One of the key concepts for the entrepreneur to understand is that product differentiation permits them to change their price according to what consumers believe they can afford. Some consumers are very price-sensitive and others are not so price-sensitive, and this can change by the type of product being purchased and by the buying context. The price that a consumer is willing to pay is called the reservation price or the willingness-to-pay price and it is somewhat unique across individuals. If you can determine the willingness-to-pay price for a product, then you may be able to charge different prices according to the willingness-to-pay. This is, of course, a form of price discrimination, or in more polite terms, price differentiation. The terms price discrimination and price differentiation will be used interchangeably throughout this discussion.
Hal Varian 1 has identified three approaches to price discrimination. They are personalized pricing, versioning, and group pricing. The ideas will be briefly introduced and then examined in greater depth in a later chapter.