Back in school, when many young men and women from my generation worked on their Marketing or Finance degrees to learn how they could earn huge wads of money, I instead chose to study economics to learn why they could earn huge wads of money. I blame Daniel Kahneman for writing articles that were too interesting to ignore.
My first encounter with segmentation was in Microeconomic Theory by Mas-Colell et al.
The book didn’t cover segmentation, at least not in the down-to-earth, marketing-friendly sense that I’m going to discuss today. It was a living example of segmentation (well, about as living as a book can be, anyway). Buying Microeconomic Theory in France was a €100 investment. Buying the exact same book in India was a €20 bargain, shipping included. But the book was not allowed to cross borders and was often intercepted by customs in either India or France.
Behind this situation was a fairly elementary reasoning: the average French student is ready to spend €100 on a good book, but you cannot expect an average Indian student to do so. Setting a worldwide price was a very difficult exercise: too high, the Indian students would not buy it ; too low, the publisher loses a large portion the money the French student was willing to pay.
The solution was to split the market into two segments: the rich western world would pay a high price, India would pay a low price, and the western buyers would be forbidden from wading in the low-price segment through artificial customs restrictions.
Segmentation is the fundamental tool of both strategy and marketing. Choosing your target splits the six billion people in the world into “want them to buy” and “don’t care” segments. (some people call this identifying, but how you build your product is ultimately your choice). And to better focus your production, communication and pricing strategies, you usually end up further dividing your target into more segments. The core of corporate strategy is the customer, and you cannot individually handle six billion people—you have to handle them in batches, and segmentation is the art of constructing those batches.
Here’s what happens: you create two segments, and you select an optimal price for each segment. Inevitably, one segment gets a cheaper price and you prevent people in the other segment from shopping there. How you prevent people from switching segments is the keystone of any price segmentation strategy.
Some Examples
Book prices are an example of price segmentation that relies on customs and geography to prevent segment-switching.
The movie industry relies on technology: every DVD and DVD reader is tied to one of six areas (the one it is sold in), and a DVD from area X cannot be read by a DVD reader from area Y. This means a movie can be sold for $40 in area X and $1 in area Y, and the vast majority of people from area X will be unable to watch the movie for $1. These are the DVD zones:
The distribution of the zones is an ostensible compromise between pricing issues (countries with different average per-capita revenues are usually in different zones) and manufacturing considerations (countries with nearly identical cultures are usually in the same zone).
Mail-in rebates follow a similar pattern: you can either buy a television for $900, or you can buy it for $700 if you mail the $200 rebate. The market is segmented into people who care about the $200 (and get the television for $700) and people who don’t care about the $200 (and get the television for $900).
Store brands are another form of segmentation: your average brand does not own factories or plants for producing every store brand product they sell—they usually just rent the factories of existing large manufacturers. So, your store brand strawberry jam was probably produced by the same factory and with the same ingredients as a major brand strawberry jam, but it was packaged to appear cheap. The market is thus segmented into people who are ashamed with themselves when they buy cheap brands (either because of the status granted by major brands, or because they believe they’re of a lower quality) and pay the full price for the major brand, and the people who don’t want to pay the price for the major brand and buy the cheap store brand itself.
Hi. I'm Victor Nicollet,
I don’t know much about economics, but this reminds me of how software companies offer very limited versions of their software and then try to up-sell like crazy. Especially the part about “artificial restrictions”. It seems all too common for software companies to differentiate between their different pricing levels by crippling the basic product and charging less rather than building even more value into it and charging more.