This blog frequently emphasizes the importance of charging different prices to different customers based on their willingness to pay. However, it has never acknowledged the challenges to implementing this as a strategy. Recently, I’ve run into several companies who can’t implement this extremely profitable strategy for one HUGE reason. Their systems don’t enable it.
If you know a company in one industry will pay more than a company in another industry, do you have the ability to quote different prices to these two companies? Then, if you get an order from both of them, can you invoice different customers the correct pricing? These are the two biggest sticking points.
Companies who mostly use a direct salesforce usually don’t have a problem with this. The salespeople negotiate prices (i.e. discounts) with each customer. The types of companies that can justify direct sales forces typically sell large deals to other businesses.
Companies (or the portions of companies) without a direct salesforce need a systematic method to quote different customers different prices. SaaS and eCommerce companies often publish their prices on their websites. Yet many of these companies still find ways to segment their pricing. Sometimes they segment by geography, some offer coupon codes, some create different versions of their product for different market segments and charge appropriately.
Companies that sell through distribution often have published price lists, yet many are able to publish different price lists for different types of customers. They have the systems in place to manage and monitor these price lists.
No matter how you think you might want to segment your pricing, you need the ability in your system to implement it. Are your systems capable?
A less common impediment is the ability to invoice. However, some older accounting software packages don’t make it easy to charge different prices for the same product. They require a price for a product. You will want to check with your accounting organization to see that this is feasible.
Here is what you should do – Check to see whether or not your systems, both quoting and invoicing, enable price segmentation. You will find one of three possible answers:
1. They are fully flexible and enable any type of price segmentation (Customer characteristics, transaction characteristics, and behaviors). If you are lucky enough to find this is the case, then you should focus on determining which segmentation methods will give you the most return and go implement them.
2. They enable some types but not others. Any accounting system will allow you to segment based on product since you are simply creating a new part number for essentially the same thing as another product. Instead, focus on the ability to price segment on customer characteristics, transaction characteristics and behaviors. You should learn what types you can implement and do your best to take advantage of them. Consider pushing for better systems (see 3 below).
3. They don’t enable price segmentation at all (or very limited). Consider taking this on as a project inside your company. Convince your own company that profits will increase as you implement price segmentation. It won’t be an easy transition, but it is almost always worth it. If you are able to drive the transition, and you can measure the results, you will look like a hero.
Every once in a while, a company in a traditional industry uses a new pricing model. Troon North Golf is one of these companies.
Typically when you go to a golf course, there is a flat fee. Sometimes their weekend price is more than their weekday price, but that’s about as far as it goes. Troon has taken price segmentation to the next level.
If you check out their website, you’ll find they put different prices based on the time of day. They are in Arizona, so the morning tee times are more expensive than mid day. But in truth, it’s based on demand. More people want to play in the morning in Arizona. It’s worth more.
Play around with their site and you’ll find that different days have different prices. My favorite though is that as a tee time approaches and hasn’t yet been booked, the price goes down.
If they are using demand to drive pricing, which I believe they are, then they also probably change prices based on weather. I’ll bet on cool days in Scottsdale (are there any?) the prices are higher in the afternoon. Do they use the weather forecast to drive their pricing? If I were leading their pricing effort they would be.
OK, so what should you learn from this? Think about how golf has had the same pricing model for a very long time, and here this course has rethought it. They found a new pricing model that more closely correlates with how much golfers are willing to pay. That’s the lesson. Just because you’ve used the same pricing model for a long time doesn’t mean there isn’t a better one out there.
Think new. Look for ways to segment your pricing based on how much your buyers are willing to pay.
Steven Forth, a fellow pricing expert that I enjoy reading, shared and interpreted an awesome story about a new pricing strategy for Saas in a blog titled Slack Is Rewriting The Rulebook on Saas Pricing. The key point of the story is that Steven was elated when he received an email from Slack saying Steven’s company didn’t use all that they purchased so there would be a credit provided to them. Wow.
First, imagine the elation whenever any company surprises you by giving you money you didn’t expect. That is incredible.
In Steven’s article, he went on to describe the history of software pricing models. A very good article you should read. The only minor disagreement I have with his article is he stated that he believes this pricing tactic is a transition to pricing based on value delivered. In other words, this is the future of SaaS pricing.
I’ve made many wrong predictions in this blog, and this may be another, but here is my prediction for the success of this new pricing tactic. It depends. In some markets this will drive competitiveness. In others, it is simply giving money back to your customer at the cost of your profits.
Think about cell phones. AT&T used to offer rollover minutes. If you didn’t use them they stayed on your account. That’s very similar to Slack’s pricing tactic, only pay for what you use. AT&T advertised this a lot as a differentiator, as more value to their customers. And yet, the other carriers didn’t follow suit. They didn’t see it as a big enough differentiator to mimic. AT&T eventually cancelled the program.
However, it’s very likely that markets with low switching costs and minimal differentiation will gravitate to pricing tactics like this. The cell phone industry does not have low switching costs, which may be why this tactic didn’t work for AT&T.
The lesson for you, if you offer SaaS products, is be aware. This may become a competitive sledgehammer in your industry. Maybe you should be the one to wield it first.
A distinctive competence is a distinct core competence. In other words, it’s something you are very good and your competition isn’t. When your products take advantage of your distinctive competencies, then by definition your product are differentiated. Your products have your distinctive competencies. Your competitors don’t.
When pricing products that have competition, you start with your competitors price and then add the value of your positive differentiation and subtract the value of your competitors advantages. Your distinctive competence is one of your positive differentiators, as long as your market values it.
If your distinctive competence is so strong that it essentially makes you a monopoly in your market (i.e. your buyers only consider your products and don’t even consider any competitive products) then that directly impacts your pricing. You have created market conditions and products with no competition. In these type markets, buyers are relatively price insensitive, meaning we can often charge higher prices and barely lose any business.
Distinctive competencies are inherent competitive advantages. Create products that take advantage of your distinctive competencies and you are creating products you can charge more for.
I had to think hard to figure out how pricing can help or is even related. Here are a few thoughts. Please share yours in the comments.
Lead generation is the moment in the buying process where the buyer reaches out to us. Let’s us know they may be interested in what we have. If they see our price early and it’s way too high (or way too low), we will never get the lead. So we need to have reasonable pricing.
The absence or presence of pricing information can effect lead generation. Unless you have a complex direct sales process, I almost alway lean towards showing your prices. Think about your own behavior. You’re thinking about buying some new gadget. You go online, find the website, read a lot, and then you go to look for the price. It’s not there. Do you call? Do you give them your email address so they can reach out to you? Probably not. You probably move on to another hopefully similar product. No lead generated. As a general guideline, you will create more leads showing your price than you will hiding your price.
Often, a limited time sale price can motivate a buyer to become a lead. If a buyer is thinking about a product but hasn’t yet contacted the vendor, a discount that goes away after a specified time could get them to move more quickly. This happens in B2C often. In B2B we see something similar when vendors announce future price increases.
That’s all I came up with. Hopefully you have even better thoughts. I’d love to hear them.
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?