We currently do have good, better, best plans for one of our services. And it is good, better, best – I know you’ve mentioned in your posts (iPhone, for example) that people sometimes don’t do it right. In our case, each plan does include everything previous plan includes plus few more things.
Here’s my question, does it always have to be 3? Reason I ask, one of our clients suggested to offer more introductory offer that’s lower in price than our current good option, which would help us pick up clients that are having hard time paying good price but might upgrade later once they increase their business. We offer B2B services, so the lower priced plan would be for solopreneurs and one-person businesses getting started. The difference would be $59/mo vs $29/mo or $39/mo, with limited core services. I don’t want to lower $59, because it does pack quiet a bit. But picking up very price sensitive clients does go with our overall strategy of helping SMBs grow. Would love to hear your thoughts on this.
Thanks a lot for your insight, feel free to use this for a blog post. Have a great Monday!
Thank you for your question.
First, it does not have to be 3, but 3 is best. We understand how people make decisions with 3 options. Three options make decisions simpler for your buyers. However, we do sometimes see 4 alternatives. One example is “Anchoring” which is offering a very high end product, and charging a very high price, to make all of the options look affordable.
However, you are in a dilemma. The risk of adding a low end alternative is some (many?) of your customers will shift their purchase decisions down market resulting in less revenue. This is true if you’re adding a third option at the low end or a fourth option at the low end. For example, people currently purchasing good may switch to the low end. To avoid that, you want to be careful when designing your low end product.
The low end product must be one your current customers would not find acceptable. This may be a minimal set of attributes that aren’t attractive to current customers. This may be purchase requirements that are so onerous that your current customers won’t switch. For example, maybe you can create a solution where people cannot collaborate, meaning it only works for sole proprietors. You can only do this if you know your market well.
Here’s another idea. If your goal is to grow your SMB customer base, you may consider a freemium strategy. For this to work, you have to be able to bring customers on line with very low cost and essentially no support. This has the potential of bringing in many new SMB customers. Your goal is to build as big a network as possible. Then some of them will upgrade as their companies grow. The advantage is you’ve built a relationship and hopefully switching costs with many more customers than simply offering a lower end fourth alternative.
This is an important decision, and of course I can’t answer it without a lot more detail and time. However, I can share with you generalities. Hopefully this post gets you thinking in the right direction.
There is a lot of talk about raising minimum wage. Of course this is a tough political issue with one side claiming it will cost jobs and the other side claiming people can’t live on $7.25 an hour. This blog is about neither of those things. This blog is about what will happen to prices.
The short answer is, prices will go up as minimum wage goes up. Many of you loyal readers know that costs don’t drive pricing, so you may be wondering why increasing minimum wage (a cost) increases prices?
First, some numbers and some math. And to keep it easy, let’s focus on McDonald’s. According to Market Realist, 24.6% of McDonald’s revenue is taken up by their labor costs. (Most restaurants run between 25 and 40%). Even with these low labor costs, McDonald’s only makes 3.6% profit.
Throughout the blog we will assume that labor rates will double with the new minimum wage. Unions are asking McD’s to go from $7.25 to $15 minimum, more than double. Of course, not everyone at McD’s is only making minimum wage, but to be consistent, let’s just assume overall labor costs double. The same story will hold true if labor costs only go up 40%, just the numbers won’t be as big.
First, what happens if a single McDonald’s owner decides to double wages on his own. If he doesn’t increase prices, he will go out of business. He just added another 24.6% of his revenue as additional cost which swamped his tiny 3.6% profit. He’s now losing money. For every dollar in revenue he brings in, he will spend $1.21.
Alternatively, he could raise prices. In order to maintain his 3.6% profit margin, he would have to raise prices about 25%. Do you think if a single McDonald’s had 25% higher prices than competing restaurants, that would effect whether people go to that McD’s or another McD’s or another fast food restaurant? Of course. Again, he would likely go out of business since his business would fall off due to high prices.
So a single McDonald’s can’t significantly raise wages for his or her employees without jeopardizing the business.
The same story holds true if all McDonald’s franchises decide to double wages. Instead of paying 25% more at McD’s many people would shift their preferences to Burger King, Wendy’s, Subway, Taco Bell, etc. McDonald’s as a chain would become less competitive and would suffer harm.
If you disagree with that previous paragraph, meaning you think McD’s could raise prices by 25% and be fine even if everyone else doesn’t, then please answer this. Why doesn’t McD’s raise prices by 25% today (without increasing wages) just to make more profit?
Finally, what happens if ALL fast food restaurants had to double their rates? In this case, all prices would go up approximately 25%. That 3.6% profit margin is an established equilibrium price in the market. All fast food chains would increase prices to cover their increased costs and the market would probably find the same 3.6% equilibrium point. This is identical to what happens to the price of gasoline when the price of oil goes up for everybody. Every station raises prices, yet the market eventually settles to the same equilibrium margins.
On April 1 Seattle, WA began implementing their new minimum wage of $11 per hour going to $15. Seattle suburbs though still have the older state minimum wage of $9.47 (the highest in the nation). What will happen is restaurants inside the city limits will raise their prices if they want to stay in business and those outside the city limits will not. Those deep inside the city limits will be fine because all local competitors will also raise their prices. Those far outside the city limits will remain unchanged because all local competitors remain unaffected.
The challenge will be those restaurants near the border. A McD’s owner just inside the city limits needs to raise prices to cover costs, but may not be able to because of competition just on the other side of the border. This will cause some restaurants on the wrong side of the city limit to close their doors simply because they can’t compete with nearby restaurants that have lower costs.
At the same time, we will see some restaurants just outside the city limits raise prices because they can. A McD’s owner just outside the border will have less competition because those inside the city limits need to raise prices. This owner just outside the border may choose to raise prices and, since his labor costs didn’t change, will make more profit. It’s much better to be the McD’s owner just outside the border. (It’s better to have lower costs than your competition.)
In the end, increased minimum wages will increase the prices we pay at restaurants. They have to. Otherwise these restaurants will go out of business. They aren’t even making enough profit to cover the proposed increase in wages. Raising minimum wage acts like a tax on diners where the tax is redistributed to those who make less. Everybody pays more so some people can make more. Opinions differ on whether this is good or bad, right or wrong. Whether benevolent or evil, it is a truth. Prices must go up as minimum wage increases.
A colleague recently pointed out that several people he knows in pricing have moved into purchasing. This simultaneously makes sense and is sadly confusing.
It makes sense because knowing pricing well is a great toolset for purchasing people. I’d guess that 50% or more of a purchasing agent’s job is to negotiate a lower price. The better you understand the pricing strategies and tactics your vendor is using, the better you can do your job. Hence, purchasing people with pricing expertise have a leg up at their role.
By the way, the opposite should be true as well. One powerful skill set pricing people could use is knowing how purchasing agents do their job. The entire time I was in corporate pricing, I never went to a class to learn how to be a better purchasing agent. What a missed opportunity. I did take negotiation classes from the sales side, but never from the purchasing side.
However, the point of this blog is to lament the over-emphasis on purchasing relative to pricing. Big companies typically have more purchasing people than pricing people. They all have purchasing departments, yet only a subset have pricing departments. Companies spend much more to train purchasing agents than they do pricing professionals. Why?
Probably because purchasing represents hard costs. When an executive looks at an income statement, they see costs and revenue. Aggressive purchasing can reduce costs. However, many things can increase revenue: sales, marketing, product definition, and maybe even pricing. Pricing isn’t immediately linked to large increases in revenue. Hence, if management puts equal emphasis on costs and revenue, pricing will get underfunded.
However, companies have spent years reducing costs. They understand this process well. There aren’t that many left to reduce and they are getting more expensive to find. Economists call this decreasing marginal returns on their efforts.
Pricing is overlooked, but has much more power to improve the bottom line. Companies tend to not revisit pricing as market conditions change. They don’t take advantage of pricing’s power when creating a product portfolio. Firms don’t focus on charging different prices to customers with different willingness to pay. They don’t even do a good job monitoring their day to day pricing activities to see what they can do to help sales achieve the prices they set.
Suffice it to say, the marginal returns on pricing efforts are likely much higher than those on controlling costs. In my company, I’d be focused on both.
Several people have asked my opinion of the pricing of the new Apple Watch, in particular the $17,000 dollar watch. Please note that I have no inside knowledge, but here’s my thinking (best guessing?).
First, It is curious that they have gone away from their standard good, better, best pricing model. All of the other iProducts seem to come with three different amounts of memory, giving Apple a way to price segment their market using products. Maybe the electronics don’t perform any better with more memory so they couldn’t justify it.
They are offering three basic versions of the electronics with the key difference being the case material. Here is a simplified summary of their pricing:
Apple Watch Sport – Aluminum case – starts at $349
Apple Watch – Stainless Steel case – starts at $549
Apple Watch Edition – Gold case – starts at $10,000 (and goes up to $17,000).
Although this might look like good, better, best pricing, it isn’t. What if someone prefer an aluminum case to a stainless case? They will buy the less expensive one, not because it’s less expensive but because it has the features they prefer. With good, better, best pricing, the middle one should be everything the lower priced version has plus more. Not be different. With Apple’s pricing, the features change as you move to more expensive versions.
Another reason this isn’t good, better, best is because the decisions are more complicated. Once you choose a level of watch, then you have to decide if you want the bigger face for $50 more (only for the Sport and Watch, not the Elite). Then you have to decide which type of band you want at different price points.
I’m not saying this is bad pricing. I am saying this is not good, better, best pricing. My belief, because they’ve made the selection more confusing, fewer people will buy than would have if the selections were simpler. After all, a confused mind doesn’t purchase.
Here is how I would probably have launched this. Start with just the Aluminum version and offer 2 or three band colors. Then, offer a lot of band colors as accessories. I would have tried to put different memory amounts so I could have a good, better, best offering. (Although maybe this doesn’t make sense for the product.) Then, when people are deciding, the decision is simple. I doubt that anyone thinking about an Apple Watch would say “I’d buy one if only the case was stainless or gold.”
Then, over time and after people have come to know the Apple Watch, I would have considered launching higher fashion versions.
Now, what do I think of the $17,000 watch? I think Apple will discontinue it within a year. (How’s that for sticking my neck out?)
The good news about the gold watch is there are quite a few wealthy tech people who will purchase it. If we assume the margin percentages are similar across the watches then Apple only needs to sell one gold watch for the same revenue and profit as 20 to 50 of the lower priced watches.
However, Apple sells millions of any item. I suspect that they will sell millions of the lower priced watches producing billions of dollars in revenue. Yet they will probably only sell thousands of gold watches. That is great business for most companies, but for Apple it’s a distraction.
A $10,000 watch is a fashion accessory, not a functional item. Although Apple makes their electronics more fashionable than any other company, they aren’t in the fashion business. They are in the easy to use electronics business. I’m guessing Apple can’t make a $10,000 watch have the same cachet as a Rolex. It took Rolex a long time to create that reputation, and Rolex doesn’t sell a $350 version of their watches.
You’ve now read my prediction. What’s yours? Time will tell.
The obvious relationship is that as we plan for new products, we should understand how much value they will deliver in the market and hence what price we should be able to charge. Before committing to a new project, we should have profit estimates, which of course requires a price estimate.
However, when you look deeper into both the concepts of pricing and roadmaps, you have the opportunity to make much better future product decisions.
First, when we think about pricing early then only products that deliver a lot of value to the market make it onto the roadmap. How often do we create products and then try to figure out how much to charge? If you understand how your market perceives value, it makes it much easier to realize what you need to build. Pricing should directly influence future products.
Second, clearly understanding pricing strategies should at least partially drive our roadmap. For example, do we create separate products targeted to different market segments? Different market segments have different willingnesses to pay. We probably should. We can’t create them all at once. We need to prioritize market segments and add them to the roadmap based on this priority.
Another powerful pricing strategy is good, better, best. If we choose to use this strategy, we need to clearly articulate what each version does and where each one fits on the roadmap.
Another pricing strategy that’s clearly related to roadmaps is complements. Once we’ve won customers in the competitive marketplace, we can often sell add-ons at much better margins. These add-ons, or complements, are extremely valuable and profitable. They need to be prioritized and placed on the roadmap if we want to create them.
Hopefully you see that roadmaps and pricing are tightly intertwined. It’s foolish to create a roadmap without understanding the pricing of the items on the roadmap, and it’s powerful to use pricing concepts when deciding which products belong on the roadmap.
So the title of this article isn’t really true. Actually, the opposite is. Pricing should lead to all roadmaps. Does yours?
Annually, Pragmatic Marketing surveys the market and this year, I was allowed to study the data.
The data I used was from the 842 respondents who completed the survey. Since Pragmatic Marketing targets product teams, you can consider that’s the population from which this data is drawn.
In the analysis below, the dependent variable I used was the answer to the question: “Which of the following business activities are your responsibility? Check all that apply.” I specifically analyzed the results to one of the possible responses: “Setting and maintaining pricing.” In essence, we are about to look at what characteristics of product people are different between those who price and those who don’t.
Experience – Product people with more experience are more likely to have pricing responsibility. Specifically, the dramatic cutoff was at about 6 years of experience. 31% of respondents with 5 or less years of product experience set or maintained prices, while 43% of those with 6 years or more had that responsibility.
Age is correlated with experience, but not perfectly. The age group with the most pricing responsibility, 37%, was 35-54. Over 54 and the number dropped to 25%. Under 35 and the number was only 19%.
Technical ability is a good predictor of pricing role. Respondents self reported as either highly technical, somewhat technical or not technical. In order, these groups had pricing responsibilities of 42%, 37% and 32%. The more technical, the more likely someone prices.
Profitability – 67% of those who said they are responsible for the profitability of their product also claimed to set or maintain prices. This contrasts with only 24% of those who aren’t responsible for profitability. Although this feels right, I feel sorry for the 33% of people who have responsibility for profits without any pricing authority.
Type of product – 57% of hardware product people have pricing responsibility. Followed by 41% of professional services product people, then 38% of software and 37% of cloud services product people. Although there is no additional evidence supporting this claim, it appears the higher the variable costs, the more likely the product people manage prices.
Hours worked per week is also an indicator of pricing role. 49% of people who work more than 50 hours per week have pricing responsibility while 29% of those who work 40-49 hours per week set or maintain prices.
Time spent in strategic roles is another predictor. 49% of those who spend more than 50% of their time in a strategic role do pricing while only 39% of the rest do.
Department – Turns out that 48-49% of people who report being in Product Marketing or report directly to the president/CEO/Managing Director have pricing responsibility. While all other departments (product management, marketing, sales, engineering, support, services or training) are well under 40%. I’m very surprised that product management is on the low list. Aren’t they the ones who best understand the value of the product? According to the data, it is more likely that product marketers are involved in pricing than product managers.
Salary – The one you really want to know. 44% of product people who make more than $140,000 per year have pricing responsibility. Only 36% of those who make less than $140K set or maintain prices.
The data are all interesting on their own (at least to us geeks), but still, here is my interpretation.
It is impossible to know causation. For example, do people work long hours because they have to do pricing or do they get the responsibility and trust of doing pricing because they are hard workers? Although I can’t prove it, my interpretation is the latter. Variables like experience, profitability, and salary indicate to me that pricing authority is bestowed upon the best performers, probably not as a reward, but as an indicator that leadership trusts these people with these most important decisions.
After all, pricing is the most powerful marketing variable, it only makes sense that companies only give that authority to people in positions of trust.
Late in 2015, Pragmatic Marketing will do another survey. What would you like to know when it comes to pricing? Maybe we can add a few additional questions to test some interesting hypotheses. Let me know.
Isn’t it great being in a relationship? I’ve been married over 25 years and still love spending time with my wife. We entertain each other. We help each other. We console each other. We advise each other. We stretch each other. We root for each other. We trust each other. We have common goals.
Buyers and sellers are in a similar relationship (but maybe not as fun). They both want a successful implementation. They both want the most value possible out of the product. They both want the buyer to look good. They have common goals … except for pricing. Pricing is the one time in the relationship between buyers and sellers where their goals are not aligned. The more one side wins, the more the other loses. Each wants to win at the expense of the other.
Just like pricing, there are some things in our relationships where we “negotiate” who does what. Who does the dishes? Who cleans up after the dog? Who fixes the computers? Neither person enjoys doing them, but someone has to. The more one person does, the less the other has to. It’s a zero-sum game. (Unless we both agree to live in a dirty house.)
OK, this is interesting, but what pricing lesson can we learn? Answer: Let’s talk about price with our buyers at the right time. Not too early. We need to build a relationship with our buyers. Create an attitude of trust. Demonstrate our true desire that our buyer succeeds. Then we can talk about price.
Think about your first date with someone with which you’ve had a relationship. If you wanted a second date, you didn’t talk about your negatives, or anything that might be deemed controversial. In fact, I’ll bet that if you do talk about these items on the first date, you’ve probably been wondering why you don’t get many second dates.
By the way, wouldn’t you love it if, on your first date, your date would confess to all of his or her bad habits? That way you can quickly weed out the bad ones in search for ones that better meet your needs.
Similarly, your buyers often want to know your price on the first meeting. They are looking for reasons to disqualify you early. When they ask the price question directly, you have to give some reasonable answer. Here are some bad answers:
“I’ll tell you that after our third meeting.”
“I can’t answer until I know more about your requirements.”
“We don’t give that out this early in the sales process.”
Each of these answers looks non-responsive and makes it look like you’re playing games. They make it less likely you will get the second meeting.
Here’s an answer I like:
“Most of our customers spend between $xxx and $xxxx, depending on their requirements. As I learn your needs and you discover our capabilities, we will be able to narrow that range down for your situation.”
This answer looks as responsive as possible given the amount of information each side has.
What other answers have you seen work?
Pricing is a taboo topic early on. It’s the 800 pound gorilla in the room. Everybody is thinking about it, but we have to manage the conversation carefully. Bring it up too early and we may never get to the second date, (i.e. have a chance to build the relationship).
Speaking of relationships, Happy Valentines Day (belated). Oh, and if you didn’t get your significant other anything on Valentine’s day, do something nice for him or her now. It will come as a big surprise and you won’t have to spend as much.
The 60-Second Mind podcast put out by Scientific American on January 31 brought us fascinating proof that price is an indicator of quality, proof that we believe this deep down in our bodies.
They described a study from the journal Neurology. [Alberto J. Espay et al, Placebo effect of medication cost in Parkinson disease: A randomized double-blind study]
The placebo effect is well known, where people who believe they are taking real medicine, even when it’s just a sugar pill, somehow heal themselves. In this study though, the researchers studied the effect of one placebo vs. another. The patients were told they were testing two treatments where one treatment costs $100 a dose while the other one costs $1,500 per dose. The patients were not told that both treatments were placebos.
Amazingly, the subjects who believed they were taking the $1,500 treatment showed 28% more improvement than those taking the other treatment. The more expensive the placebo, the more powerful the effect.
This is proof that even subconsciously we deeply believe that price is an indicator of quality.
One implication of these findings: the drug companies might be doing us a favor by keeping their prices so high. (Sarcasm)
A student wrote in to ask the following question. It was fascinating enough I want to share it with you. All identities and industries are modified to protect the privacy of the actual situation. Here’s the question:
Hi Mark, I’m wondering if you can assist me with something I’m struggling with. I’m working on a deal right now and trying to price it based on value but the customer is pushing back very strongly saying that it’s not worth the fee we’re trying to charge.
We’re a private B2B company. With our magic, the use of our product will allow this particular client to increase revenue in an area of their business from about $90k to $260k, without having to charge their customers any more money or to fundamentally change the way they do business; they do what they’re doing, charge their customers the same amount of money, yet they almost triple their revenue. We have built a compelling economic model, which they worked with us on, and which they agree will have a significant impact on their bottom line.
Our product is a license based service that will help them realize $180k in new annual revenue. Using what I learned in the pragmatic marketing pricing course, I applied the 10% principal so our license fee should be $18,000 / year = $1500/month. Despite showing them a strong economic model, which they have said they agree with, they have only offered to pay us $2500 annually for a license.
I’m not really sure what to do now. They love the product, and want it. We know the value that we add to them, but they are simply refusing to move off that number. We don’t want to walk away from the deal, but we’re also conscious that the value that we’re delivering them is substantial and they should pay a reasonable amount for it. No way we’re going to accept a $2.5k license, so we’re not really sure what to do.
Any thoughts/ideas/suggestions? Thanks, Jason
From what you describe it seems you are spot on. Here are a few thoughts on what may be happening.
First, make sure this is a Will I? type product, meaning you have no competition. Assume for a second that your buyer decides to not purchase from you. What will he do instead? If the answer is nothing, then your thinking is correct. If the answer is purchase a competitor’s product or build something similar himself, then you’re probably not going to be able to capture 10% of the economic value you deliver.
Second, we have to make sure the customer believes the economic value we promise. You said your customer agrees with your numbers so that’s probably not the issue. But we will only get 10% of the economic value our customers believe they will get.
Third, although our costs don’t drive our pricing, often our customers think they do, or at least should. Your customer may be looking at what they think this costs you and don’t feel your price is fair. Alternatively, they may be looking at prices of similar (not competitive) products that are priced much lower. In these cases the buyer has a price he expects to pay and you are asking a much higher price. This is often very difficult to overcome. It may take a little time for the buyer to get used to your price.
Fourth, maybe your buyer is simply a tough negotiator.
Here are my suggestions.
1. Change the structure of your offer. In conversations, offer to give him the product for free and share the upside 50-50. This looks fair and is essentially free money to your customer. However, your customer will never go for it. The purpose is to get the customer focusing on how much of the upside he wants instead of how much he’s paying. (By the way, these incremental profit sharing plans are extremely difficult to enforce. You really don’t want them to accept it so don’t push too hard. Instead, you are using it as a tool to make the 10% number look inexpensive.)
2. Be patient and walk away. In negotiations, patience pays. If you show you are anxious to close quickly, the buyer will not budge. If you look like you’re willing to walk away the buyer will likely move his price up. It would be foolish of the buyer to walk away from the additional profit you can deliver to him just to spite you because he doesn’t like your price. If it appears the buyer walks away (which looks like a couple of weeks of silence) then you can always go back and accept a price closer to his offer if you want.
Oh, and you probably don’t want to just hold your price. Find a reason to give a little to show you’re not unreasonable, but don’t give much. Maybe a 3% discount. It looks like you’re trying, but you don’t have room to go.
3. Offer a free trial period. If the implementation isn’t too onerous, the customer may be willing to try it out and then find out if the additional profits do appear. Then, when you go to take it away the decision becomes much easier for him to make. However, if the implementation is challenging, then the company may not want to invest that much of their own resources for the test.
And to close the story, here was Jason’s reply:
Hi Mark, Thanks for writing back so quickly… I really enjoyed my 3 days with you, and I appreciate you taking the time to help me out; I owe you a steak and a beer the next time you’re in my town
I think he’s on the right track. Hopefully he will write back and let us know how it ends.
Photo by Leo Reynolds
The Pragmatic Marketing framework activity of the month is Market Problems. If you know about Pragmatic Marketing you know that the foundation of all that we teach is understanding and then solving market problems.
At first glance, it appears that pricing is directly related to the size of the problem solved. Some life or death medicines sell for thousands of dollars a dose. It’s a no brainer that we would pay that much if it would save the life of a loved one. On the other hand, most of us would never pay thousands of dollars for something with much less impact. Think about a medicine that heals cuts quicker.
This is even easier to understand when thinking about B2B opportunities. If you build a product that will save a customer $10M, companies would pay a lot for it. Compare that to a product that will save them $100K. Obviously the customer would pay a lot more for the product that will save them more.
So far so good. The bigger the problem solved, the more a customer is willing to pay. However, it’s not really that simple.
This situation changes when competition enters the picture. The most a buyer would pay to solve a problem doesn’t really change, but what does change is how much they HAVE to pay.
As an example, assume a buyer would pay $1,000 to a monopolist to solve a problem. Obviously both the buyer and the seller are happy, otherwise they wouldn’t have entered into the agreement. Then, one day a new competitor enters the market and solves the same problem for only $200. Now, the customer would no longer pay $1,000. Assuming the competitor really does the solve the problem, the most the buyer would now pay is $200.
In high technology we see this frequently, where a company creates a new solution, is successful in the market, and then competition enters and drives down industry prices. Another example is in the pharmaceutical industry. Drugs are often protected by patents, making the manufacturer a monopolist, but the moment the patent expires competitors enter the market and prices decrease.
To summarize the point of the blog, the most a buyer would pay is the smallest of these two prices:
The amount they would pay to make the pain of the problem go away.
The price of a competitive product that solves the problem equally well.
So yes, the more severe the problem, the more buyers would pay to solve it. But the price we can get away with charging is often tempered by competitive offerings.
Photo by Tomasz Stasiuk