Here’s one way to look at price segmentation. You are taking from the rich and giving to the poor. You are following the Marxist philosophy, “From each according to ability, to each according to need.” You are redistributing wealth.
As an avowed capitalist these concepts are hard for me to type, but the interesting thing is in most situations for price segmentation we really are acting Marxist. And in many ways, it makes us feel good.
Let’s start with an easy example. Airlines make huge margin when they sell first class seats. Why can’t they be more profitable? It’s because all of us normal travelers are beating them down on price. If it wasn’t for first class and business class, either airlines would go out of business or we would all be paying higher fares. You see, the first and business class travelers are subsidizing our seats. They can afford it or they wouldn’t pay those prices. We can’t. They pay more, we pay less, the airlines barely stay in business. Sounds like Marxism.
This could be one of the best examples. On May 12, 2000 the New York Times opened an article with “Five pharmaceutical companies offered today to negotiate steep cuts in the price of AIDS drugs for Africa and other poor regions afflicted by the disease.” They go on to describe how one treatment, that has a worldwide ASP (average selling price) of $16 would sell for only $2 in Africa. This is an 87.5% discount. This should have saved or prolonged many lives in Africa.
From a segmentation point of view, poor Africans can’t afford the full fee while most rich Americans can. But what about the Americans? If they can’t afford it they can’t buy it? This is true, that some Americans may have not been able to afford it, and that is truly sad. However, if the drug companies didn’t have the rich American market to sell into, they couldn’t justify developing the drug. The rich American market is what motivated the drug companies to attack the problem.
But it still doesn’t seem fair. The development costs are all sunk costs. They’ve already been spent. Why not just make them sell in America at $2 like they do in Africa? Surely that covers the cost to manufacture the product. Here’s the problem. If we do that, the drug companies won’t develop drugs for the next huge epidemic. They won’t even work to improve the current drugs. The rich American market motivates drug companies to invest in R&D.
Price segmentation isn’t perfect Marxism by any means, but from many perspectives it achieves similar goals. From each according to ability, to each according to need. This sounds a lot like pricing to Willingness to Pay.
Mark Stiving, Ph.D. – Pricing expert, speaker, author
Photo by loop_oh