In two jobs prior to Dstillery, among other things, I had responsibility for managing product pricing. In that role, I’ve priced hardware, software, SaaS services, professional services, support services, and labor. At some point, I had jotted down a bunch of notes on how the pricing process should work and I thought I would share them here.
It has been said that pricing is not an event, it is a process. And it is not just a process that should be owned by finance, sales or marketing but one that needs to be truly cross-functional.
This diagram outlines the key activities that go into setting, managing, and measuring prices. The various activities can be, and often are, owned by different functions depending how each organization is structured, but there needs to be someone looking across all of these activities in a holistic manner. The key role of the “pricing owner” is to coordinate across all the interested functions and drive the process to establish the best pricing model for the company.
Lots has been written about the ethe “freemium” pricing model, particularly as it relates to web services companies. Essentially, it is a penetration pricing play where the vendors attempts to get widespread adoption at a low price ($0) and upsell some form of premium service to generate profits.
Most recently, Knowledge@Wharton has this article. Its no surprise that “free” impact on has a significant on demand:
Indeed, the appeal of “free” has been shown to be so extraordinary that it bends the demand curve. “The demand you get at a price of zero is many times higher than the demand you get at a very low price,” says Kartik Hosanagar, a Wharton professor of operations and information management who studies pricing and technology. “Suddenly demand shoots up in a nonlinear fashion.” Josh Kopelman, a venture investor and entrepreneur who founded Half.com, has written about what he dubbed “the penny gap.” Even charging one cent for something dramatically lessens the demand [generated at] zero cents.
This article has a very way to address this penny gap (which is described in more detail here):
Then there are two-sided markets, which derive revenue from two sets of customers. In those, “whichever side is more price inelastic [less sensitive to price changes], that’s the side you want to charge more [for],” says Zhang. In the case of “Ladies’ Nights,” he says, establishments may increase overall revenue by letting women in for free to attract more males — who are price inelastic in that their desire to be there will not be greatly affected by entrance price.
In addition to “ladies night” the other example given is Adobe which gives away the Reader for viewing PDFs but charges for software to create them. Not too many businesses have solutions that lend themselves to this type of pricing but its an interesting approach if you do.
Saeed at On Product Management has a post cautioning against half measures when moving to subscription pricing.
There is a real tendency if you already have an on premise solution to…ensure you don’t cannibalize the revenue coming in from that solution…always [putting] the existing product ahead of the subscription based product. This is what happened with Siebel on Demand. The existing business had to be protected from encroachment or cannibalization by the on demand business and it hampered the on demand business significantly. Your company will really need to shift it’s thinking to manage this well.
Macromedia published a survey in November [free registration required] that predicts a growing number of software vendors could benefit from this advice. According to the study, roughly half of all software vendors will offer some form of subscription pricing by 2009. Oddly, only 7% of these are doing so in response to customer demand. The most popular answer, 29%, wanted to move towards subscription pricing for a more predictable revenue stream. This is not the type of rationale that will lead to a successful customer adoption.
More encouraging, 21% are using subscription pricing to increase the adoption of their software. Saeed rightly suggests that product managers evaluating subscription models need to look at the overall value proposition and that pricing is simply a tool in delivering on thatproposition . If these vendors are using subscription pricing as part of a different go-to-market strategy or targeting different customer segments, they are much more likely to succeed than the ones who simply want to smooth out their revenue.
A group academics from Stanford and University of California, Santa Cruz have completed a study on movie theater pricing in Spain which concludes that when primary goods, movie tickets, are priced higher than the secondary goods, popcorn, it can benefit everyone. The less prices sensitive moviegoers spend more money at the concession stand, in effect paying for a “premium” experience. This research is summarized here.
Pricing in this manner is such common practice that I was surprised to learn that it had not been studied quantitatively before:
The argument that pricing secondary goods higher than primary goods can benefit consumers has been circulating for decades, but until now, no one has looked at hard data to see whether it’s true or not.
Freemium pricing, popular with many web start-ups, is the logical extreme of this approach. The primary good, basic access to the site, is free while the secondary goods, premium features, integrations options, administration tools, etc., typically require a subscription fee.
There are more than a few entrepreneurs hoping that web users exhibit similar characteristics to Spanish movie-goers to make this model work profitably.
via: Dollars and Sense: The Pricing Blog
The folks at TechCrunch covered item a while ago but it has become particularly relevant to me as a brand new father who’s sending out tons of pictures.
Presto has a seemingly perfect solution for sending pictures to a segment of the market that aren’t users of technology but places a high premium on receiving pictures. Since most pictures these days are shared digitally, grandparents seem to be the perfect target market for a solution that allows them to easily receive pictures without a PC.
The problem to me is the pricing. The price for the hardware is reasonable at $150 but $9.99 per month for the service is a bit pricey, particularly when you factor in that a high percentage of that market is on a fixed income.
Full blown dial-up up can be had for $9.95. You’d think it a service like this with a more limited application would be cheaper, no?
Presto is placing a value on simplicity, but part of the issue could be in the cost structure. Presto likely has to buy and resell dial-up access from a wholesaler and can’t make margins without charging rates that are comparable to full dial-up. So, they have a cost structure comparable to providers of full access, but only need to offer a small fraction of the functionality. They charge rates comparable to full access and position the limited functionality as a positive due to increased simplicity.
I wonder how well its working?
Seth Godin posts some thoughts on pricing that would probably make a microeconomics professor cry. But I get the point he’s trying to make. The problem with his thesis is that while pricing is a marketing decision, it is also fundamental to how a business architects itself.
There are two generic competitive strategies that a business can pursue; do it cheaper or do it better. If you do it cheaper, you architect your business for operational efficiency and generate profits through higher turnover. If you do it better, you invest in creating differentiators that can that can justify a price premium and make profits through higher margins.
Seth rightly points at Walmart as the classic example of doing things cheaper. They strive for operational efficiency and make a fortune by selling lots of low margin products. Starbucks, who Seth also seems to respect, is a great example of doing things better. They’ve created a customer experience that allows them to charge twice as much as Seven Eleven next door and reap higher margins.
Very few companies are able to “create a blend” of high and low prices as Seth suggests. In fact there are numerous examples of companies who have tried and failed.
TechCruch reports on a service from Usphere that makes it easy for college applicants to apply to multiple schools using a common web form and one $65 fee.
Usphere advertises the service as an opportunity to apply and be accepted to schools “off the beaten path” that students may not have thought about before. They doesn’t openly publish the schools in its directory, but one can guess it consists of niche schools who need the extra applicants and that applicants might not know a lot about.
I wonder if the administrators of these schools have considered the full cost burden that this program will place on them. They may see Usphere as a great way to get “free” applicants but a program like this will have a real costs. Every application will need to be evaluated in some way regardless of how seriously the student is considering the school.
Since each additional school has a marginal cost of zero for the applicant, there is no incenetive for them to limit the number of schools they apply to. This situation will lead to high costs for the school and lower yield rates in terms of accepted applicants to matriculated students.
The book Strategy and Tactics of Pricing contains a great quote by Raymond Corey who taught at Harvard Business School in the 60s.
“All of marketing comes to focus in the pricing decision.”
The main purpose of marketing is to attract a customer to your product and influence the buyer’s perception of its value. A customer may love your product, but if the perceived value and the price don’t line up, you’ve got a problem. If you have a good product, you can probably survive lousy advertising and bad positioning, but if you screw up the pricing issue you’re not going to get everywhere.