Exploring Price Discrimination in an e-Commerce Environment

EXPLORING PRICE DISCRIMINATION IN AN E-COMMERCE ENVIRONMENT

Dmitriy Chulkov, Indiana University Kokomo Dmitri Nizovtsev, Washburn University

CASE DESCRIPTION

This case study focuses on e-commerce price-setting practices and provides an opportunity to review the underlying principles of price discrimination as well as other pricing strategies. Its instructional value extends beyond its focus on the growing specialty tea market. The case is designed to address a number of learning outcomes in a managerial economics course at the M.B.A. or upper undergraduate level and has been tested in M.B.A. economics courses at two business schools over several semesters. The content of this case may also be relevant to other business disciplines concerned with pricing issues, such as marketing.

CASE SYNOPSIS

The market for specialty teas in the USA is experiencing robust growth. The US is now the second largest importer of tea in the world. A small specialty tea store featured in the case seeks to participate in the growing market, but must adjust to the online environment in which consumers find pricing information easily and many sellers offer similar products. A number of recent studies have demonstrated that charging customers different prices for the same product or service is becoming more common in the online marketplace. This case asks students to evaluate the feasibility of non-trivial pricing, in particular third-degree price discrimination, in an e-commerce setting. It is designed to help students better discern between different pricing strategies and review the conditions for their successful implementation.

CASE INTRODUCTION

Jason Lee has been selling specialty teas for fifteen years. It all started when, as a teenager, he was helping his father manage a brick-and mortar shop selling imported teas in a Chicago suburb. His father’s knowledge of the tea market helped establish relationships with importers and bring in specialty teas directly from India, Sri Lanka, China, and Japan. Upon graduating college with a business degree, Jason chose to take over the operations, in part because of his father’s health issues combined with the strong reluctance to sell the business. Tea is the most widely consumed beverage in the world, but other than the iced tea version it has not been quite as popular in the US Midwest. However, the twenty-first century has brought a revolution to the tea market in the US as the millennials have taken a taste to the beverage, and the search for a healthier lifestyle brought millions of new customers to tea sellers. Jason wanted to position his business to benefit from this market change.

Jason has always been fascinated with technology. Ever since he took his first and only college course in e-commerce, he was thinking of giving his family business a stronger online presence. Finally, two and a half years ago the online store of Lee’s Teas went live. Along with exposure to a broader market, that transition came with a handful of new headaches. The sales volume increase resulted in greater expenses required to ensure the availability of the product. Jason considered outsourcing some of the logistics to Amazon’s fulfillment program that is designed to help small businesses sell through the Amazon platform while taking advantage of Amazon’s expertise in order fulfillment. He also worried about the promotion of his online store to help it rank highly on the search results lists. This required doing some research on how the content and keywords on the e-commerce site reflect on its search results placement. Making the website mobile-friendly and easy to share on social media also helped its visibility and drove additional customer traffic.

The most important challenge, however, consisted in the changed nature of the competition he was facing. Previously, he had a well-established niche in his geographical region and had a consistent pool of loyal customers who learned to appreciate his father’s quality teas as well as fair pricing. The new environment, however, was very different. On the Internet, no one knew him. There were plenty of other online stores selling a similar selection of teas. All this made his profit margins decline.

Growing Tea Market in the USA

Tea is the second most popular beverage in the world after water. People have been drinking tea for nearly 5,000 years. According to Chinese legends, tea was discovered in 2737 BC by Chinese Emperor Shen-Nung when some tea leaves were accidentally blown into the Emperor’s pot of boiling water.

The growth in US tea consumption in recent years has been very impressive. USA is currently the fourth country in the world in tea consumption behind only China, Russia, and Japan, and is the second largest importer of tea behind Russia. The total wholesale value of tea sold in the US grew from $2 billion in 1990 to over $10 billion in 2014. (Tea Association of the USA, 2015)

The preference for healthier beverages is driving consumers away from sugary drinks and boosting the demand for tea. According to the USA Tea Association, “tea is an all- natural and environmentally sound product from a renewable source. Tea contains flavonoids, naturally occurring compounds that are believed to have antioxidant properties. Tea flavonoids often provide bioactive compounds that help to neutralize free radicals, which scientists believe, over time, damage elements in the body. Every day, new findings from the international scientific community lend credibility to tea’s healthy properties.” The USA Tea Association lists a number of academic studies that have shown health benefits of tea for prevention of heart and neurological diseases, certain cancers, and osteoporosis.

The majority of the tea consumed in the US is ready-to-drink bottled teas such as Snapple, Lipton, and Gold Peak owned and promoted by food industry giants PepsiCo, Coca- Cola, and Dr.Pepper. However, specialty teas including high-quality loose-leaf teas constitute a healthy 17.5% of the market and saw total sales of $1.9 billion in 2014 (Tea Association, 2015). Specialty teas include different varieties of white, green, and oolong teas. They are typically of higher quality and have higher prices both on the wholesale and retail markets. Specialty tea is attracting affluent, young, educated and health conscious consumers who like to experiment with unique and organic flavors. The recent acquisition of Teavana chain of tea stores by Starbucks has helped fuel significant growth in this segment. As the number of restaurants serving specialty tea and the number of tea salons have also been increasing, the consumer exposure to this segment of the tea market and the consumer demand have been on the rise.

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