The Ethics of Price Discrimination

To our modern ear the very term "discrimination" sounds bad. However, in the pricing discipline, "price discrimination" is not necessarily a bad thing. The term refers to creating a pricing and product structure which finds a way to charge customers with different willingness or ability to pay different amounts.

Examples include:

The price of clothes in a department store vs. in an "outlet" store.
The price of a newly released novel versus a backlist novel.
Name brands vs. store brands in grocery stores.

In most cases, price discrimination involves creating a situation in which customers can make a trade off between convenience and price or quality and price in order to get fairly similar products for very different prices. This ends up being good for both customers and companies. Companies are able to maximize their sales, allowing them to pay their employees, grow, and produce profits for their investors. They're able to do this by getting the most money from the customers most able to pay, and providing customers with the least ability to pay with the best deal.

However, some forms of price discrimination work more like an intelligence test. One of these I was reminded of recently when setting up travel arrangement for some upcoming trips. Most car rental companies now offer an option where the customer is offered the chance to pay for a tank of gas up front, usually at a rate $0.10 to $0.40 lower than the standard gas station price in the area. This seems like a great deal, until you remember that it only works out as a savings if you return the tank entirely empty. If you return the tank half full, you get no refund for that half tank, and you end up effectively giving the car rental company an extra $20 or so. By making money on the pre-sold tank of gas, the car rental companies are able to offer lower daily rates, allowing them to win more business, pushing other companies to lower their rates and make their money back in other less obvious ways like pre-paid gas, car rental insurance, etc.

This does offer customers who can think through all the offers they're given an opportunity to pay less, so it clearly benefits some customers. However, rather than doing so based on the willingness of customers to make small trade offs in convenience or quality, it does so based on their ability to problem solve. The pre-paid gas is particularly tricky, because at first pass the pre-pay at the lower price actually seems like a way to save money, but in most cases it will turn out to be an extra fee.

These kinds of price discrimination seem more ethically troubling, and yet it's very hard for companies to resist such approaches when they catch on, because "hiding" profits through this kind of pricing allows the companies that adopt such tactics to offer lower up-front prices.