Differential pricing involves selling the same, or at least very similar, product to different people at different prices depending on how they value it. Hopefully even the buyer that places a relatively low value on the product will find a price low enough that it appeals to them (while remaining profitable for the seller) while the customer with a higher valuation will be able to spend more (on a sale that is even more profitable to the seller).
It's hard to imagine a better example of this than the displays of new movie releases at an electronics store. Take a look at the contents of these two displays, for the same movie in the same store, on the same day...
To a very large extent all these different versions are the same in that they are all versions of the same movie, but they are being offered in a multitude of versions at five different prices. Most notably the most expensive version costs almost twice as much as the least expensive version.
The parent who just wants a copy for the car to keep the kids entertained on a long ride only has to spend $17.99. The people who value it more might be interested in the Blu-Ray version, or one of the packages with the souvenir dog tags. And somebody who is real into the movie (or buying it as a gift for someone that is) might spring for the most expensive version that includes Blu-Ray 3D, Blu-Ray, DVD and Digital Copies.
The seller is using price and packaging to ensure effective product differentiation. It's not enough for them to release and offer the different versions, they must be sure to distinguish the differences enough that they are perceived by the customer.
This is a beautiful example of differential pricing. The seller has realized that customers will pay between $17.99 and $34.99 for this movie. If they priced it in the middle, around $25.99 they would miss out on selling anything to those who valued it for less. At the same time they would be substantially undercharging the people that would happily pay almost ten dollars more.
Instead they use differential pricing and product differentiation to effectively stream the buyers of this movie into five groups and charge accordingly.
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