Price Differentiation: Different Prices, Fairly Justified

Why most businesses already differentiate, just unplanned

Many owners would say they have one price for everyone. A look at the invoices tells a different story. The long-standing customer pays less because they never received an increase. The customer who negotiates hard gets a discount. The customer who never asks pays the list price. The guide managing discounts uses the price waterfall to describe how far actual prices can deviate from the list price. That is price differentiation, only by negotiating skill rather than by reason.

Put simply, the question is: when is it right to charge different customers different prices, and how does a business justify such differences so that customers perceive them as fair? To answer it, we first clarify the terms and the classic mental model of the three degrees, then what research shows about price fairness, weigh two views, and finally set out a test with which every price difference can be checked.

Different prices are not unfair. What is unfair are differences nobody can explain.

Terms: what price differentiation is and what it is not

Price differentiation means charging different customers, or at different times, different prices for the same or a very similar service, without cost differences fully explaining this. In economics it is also called price discrimination, without any value judgment attached. The aim is to make better use of customers’ different willingness to pay and to reach customers who would not buy at a single price.

Two other cases must be distinguished. A price difference for cost reasons is not differentiation in the narrow sense: a customer 60 kilometers further away causes higher travel costs. And different services at different prices, such as the tiers in the guide good, better, best, are a form between the two: the services differ, but the price gap often follows value more than costs.

Another term matters for fairness, the comparative transaction. Xia, Monroe, and Cox (2004) define price fairness as a buyer’s assessment of whether the difference between their price and the price of a comparative transaction is reasonable and justifiable. The comparison is with other customers, with one’s own earlier price, or with other providers.

The mental model: the three degrees of price differentiation

At the beginning of the 20th century, the economist Arthur Cecil Pigou distinguished three degrees that still organize every textbook. They differ in who decides which customer pays which price.

For small businesses, the model has a clear message. In practice, the first degree is usually what arises without a plan: every price is negotiated individually. The second degree is easiest to justify because the customer chooses and everyone sees the same menu. The third degree is useful but requires that the groups be objectively distinguishable. The price traffic light from the guide raising prices without losing customers is such a grouping: it gives customers with different margins and loyalty different increases.

What research shows about price fairness

Xia, Monroe, and Cox (2004) brought together research on price fairness. Three insights from their framework are central to price differentiation.

• Fairness is a comparison. A price is never judged on its own but against a reference: the price paid by other customers, one’s own earlier price, or that of other providers. The comparison with customers similar to oneself has the strongest effect.
• Similarity decides. If two transactions are very similar, buyers expect equal prices and perceive a difference as unfair. If service, volume, or terms differ recognizably, the difference itself provides the explanation.
• Reasons matter. Whether a difference is accepted depends on what reasons the buyer sees for it. Cost reasons are accepted more readily than simply exploiting demand.

The authors also emphasize a finding from decision research: being disadvantaged relative to one reference weighs more heavily than being advantaged relative to another. A customer who learns that another pays less is more annoyed than they are pleased when they themselves pay less. The framework is based mainly on studies with consumers. In B2B, buyers also talk to each other and prices are often in writing, so comparisons are, if anything, more likely.

In one qualitative and three quantitative studies, Bambauer-Sachse and Young (2024) examined how customers react to different prices for services. Dynamic prices that change frequently and opaquely for the customer caused considerably more confusion than simple, fixed price differences. The confusion intensified the feeling of unfairness, and this increased disadvantaged customers’ willingness to speak negatively about the provider. For rarely purchased services, mainly the sense of unfairness mattered; for frequently purchased ones, mainly the confusion.

Two views: profit lever or trust risk

The first view sees price differentiation as a profit lever that can benefit everyone. A single price leaves customers with high willingness to pay a large surplus and excludes customers who would only buy at a lower price. A cheaper price outside peak season fills capacity that would otherwise remain empty. The business and price-conscious customers both benefit.

The second view emphasizes trust. In B2B, relationships are long and prices get around. A customer who learns that a comparable customer pays less for the same service loses not only money but the confidence of being treated fairly. The findings of Xia, Monroe, and Cox support this concern: similar customers in particular compare, and being disadvantaged weighs heavily.

I consider both views correct and see the solution in the form, not in giving it up. Second-degree differentiation, where everyone sees the same menu, and group prices with an objective reason combine the profit lever with fairness. The main problem is unplanned first-degree differentiation, where the price depends on who negotiates best. It usually brings less profit and more distrust.

The justification test: which price differences hold up

The justification test is the tool of this analysis. It transfers the findings on similarity to everyday practice: a price difference holds up if it can be traced back to a difference in the transaction that the customer can see and understand. Five such differences are most common in B2B.

1. Make differences visible

   List your twenty largest customers with their actual price per unit of service after deducting all reductions.

2. Justify each difference

   Next to each deviation from the list price, write the reason from the table. Where none fits, flag the case.

3. Rules instead of individual cases

   Translate the sound reasons into rules that apply to everyone: scales, time windows, surcharges. What discount rules that protect the margin look like is shown in the guide managing discounts.

4. Align flagged cases

   Phase out unjustified reductions step by step, for example as part of the next price adjustment, and tell customers openly which rule will apply in future.

For many businesses, timing is the underestimated reason. Offering lower prices off-season also smooths utilization. How the two are connected is described in the guide planning and smoothing seasonal fluctuations.

Transfer and limits

Price differentiation requires that customers cannot simply switch between groups. An off-season price only works if the customer actually has to move the appointment to get it. A new-customer price only works if it does not openly disadvantage existing customers. Serving new customers more cheaply than loyal ones on a permanent basis violates exactly the comparison rule Xia, Monroe, and Cox describe, because the most similar comparison customer is the long-standing one.

If you know your customers’ willingness to pay, you can differentiate better. It depends on the value the service creates; how to express that in euros is shown in the guide expressing customer value in euros. Which customers have priority is answered by the ABC customer analysis.

Conclusion: differences that can be justified

When is it right to charge different customers different prices? When the difference rests on a difference in the transaction that the customer can understand: service, volume, timing, effort, or risk. Research on price fairness shows that customers compare prices, that they perceive differences between similar transactions as unfair, and that opacity intensifies this feeling. It follows that the most sustainable form of differentiation is the one in which everyone sees the same menu and chooses for themselves.

1. This week: List the actual price per unit of service after all reductions for your twenty largest customers.
2. Next week: Check each difference with the justification test and flag the cases without a reason.
3. In a month: Put the sound reasons into written rules and plan to align the remaining differences at the next price adjustment.

A customer can accept that another pays less. They do not accept not being told why.