Price discrimination has a negative connotation because monopolies and oligopolies sometimes use their market power to unfair advantage and engage in predatory pricing schemes. Predatory pricing, however, is rare in markets characterized by monopolistic competition because there are many sellers and the products are largely substitutable, even if only slightly differentiated. In some ways, price discrimination is the rule rather than the exception in contemporary commerce transactions. Here are several relevant guidelines on price discrimination from the FTC (Federal Trade Commission):
A seller charging competing buyers different prices for the same “commodity” or discriminating in the provision of “allowances”—compensation for advertising and other services—may be violating the Robinson-Patman Act. This kind of price discrimination may give favored customers an edge in the market that has nothing to do with their superior efficiency. Price discriminations are generally lawful, particularly if they reflect the different costs of dealing with different buyers or are the result of a seller’s attempts to meet a competitor’s offering.
… There are two legal defenses to these types of alleged Robinson-Patman violations: (1) the price difference is justified by different costs in manufacture, sale, or delivery (e.g., volume discounts), or (2) the price concession was given in good faith to meet a competitor’s price. 1
… Can prices ever be “too low?” The short answer is yes, but not very often. Generally, low prices benefit consumers. Consumers are harmed only if below-cost pricing allows a dominant competitor to knock its rivals out of the market and then raise prices to above-market levels for a substantial time. A firm’s independent decision to reduce prices to a level below its own costs does not necessarily injure competition, and, in fact, may simply reflect particularly vigorous competition. Instances of a large firm using low prices to drive smaller competitors out of the market in hopes of raising prices after they leave are rare. This strategy can only be successful if the short-run losses from pricing below cost will be made up for by much higher prices over a longer period of time after competitors leave the market. Although the FTC examines claims of predatory pricing carefully, courts, including the Supreme Court, have been skeptical of such claims … 2
There is a significant amount of latitude in the way that firms can use price discrimination, yet still remain on the right side of the law. Here are a few guidelines, derived from the FTC pronouncements, which can be used to assist in determining whether versioning strategies and group pricing strategies are legal.
- Guideline 1: You may be able to legally charge different prices for a product (price discrimination) if you differentiate your product, by way of features and services.
- Guideline 2: You may be able to legally charge different prices for a product (price discrimination) to different groups if you can demonstrate that there are different price sensitivities between the groups.
- Guideline 3: You may be able to legally charge different prices for a product if the price discrimination reflects the costs of dealing with different buyers or it reflects an attempt to meet a competitor’s offering.
In general, a versioning strategy may be legal if a product is differentiated by way of features and services. It can be inferred that a practice is probably not price discrimination if you can segment people into different income groups according to their price sensitivities and their willingness-to-pay. Groups such as seniors and youth are price-sensitive. It is sometimes ok to charge differential prices to groups that are underrepresented in a market. For example, women are often charged less when they attend happy hour. The key to avoiding charges of predatory practices is to set the price above the marginal cost to produce the product. Selling a product at a price that is lower than the variable costs to produce the product can lead to charges of dumping. This strategy is illegal, but many companies use it in subtle and not so subtle ways in international markets to gain market share. The final key is to always seek legal counsel if there is any doubt that a business practice is predatory, illegal, or both.