A Price Segmentation Tale: The Amazon Book Market

As a customer of the Amazon online marketplace and self proclaimed elastic demander of new books in all forms and genres, I find myself intrigued by the pricing segmentation strategies employed.  Forcing the consumer to self-identify their willingness to pay using tactical segmentation hedges circumvents the blind online interface between the customer and firm.  The consumer’s marginal benefit is indirectly discovered by the time of purchase and method of delivery.  Essentially, Amazon has captured a significant array of customers at different pricing points for the same desired good, resulting in revenue outcomes more consistent with quasi-complete price segmentation.

The segmentation hedges previously discussed stands up to the criteria established by Tim Smith required for effective market division.[1] The time of the transaction after the original release date offers a direct indication on how much the consumer desires the new book.  Customers with an inelastic demand for a product will accept a higher transaction price to receive potential benefits immediately.  To reap a premium price, Amazon first delivers a hard cover version of the book to eager consumers.  It is understood that most hard cover demanders buy the book not only for satisfaction, but also for shelf life durability.

Once this market segment is satiated and sales volume dissipates, introducing a paperback version of the text at a lower price appeals to the more price sensitive target market.  The paperback must be offered at a lower price for several reasons.  First, the marginal cost of production of the paperback version is lower relative to hard cover even though the same content is being presented.  Also, the presence of a secondary market for used books provides direct substitutes for price elastic customers.  This weakly questions the strength of the segmentation hedge due to the transfer transaction between a book owner and a second hand demander in alternate market.  Amazon still realizes the profit of a dual price market because the used book transaction does not eliminate the initial purchase by the inelastic book lover.

In addition to tangible book sales, Amazon introduced electronic books via Kindle in late 2007.  This ultimately created a new type of market segment with potential profits to be garnered.

The tier-pricing scheme directly ensures self-identification by consumers willing to make the initial investment of a Kindle.  Consumers that embrace technology, space minimization, and possess borderline unitary elastic characteristics are prospective e-customers. Only avid readers would rationalize purchasing capital as a means of delivering their favorite reading material electronically.  The second tier price, the book content, usually rewards the customer for the primary Kindle transaction.  As anyone can observe, downloadable electronic books can be purchased at discount prices.  Is the true marginal cost of information content being approached when consuming electronically?

Sound price differentiation strategies result in healthy positive profits for the firm.  Amazon clearly understands the value of defined segmentation hedges in their pricing methodology.  Observing consumer behavior and allowing customers to self-allocate according to demand characteristics creates three distinct market segments.  Price sensitivity analysis and strategic methods of delivery ensure each customer is served at the appropriate time and price level.  Consistent price maintenance preserves Amazon’s significant market share and competitive advantage.

[1] Pricing Strategy: Setting Price Levels, Managing Price Discounts, & Establishing Price Structures, Tim Smith, January 2011.