy them. Also, the discounts are irregular, and different players get different discounts in the lottery. This is obviously “price discrimination”.
However, in stark contrast to the conclusions of the previous analysis, the differential pricing for different consumers is not hated or resented. On the contrary, it encourages players to spend more. Why?
First and foremost, it’s because “uncertainty” removes “dysphoria.” The discount rate that players win in the lottery is obviously not random – it’s calculated based on their consumption data. But players don’t see it that way – they attribute the win to luck.
Next, the “anchoring effect” comes into play. The “anchoring effect” refers to the phenomenon that when we evaluate a person or thing, we are heavily influenced by our first impressions or the first information we encounter. Like a ship anchored at sea, our minds are “anchored” in one place.
In the game’s “store”, the regular price is the “anchor” and becomes the “reference point” for customers. By forcing users to compare the regular price to the price after the discount, it weakens the comparison phenomenon among users. The anchoring effect gives consumers a sense of harvesting joy, giving them a sense of “buying is making money”.
Now that you understand how price discrimination works, you’ll be able to sense the seller’s “intent” when you see coupons offered when you buy something. So, if you’re a restaurant owner, do you now understand how you should price your menu?