Self-Selection of Customers

Businesses often use self-selection to induce different groups of customers to take different visible actions. By getting customers to voluntarily self-select into separate groups, businesses can enhance their profits through price discrimination.

Coupons

Coupons are a brilliant means of getting customers to self-select into two groups: (1) price-sensitive customers and (2) price-insensitive customers. Superficially, coupons seem silly. In return for slowing up the checkout line and turning in some socially worthless pieces of paper you get a discount. Coupons, however, effectively separate customers and give discounts to the price sensitive.

Coupons allow customers to trade time for money. To use a coupon you must usually go to the effort of finding, clipping, and holding a small piece of paper. Coupons therefore appeal most to those who place a low value on their time relative to their income. Coupon users are therefore the customers most likely to shop around to find the best price and consequently are exactly the type of people companies most like to give discounts to. In contrast, shoppers who don’t use coupons are probably not that price conscious, and companies can safely charge these people more, confident that their high prices won’t cost them too much in sales.

Movie theaters require students to supply identification so that theaters can determine which group a consumer belongs in. Colleges place financial aid applicants in different categories based upon submitted financial data. Coupons, in contrast, rely upon customers to sort themselves. Coupons sort customers based upon self-selection. The fundamental essence of coupons requires that those who use them are almost automatically the people who are the most price-sensitive.

Airlines

Airlines too rely upon self-selection to price discriminate. It’s usually much cheaper to fly if you stay over a weekend. Business travelers generally don’t want to spend weekends away from home, and thus by giving discounts to those who do stay over a weekend, airlines effectively charge business customers more than other travelers. Business travelers usually have more fixed schedules than other airline customers; consequently they are, on average, less price sensitive. Airlines, therefore, increase their profits by charging business travelers more than other flyers.

Ideally, the airlines would like to verify independently whether a passenger is flying for business or pleasure and charge the ones traveling for business more, but, of course, in such a game business travelers would hide their true purpose. The airlines therefore have to rely upon self-selection and assume that most travelers staying over a weekend are not flying for business.

Airline price discrimination shows that when firms in the same industry price discriminate, then they must, at least implicitly, coordinate their efforts. If two airlines had flights to the same city, but only one price discriminated, then consumers would always go to the lowest-priced airline, and any efforts at price discrimination would fail. Individual airlines can price discriminate only because nearly everyone in the industry does so.

Airline check-in counters usually have separate lines for first class and cattle. The lines the first-class customers wait in are invariably much shorter than those that coach passengers must endure. This seems reasonable, because first-class customers pay more. The greater the benefits to first-class customers, the higher the premium over regular tickets that they are willing to pay. Thus, airlines benefit by reducing the length of first-class ticket lines. Airlines could also profit, however, by increasing the wait for nonpreferred customers. First-class customers are concerned about the difference in waiting times, not just the speed of the first-class check-in line in. Hence, airlines can increase the demand for first-class tickets by either improving service for first-class customers (by increasing the number of first-class ticket agents per passenger) or through increasing the annoyance of those traveling by other means.

Further Examples of Price Discrimination Through Impatience

Book publishers get buyers to self-select based upon impatience. Books frequently come out in paperback about one year after they are first published in hardcover. Paperback books are significantly cheaper than hardcovers. Only a tiny bit of the difference comes from the extra cost of producing hardcovers. Publishers assume that customers who are most eager to buy a book are the ones willing to pay the most. Publishers make impatient customers, who are less price sensitive, buy expensive hardcover books and allow patient readers to acquire relatively inexpensive paperback copies.

The Universal Theme Park also price discriminates through impatience. Long lines are the bane of child-toting amusement park visitors. For an extra $130, though, Universal allows patrons to move immediately to the front of their lines.^[2]

Supermarkets could benefit from Universal’s price discrimination methods by offering speedy checkouts to those willing to pay more. All they would have to do is have one checkout line where prices were, say, 10 percent higher. A customer would go in this line only if he was price insensitive and willing to pay for faster service. The expensive line would be like a reverse coupon: customers could trade money for time.

Supermarkets could also charge different prices at separate times of the day. If a supermarket estimated that business people were most likely to buy at certain times (say between 5:30–8:00 PM), they could charge the highest prices at these times. By making prices time dependent, supermarkets would get customers to self-select based on when they shop. Clothing and department stores that offer sales only during working hours use this tactic.

Hollywood also uses impatience to price discriminate through self-selection. Movies first come out in theaters, then become available for rental and pay-per-view-TV, next are shown on premium cable channels, and finally are broadcast on free network TV. Customers who most want to see a movie, and are presumably willing to pay the most, see the film when it first comes out in the theater. More patient and thus more price-sensitive customers wait longer and pay less.

Gadget manufacturers also use impatience to price discriminate. Some consumers desperately desire the latest gadgets. How can a producer get top dollar from early adopters and yet still set a reasonable price for the masses who buy for more utilitarian reasons? The obvious solution: Set a high initial price, which will fall after six months or so.^[3] The cost of such a pricing scheme, however, is that most consumers know not to buy recently released high-tech toys.

Upgrades

Software companies price discriminate when they charge different prices for product upgrades than for a full version of the new software. When Microsoft released Word 2002, it charged much less for an upgraded CD than for the full version of Word 2002. Obviously, it doesn’t cost Microsoft anything extra to sell you a full rather than an upgraded version. Microsoft probably figures, however, that customers who already have a previous version of Word are willing to pay less than new customers.

The Future of Price Discrimination

While Big Brother probably isn’t watching you, a massive number of corporations are. The supermarket cards that get you those discounts also allow stores to track your every purchase. When you venture onto many web sites, cookies are placed on your computer that keep track of where you have been. Every credit card payment you have made or missed has been recorded somewhere. Soon your cell phone will have a GPS chip that could allow others to keep track of your every move. This book even contains hidden cameras and transmitters that monitor and report on your breakfast cereal consumption. All of these data would be very useful to a company that price discriminates. In the near future, firms might put everything that they know about you into a computer program that scientifically gives you a custom-made price.

^[2]Slate.com (July 3, 2002).

^[3]Watson (2002), 155–156.