The ethics of price discrimination

Price discrimination is the practice of charging different customers different prices for the same product. It is also referred to as “differential pricing or “tiered pricing”, and more recently, “dynamic pricing” or “smart pricing”. Price discrimination can take different forms, for instance, offering different prices for an early version of a hardcover book and the later paperback version, different subscription rates to academic journals for individuals and libraries, different prices for software intended for personal and business use, and offering different prices for the same drug in different countries etc. Certain conditions have to be met for price discrimination to be possible: (1) the seller must be able to identify the reservation price of each consumer or group of consumers, or at least have reliable indicators of the reservation price; (2) there must not exist significant price competition in relation to that product by rival firms; (3) those buyers who purchase the product at a lower price must not be able to resell it at a higher price to those who are willing to pay more for it. Many people consider price discrimination unfair, particularly when they have paid a higher price than others. However, the condemnation of price discrimination is not universal.

The typical economist’s point of view on price discrimination can be stated thus: “generally, discriminatory prices are required for an optimal allocation of resources in real life situations” They argue that in many cases price discrimination is likely to lead to greater welfare than the uniform pricing alternative—sometimes for every party in the transaction. Economists have also studied the distributional effects of price discrimination. While it can sometimes result in higher prices for the poor, generally speaking, price discrimination redistributes income from less price-sensitive to more price-sensitive groups, and as the former are often the wealthier consumers, in many occasions, price discrimination will have positive distributional effects.

From an ethical standpoint, we might be suspicious of price discrimination for reasons such as: the customer paying the higher price is being exploited, the seller can cover costs at a lower cost therefore customers paying high costs are being treated unfairly, and charging different customers different prices for an item indicates treating customers unequally. However, this will not necessarily mean that there is anything inherently wrong with price discrimination itself. Instances of price discrimination will be wrong when it is linked to wrong purposes or attitudes. If the price discrimination is targeted at individuals who belong to a vulnerable group i.e. discriminating based on factors such as race, gender, religious affiliation and the likes, the practice of targeting a specific group is unethical but not necessarily price discrimination by itself.

Price discrimination often does not necessarily result in an abnormally high profit for the seller; in many cases it just makes the provision of the product economically feasible. Many industries—such as pharmaceuticals, biotechnology, telecommunications, semiconductors, and software—face very high fixed costs and very low marginal costs. In such situations, setting prices at the level of marginal costs would make it impossible to recoup the original investment (and therefore would result in no investment being made and no new products being offered); consequently, price discrimination may easily result in better outcomes for everyone

The view defended in this article is that, in itself, price discrimination is a morally neutral practice that businesspeople are entitled to use if it advances their morally legitimate interests.

In conclusion, so long as a buyer of a product pays a price that is itself fair, the mere fact that another customer gets an even cheaper price does not make the price paid by the first customer unjust. Therefore, there is no independent ethics of price discrimination.

This article was originally published by Prof Juan Elegido in the Journal of Business Ethics Quarterly (2011, October, Volume 21, Issue 4, pp.633-660), and has been adapted for you by the Christopher Kolade Centre for Research in Leadership and Ethics (CRLE) at Lagos Business School. CRLE’s vision is creating and sharing knowledge that improves the way managers lead and live in Africa and the World. You can contact CRLE at [email protected].

 

 Juan Elegido

 

Elegido is a professor of Business Ethics and the Vice-Chancellor of Pan-Atlantic University