Price Discrimination and Customization

It's likely important to prefix this meditation with a comment on the concept of discrimination - as the word itself is so closely linked to politically sensitive issues of race, gender, etc., that it's difficult to consider in its intended context without those issues intruding.    In short, "price discrimination" is an economic concept that pertains to charging different prices to different customers - and for the purpose of this piece, it is intended to deal with reasons for discrimination that can be objectively substantiated.

To further disambiguate, I'm setting aside price discrimination as a concept related to the goal of revenue maximization, which takes as its sole consideration the customer's willingness to pay and, in effect, seeks to inform the decision of the supplier toward the goal of asking as high a price as possible to fully absorb consumer surplus. That is the context in which it is most often considered, but the context least germane to my present train of thought, which focuses more on price discrimination as an effect of cost.

That said ...

Creating a product that is customized to the needs of a specific customer requires price discrimination in the highest degree. In part, it is a matter of financial necessity - where customization for the needs and desires of a specific individual require additional production cost, the additional cost must be borne by someone.  In another sense, it is a matter of ethics that the additional cost be borne by the very individual whose demands necessitated that they be expended.

Said another way, a customer who desires something extra should (and generally does) accept that the cost of the "something extra" is added to the price he is charged for having it. It's not really considered where the "extra" is a discreet product: a customer who wants shoes and a matching belt pays the cost of the belt in addition to the cost of the shoes, whereas another customer who simply wants the shoes does not pay for the belt (provided the two are not bundled by the retailer, such that he must purchase the belt to obtain the shoes).

It becomes slightly less straightforward when the purchase is perceived as a single product, especially a complex one, but my sense is that customers generally understand and accept the concept of additional features that add cost to a basic product: a vehicle with power windows costs more than a vehicle of the exact same type that does not have this added feature.  This comes as no surprise and raises no objection.

And the complexity becomes even greater when hidden factors create discriminate prices for the same good: a shirt costs far less at the factory store than in a department store in another state because of transportation costs; or the shirt costs more when purchased form a shop in a mall than it does from a strip mall because of the higher rent the shopkeeper must pay.

It was simple enough to understand before the Internet came about, but broad knowledge of market details (the price of goods in various places) and complete ignorance of others (the factors that cause the price to be different in various locations) led to something of a calamity: customers cried "unfair" when the same article had different prices in different locations, particularly when the locations were in the same general vicinity (the same item costs considerably more at two shops in the same town).

It's a bit ironic that the notion of "fairness" is raised at all. The alternative approach, to charge the same price in all locations, means that individuals who purchase the item in locations where it could be had for less (lower transportation cost, lower shop overhead, etc.) must now pay more than their fare share to subsidize the cost of making the item available in places where it costs more to provide it. It that sense, the objection to price differences is a demand for unfairness.

Dragging myself back to the notion of customization: the demand of a customer to have a product tailored to his specific needs and desires must necessarily be accompanied by a willingness to pay a price that covers the cost of tailoring it, as differentiated from other customers who accept the "standard" product or have a list of customizations all their own. This is true whether the differentiation is the result of differences in the physical product (an item with or without a given feature) or in the location (an item sold in one location or channel versus another).

This results in an increasing complexity in the structure of cost to produce and furnish a given item to a given customer. For a firm that chooses to customize, there can be no standard price, nor any way to give the customer an expectation of the price until there has been a long discussion of the variables involved.

This places a great deal of burden on the customer, such that many product decisions must be made and communicated to the vendor before a price can be given.  Pricing by feature is fairly standard practice in certain industries, generally those that provide high-cost items that are infrequently purchased: buying a car or having a house built is a very complex purchasing event and customers accept and expect that the price relies on the features chosen for their product. Buying a computer, with all the options and related costs, is likewise complex.

But the same level of complexity is involved in decisions of far lesser magnitude: ordering a hot dog from a street vendor requires the customer to make a set of decisions: what kind of sausage, what kind of bread, what additional toppings to include. However in this situation, the customer's options have no effect on the price of the item, and the vendor merely includes them - but they are not gratuitous: the cost of the most expensive options is borne even by customers who do not choose to have them. Their cost is so negligible that customers are largely indifferent to this fact, and may often be oblivious to it.

In that instance, it is largely a matter of magnitude - a customer doesn't demand a three-cent discount at a deli because he opted not to have mustard on his sandwich, but he might be outraged at a $20/night "resort fee" at a hotel to pay for a pool, sauna, and workout room that he never used during a week-long visit (which hotels get away with because of business travelers who expense their bill and don't pay much attention - another factor entirely).

But because of the freedom of information, customers are becoming increasingly aware of and concerned about price discrimination, and the vendor of a product that can be customized at all must be sensitive to the reaction the customer will have when every modification impacts the price, and especially where invisible factors cause price discrimination, they are increasingly intolerant of it.

And it does seem like a no-win situation: to offer the same product at the same price to all customers requires a great deal of coordination (and even collusion if the same manufactured item is sold through competing retailers), and customers who expect to get a better price for accepting a standard product are hostile to the notion of paying more to absorb the cost of serving more finicky customers.

The net result of this on customer experience is also conflicted, between the customer's desire to have a highly customized product, yet to be quoted a firm price in advance of providing any information whatsoever about the customizations the customer desires; and the vendor's desire to offer an attractive price for a product most people want, and yet be able to serve the demand for customization.

All things considered, it's a problem to which I can see no solution - and what's more, it is a dilemma that more and more industries will continue to face as customers become increasingly demanding of customization.