Market Segmentation, Self-Selection, and Product Line Design

TLDR

Existing market‑segmentation theory relies on Pigou’s third‑degree price discrimination model, which assumes firms can directly target and isolate individual segments. This paper develops a theory of market segmentation grounded in consumer self‑selection. By leveraging consumer self‑selection, the authors relax the isolation assumption and model cannibalization and inter‑firm competition. The relaxation leads to significant changes in product‑line design, allowing segment aggregation even without economies of scale.

Abstract

The purpose of this paper is to develop a theory of market segmentation based on consumer self-selection. The extant theory is based on the third-degree price discrimination model of Pigou, central assumptions of which are that the firm can directly address individual segments and isolate them. By using consumer self-selection, I am relaxing these assumptions. In the context of a monopolist designing a product line, I show that this relaxation has significant implications for how the products and prices are chosen and what they look like. In particular, segments may be aggregated even though there are no economies of scale. Furthermore, consumer self-selection enables us to model “cannibalization” and competition among firms.