Market Segmentation and Decision Making

2011 June 13
by Emmanuel Goossaert

Setting the right price for a product is always a very complex task. Looking for the optimum price on a supply and demand curve would be the first step. However, most of the time you do not have this supply and demand curve. So you test different prices during long-enough periods of time, analyze the results, and try to set the price accordingly. This is A/B testing applied to pricing. Segmentation, which consists in having multiple offers for the same product instead of just one, can also be helpful to capture a larger chunk of the potential customer pool.

Segmentation

Even with the optimum price for your product, you will be losing money if you only have that one offer. By selling a product at its optimum price, profits are maximized with regards to the other possible prices, but they are not maximized in the absolute. Indeed, there are still people who would be willing to buy your product at a different price, and you are not taking that money. These people are all the dots outside the optimum price on your supply and demand curve. Technically, there would be a guy to buy your product at any price you set, or looking at the problem from the other side, every guy would be willing to give you money for your product, given that he can find some use for that product. If you can find the maximum amount of money each guy would be willing to give you and sell him the product at this particular price, then you would really maximize your profits.

Maximizing the profits in absolute is obviously impossible in real life, but it can be approximated. Instead of having just one offer for your product, you could have three. This is what most software vendors are doing. For instance, a company would ask $30 for the basic version of their photo-editing software, $40 for the professional version with more brushes, and $60 for the professional version and free customer service. Same product, with multiple segments based upon features and services. Different customers would be interested in different versions, and with the optimum price for each of these segments, revenues get maximized.

Decision lies in comparison

Another important reason why having multiple offers is important is because of the mechanics of the decision process. People do not make purchase decisions in the absolute, but take decisions based on comparisons. Instead of “Well, this is worth $10, which is okay for this kind of application”, they think “Well, this is worth $10, which means I could also use these $10 to buy something else, *anything* else”. By presenting multiple offers to a potential customer, you can influence the decision process by restraining the alternative options he considers. The option of buying your product becomes in the mean time more attractive. This is also how restaurant menus are designed, or at least, the ones that know what they are doing. The choices and prices for the dishes they offer are designed to control the comparison and therefore the decision process. A good starting point on the topic is Colleen Roller’s article (link given in the references below).

References

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