Second-degree price discrimination is a pricing strategy where a business charges consumers different prices based on the quantity or amount of a good or service they consume. Instead of differentiating prices between different types of customers, this method varies the price per unit depending on the volume purchased by the same customer.
This form of price discrimination operates by offering a schedule of prices, typically structured so that the average price per unit decreases as the quantity consumed increases. Consumers then self-select into the pricing tier that best matches their consumption needs, effectively determining the price they pay per unit.
How Does It Work?
Businesses implement second-degree price discrimination by segmenting their product or service offerings into distinct blocks or tiers. The core principle is to incentivize higher consumption by making additional units progressively cheaper. This strategy allows companies to capture more of the consumer surplus that would otherwise be lost if a uniform price were applied to all quantities.
Common examples of second-degree price discrimination include:
- Tiered Utility Billing: Providers of electricity, water, or natural gas often charge a higher rate for the initial block of units consumed (e.g., first 100 kWh) and a lower rate for subsequent blocks, encouraging greater usage without penalizing low consumers.
- Volume Discounts: Many retailers offer lower per-unit prices when customers buy in larger quantities, such as "buy two, get one free" deals, bulk pricing for wholesalers, or "family packs" that provide more product at a reduced average cost per item.
- Mobile Phone Plans: A phone plan might charge a standard rate for a determined amount of minutes or data, but then impose a higher per-unit rate for any usage that exceeds that initial allowance. Conversely, some plans offer unlimited data at a higher base price, catering to heavy users.
- Loyalty Programs and Reward Cards: These programs often provide frequent shoppers with a discount on future products or access to special pricing once a certain spending threshold or purchase volume is achieved. This encourages customer loyalty and increased overall spending.
- Software Licensing: Enterprise software often has tiered pricing, where the cost per user decreases significantly as the number of licenses purchased increases.
Key Characteristics
Second-degree price discrimination is defined by several distinguishing features:
| Feature | Description |
|---|---|
| Pricing Basis | Price variations are based solely on the quantity or amount consumed by an individual customer, not on the customer's identity or group affiliation. |
| Consumer Choice | Consumers self-select their price tier by choosing how much they wish to purchase, allowing them to pay a lower average price for higher consumption. |
| Information Needs | Requires less information about individual consumers' willingness to pay compared to first-degree price discrimination. |
| Primary Goal | To capture a greater portion of consumer surplus and encourage increased sales volume by offering lower effective prices for larger purchases. |
| Examples | Volume discounts, block pricing (utilities), tiered service plans, loyalty programs. |
Why Do Businesses Use It?
Companies implement second-degree price discrimination for several strategic reasons:
- Maximize Revenue and Profit: By selling additional units at a lower price to customers who wouldn't pay the higher initial price, businesses can increase overall sales and revenue from different segments of their demand curve.
- Encourage Higher Consumption: The declining average price per unit for increased quantities acts as a strong incentive for customers to purchase more than they might at a flat rate.
- Optimize Resource Utilization: For service providers (like utilities or internet), tiered pricing can help manage peak demand and encourage off-peak usage, leading to more efficient resource allocation.
- Reduce Inventory: For physical goods, volume discounts can help move large quantities of products, reducing storage costs and inventory risks.
Impact on Consumers and Businesses
Second-degree price discrimination offers distinct impacts for both sides of the market:
-
For Consumers:
- Potential Savings: Consumers with high consumption needs or those willing to buy in bulk can benefit from significantly lower average prices per unit.
- Increased Choice: It provides flexibility, allowing consumers to choose a consumption level and associated price point that best fits their budget and usage patterns.
- Complexity: Some tiered pricing structures can be complex, making it challenging for consumers to understand the exact cost breakdown or compare prices across different providers.
-
For Businesses:
- Higher Sales Volume: This strategy effectively drives increased purchases, particularly from high-usage customers.
- Improved Profitability: By capturing more consumer surplus, businesses can boost their overall revenue and profit margins.
- Effective Market Segmentation: It allows businesses to segment their market based on consumption patterns without needing to identify specific customer characteristics, leading to more targeted pricing.
Ultimately, second-degree price discrimination is a common and effective strategy utilized across various industries, balancing profitability for businesses with opportunities for savings for high-volume consumers.
