Price Discrimination is the business practice of selling the same product or service to different buyers at different prices. It’s a strategy companies use to move beyond a one-size-fits-all price tag and instead charge each customer, or group of customers, as close as possible to the maximum amount they are willing to pay. Think of airline tickets: the person in seat 14A might have paid €500 by booking last minute for a business trip, while the vacationer in 14B paid just €150 by booking months in advance. Same flight, same cramped legroom, vastly different prices. The airline isn't being random; it’s systematically trying to capture the most Revenue from every single seat. This practice works because the cost of providing the service to each customer is roughly the same, but the customers' willingness (or desperation) to pay is not. A successful strategy requires the company to identify different customer groups, prevent low-price buyers from reselling to high-price buyers, and, most importantly, possess some degree of Pricing Power.
Economists generally classify price discrimination into three categories, moving from a theoretical ideal to what we commonly see in the marketplace.
Also known as perfect price discrimination, this is the company's ultimate fantasy. It involves charging every single customer the absolute maximum price they are willing to pay. It’s like a mind-reading salesperson who knows your exact budget and won't let you leave with a cent to spare. In the real world, this is incredibly rare because it's nearly impossible to know every individual's true willingness to pay. However, you might see approximations of it in places like:
This is pricing based on the quantity consumed. The more you buy, the cheaper the price per unit becomes. It’s a way for companies to entice heavy users to spend more while still capturing sales from more casual customers. You encounter this all the time:
This is the most common and recognizable form. The seller divides its customers into distinct groups and sets a different price for each group. The key is to segment the market based on observable characteristics that correlate with willingness to pay. Classic examples include:
For a Value Investing practitioner, spotting effective price discrimination is like finding a clue that points to a hidden treasure. It reveals crucial information about a company's underlying strength and profitability.
The ability to consistently and successfully practice price discrimination is a powerful indicator of a durable Competitive Advantage, or what Warren Buffett calls an economic Moat. A company in a cutthroat, commodity-like industry can't pull this off; if it tries to charge one group more, those customers will simply flee to a competitor. To make different prices stick, a business needs:
In short, price discrimination is the result of pricing power, which itself is the result of a strong moat.
By tailoring prices, a company can dramatically increase both its revenue and Profit Margin. A single price inevitably leaves money on the table—either by charging too little to those who would have paid more or by pricing out those who would have bought at a lower price. Price discrimination allows a company to capture both. This leads to higher profitability and a better Return on Invested Capital (ROIC), which are core ingredients of a long-term compounder.
Price discrimination isn't just a clever marketing trick; it's a window into the economic soul of a business. When you see a company executing it skillfully—like a software giant with tiered enterprise plans or a consumer brand with premium and budget versions of the same core product—don't just see different prices. See the signs of a powerful, profitable business that has carved out a defensible space in the market. That's a business worth investigating further.