Customer segmentation is a simple concept – identify groups of customers who tend to have similar levels of price sensitivity and set distinct prices for each group. Unfortunately, many companies either think all their customers are the same, or they don’t have enough information to create segments. In particular, we often see this in retail businesses. Unfortunately, assuming all customers are the same results in missed profit opportunities. With a little creative thinking, it is possible to let customers segment themselves and capture more profit.
Airlines are great examples of businesses that have figured out how to let their customers segment themselves. The customers are all asking for the same thing, a flight between two cities; but some customers are very concerned about the price while others are not. So, the airlines offer a variety of price points. First class seats are the highest priced and non-refundable middle-seat economy class tickets purchased well in advance are the cheapest. There are more options in between. If other businesses think about their customers the same way the airlines have, they can find differences among their customers. Let me give you some examples.
I previously lived in a small town in Western PA whose residents spanned the entire spectrum of economic status, from the top 1% down to some with no income. There was a Mexican restaurant that we frequented, enjoying the food and margaritas. Some of the staff knew my wife and me by name, and would prepare our preferred margaritas when they saw us enter. Obviously, we liked that service. Since the area included many lower income residents, the restaurant owner believed he had to keep prices low. However, I told the owner I thought there were many customers, like my wife and me, who would purchase more expensive, upscale items if they were available.
Perhaps it was coincidental, but not long after that conversation, the restaurant switched from pre-made to table-side-prepared guacamole and began charging a higher price for it. It was a good move, but a better move would have been to offer both the pre-made and table-side versions. I suspect some customers completely stopped ordering the guacamole because the price doubled. If they had offered both versions, they could have captured higher margins from the table-side buyers, and retained the more price-sensitive buyers of the pre-made guacamole.
In a similar move, the restaurant began to offer special entrees for slightly higher prices than their regular entrees. I frequently ordered the special entrée, but I would have paid even more for more upscale options. Since there are many residents in the area much more affluent than me, I suspect they would have enjoyed more upscale, and expensive, specials too. By creating more options with a wider range of price points, the restaurant could have captured more income from the less price-sensitive customers without alienating those for whom prices were more important.
My second example relates to haircuts. We moved to Florida last year, and based on a friend’s recommendation I tried a nearby hair salon – let’s call it Johnny Cuts. Both men and women are served. For women, there are a variety of options and prices; but for men, a haircut and blow dry is $18. All men pay the same.
My first observation at Johnny Cuts was the men in this area can and would pay more for a haircut. I know you can’t tell a book by its cover, but the people I have seen in the salon are always well dressed and the cars in the parking lot seem relatively newer. I told the owner that I was not anxious to pay higher prices, but I thought $18 was a great deal. He agreed, but said there were other salons in a strip mall a mile away who only charge $18. He thought he would lose customers if he raised prices. I doubt that is true, but he could find out by offering some options. For example, Johnny Cuts could raise the price of a men’s cut to $20 and offer a $2 discount to those who can come at certain times that are generally slow. If the price increase really is a problem, those who are price-sensitive can come during the discount periods.
Another option for the hair salon is to offer more services for men. For example, the current haircut includes wetting your hair, cutting it, and drying it. For an extra $2 or $3 they could include a shampoo. The price-sensitive customers could save that money and shampoo themselves. They could also offer a premium service (at a higher price) that could include a hot facial towel, or a shave, or perhaps a complimentary glass of wine (if that is legal).
The point is - all customers are not the same, even if you can’t tell by looking at them. If you think some, but not all, will pay a higher price, offer them something that lets them pay more. Don’t assume that you must charge everyone the same thing. Think about the problems like the airlines and you will find a way to make more money.