BUSN 491 Rought Draft Pricing Strategy

Developing Your Pricing Strategy

CHRISTOPHER O’DONNELL

PRICE INTELLIGENTLY

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CHAPTER 1

The Challenge and Importance of Pricing

IN THIS CHAPTER

1. The most important business decision you will make

2. Revenue optimization

3. Unit sales maximization

4. Value perception

5. Exercises

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The most important business decision you will make Every business’ profits and losses can be described in a spread- sheet, and though the model of each is unique they all share one thing in common: at some point the number of customers is multiplied by the sale price of the good or service.

Optimizing the value of each potential buyer is the most criti- cal activity to making a business model work. Understanding price sensitivity, value systems, and the buying behavior of your target customer is perhaps the single most treasured piece of institutional knowledge an organization can develop, though shockingly few get that far.

As a business owner, operator, or manager you generate value day in and day out by making good decisions. Some of these decisions are creative decisions, some are interpersonal, and many are quantitative. Though there are thousands of these decisions that need to be made in order to operate a business profitably, none is more important and fascinating as the deci- sion of how much to charge for your product or service.

Pricing is an art as well as a science: a decision making proc- ess that requires both qualitative and quantitative inputs. While it is valuable to acquire a deep knowledge of the target customer, and thus an instinct for their value system, pain points, and requirements, this knowledge does not suffice. At a minimum, it is necessary to acquire a working awareness of the methods and vocabulary of pricing specialists, which will

allow you to make far more informed decisions. Developing this awareness is the goal of this publication, and we are confi- dent that you will quickly and efficiently get up to speed, speaking the language of price strategy.

Revenue optimization Clearly the first benefit of optimal price point identification is to ensure that no money is being left on the table. That is, that your product or service is not identifiably more valuable than the price you are charging for it. Perhaps you have had people make a purchase decision with few objections, seeming to glance over price as small administrative detail. These scenar- ios are common and represent opportunities to affect mean- ingful business change by understanding more about the cus- tomer’s price sensitivity and ultimately finding a higher, more appropriate price and package. Goods and services should rep- resent a good value, not a “no-brainer” purchase decision; if your market never comments on or discusses your pricing and packaging, it is a sign that more thorough research is war- ranted.

Unit sales maximization On the other side of the coin is the effect of price sensitivity on product or service adoption. In certain circumstances, such as the early stages of a startup business, there is meaningful value to the business to have potential customers adopt the use of the offering. A thoughtful pricing strategy should take this into consideration and recognize that momentum of adop- tion can offset marginal lost revenue through generating

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greater awareness that leads to future sales. The optimal price point to maximize revenue is often different from that which aims to optimize the rate of adoption. It is a key factor in pric- ing strategy to understand if there is a wide delta between these two numbers, and to act in a manner that is consistent with the business’ current strategic priorities.

Value Perception One realization that most often shocks pricing newcomers is that, below a certain point, a price can deter potential custom- ers who perceive low price as an indicator of low quality. Con- sider a $15 mountain bike, or an urban condominium listed at half the price per square foot as the market rate, or maybe a $30 pair of running shoes. While there may be generated inter- est in products priced so aggressively, the suspiciously low price will draw buyers’ attention to shortcomings while en- couraging a skeptical mindset.

The strategy of deliberately pricing products much higher than, say, a competing offering has worked marvelously in cer- tain circumstances. In new markets, or with novel new prod- uct offerings it should be considered and understood what the impact of intentional “overpricing” could be vis a vis the mar- ket perception of the new widget. The best cases have the sur- prisingly high prices triggering a renewed interest and deep curiosity for the value proposition of the product, often result- ing in speculative purchases.

Exercises For this section, consider these questions on the left, writing 2-3 sentences in response to each.

QUESTIONS

1. When did you last choose a price for a product or service? What quantitative and qualitative information did you use to make that decision?

2. What impact would a 10% price increase have on your overall profitability as a business, assuming you did not lose sales?

3. What impact would a 10% unit sales increase have on your overall profitability, assuming your price were 10% less?

4. Can you identify any “suspiciously low” priced products or services in your field?

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CHAPTER 2

The Value Metric

IN THIS CHAPTER

1. What is a value metric?

2. The importance of being understood

3. Exercises

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What is a value metric? The reality of pricing is that ultimately you have to charge for something, and that something is traditionally described and counted in the form of a value metric. If you are selling eggs, the value metric is the egg. Seems simple, right? Well, it ought to be simple but often the best intentions lead to the presenta- tion of a convoluted pricing scheme with an unclear or confus- ing value metric.

Consider, if you will, selling online email services. At first shade it seems simple: you offer the ability for a company to send email to individuals, and should therefore charge for each email sent. Or is it for each person who receives an email? Or is it for the size of a list, or rather for the number of sends per month? All of these options incur incremental cost for you, the service provider. You could, for example, imple- ment a pure, transparent “cost plus” pricing tactic that marked up the cost of goods sold, so to speak, and charge cus- tomers a premium for a simple-to-use service with tremen- dous underlying complexity. But how, in this scenario, are you to present clear pricing on your website and marketing materi- als? Clearly, this is not a good approach. In fact, the most valu- able exercise here is to identify who your target buyer is, and work to determine the correct value metric for that buyer.

Maybe your buyer is a small business that sends varying amounts of email month-to-month. For these folks, the right value metric is probably the total size of their list. By bucket- ing these customers into different discrete purchase options

you can serve them properly and charge them an accessible, transparent and predictable price.

If your buyer is, instead, a large company with a dedicated email marketing team whose job it is to send various targeted email blasts to segments of contacts within their overall list, your value metric might well be the total number of unique emails sent.

The importance of being understood The single most important test of a value metric is simple: does your customer know how many [your metric] he needs?

In the above example, the small business owner certainly knows the size of his email list but perhaps doesn’t know how to easily predict the number of emails sent [within a certain time frame]. The email marketing team, on the other hand, knows not only how many emails they send (in addition to their list size), but also how many they might need to send dur- ing special promotion periods or other circumstances. In each case, the value metric is clear and understandable by the tar- get buyer.

When someone asks you to clarify your value metric, you know you have a problem.

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Exercises For this section, consider these questions on the left, writing 2-3 sentences in response to each.

QUESTIONS

1. List three different value metric options you have for your product or service, even if you have identified one you like.

2. For each of these value metrics, is there a type of customer who knows how many he needs? Is there a type who would be confused or be forced to perform an unnatural calculation?

3. Name a creative value metric! Think of businesses that have been radically disrupted in the last few years; in which cases have new companies used creative new value metrics to introduce a disruptive product?

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CHAPTER 3

Packaging & Bundling

IN THIS CHAPTER

1. Packaging basics

2. Making bundling work

3. Tiered pricing

4. The power of customized pricing

5. Exercises

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Packaging basics An aspect of pricing that is as old as time is the principle of combining goods or services in various combinations and then offering a price for such a group. In industry parlance this is known as packaging or bundling. Don’t be fooled by the name, this topic extends well past the method in which a physical good is wrapped and presented. Packaging encompasses a far- ranging set of tactics and considerations designed to entice the buyer while rewarding the seller. A working vocabulary of the common approaches used in bundling remains a funda- mental building block of a professional’s pricing knowhow.

Generally speaking, bundling of discrete purchase options into a single package benefits the seller. In the rational buyer’s perfect world, each component piece of a purchase transac- tion would be separate and priced in consistent relative value to the others. In such a world, the buyer would have access to his most efficient deal, as he would choose only the options that suited him. Imagine buying a car from a dealer who let you customize every last option, choosing only what you really need. Now remember every time you’ve bought a car: every- thing works on the idea of packages. Though there are quite a few sunroofs out on the road that get little to no use, they were all paid for - at high margin.

Making bundling work We know that bundling is invariably in the seller’s favor, and so we must wonder: how can bundling goods generate per- ceived value for the buyer? The answer is straightforward:

bundling presents an opportunity for the seller to propose a discount.

Leveraging an intelligent bundling strategy, the seller can en- large average deal size by dangling unnecessary but heavily discounted items in front of the buyer.

The buyer will often be irrationally enticed by such offers, sensing that the incremental power of each purchase dollar is uniquely enlarged in the context of the bundled offer being presented.

Tiered pricing Bundling often presents itself in the form of tiered pricing. Par- ticularly in the modern world of software, there is an increas- ing and justified investment in understanding the segmenta- tion of the target market, and offering bundles at different price points to each segment of this market.

In practice, this segmentation is often a ruse. A product that is available for a monthly subscription may offer 4 different plans for the express purpose of framing the intended plan in a favorable, understandable light. The distractor plans will typically serve to establish value of each component part by il- lustrating the price of at least one plan that is insufficient, and at least one that is bloated and too expensive. This tactic can work brilliantly, demonstrating the thoughtfulness of the bun- dle (all the things you seem to need, none you don’t) while – as we know – serving to offer a bundled discount that is quite favorable to the seller.

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The power of customized pricing One of the main advantages to tiered pricing is that it helps the buyer understand why the pricing and packaging being presented is appropriate for them. One can take this principle a step further through the use of editions, deliberately bun- dled offerings that represent turnkey purchase options for vari- ous target buyer personas. Once again, we see the simultane- ous power of presenting the buyer with marginal buyer power while optimizing for deal size and margin for the seller. What is critical when offering pre-set customized bundles for your different type of buyers is to deeply understand their value sys- tems, and to see the relative value and importance of each fea- ture or item you can offer. Conjoint analysis and discrete choice modeling are strong options should you choose to in- vest in quantitative research in this regard.

Exercises For this section, consider these questions on the left, writing 2-3 sentences in response to each.

QUESTIONS

1. What bundling does your business employ today? Where is marginal gain realized through this bundling?

2. What customized pre-set bundles could your business consider offering? Is there a type of buyer that remains underserved by your current bundling options?

3. Does your business have a “sunroof,” something that buyers happily purchase [because it is bundled with other products] regardless of actual need?

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CHAPTER 4

Discounting

IN THIS CHAPTER

1. Offers

2. Promotional discounting

3. Long-term value perception

4. Exercises

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Offers To maximize sale volume and deal flow, introducing urgency into the buying decision has as large an effect as anything. Amongst qualified leads the primary objection to moving for- ward with a deal is almost always “now is not the right time.” Sometimes this is true, more often it is an alibi; it’s your job to make it the right time for the lead, and providing a due date is a fine idea.

When exploring the use of discount offers, keep in mind the two factors that together combine to generate value for the seller:

1. Introduction of urgency

2. Promise of value

One of these factors, even done right, will cripple the effective- ness of the offer if done without the other. Showing a huge dis- count with no end date, or having a one-day sale without a meaningful discount both fall well short of their goal.

Instead, clearly show the end date and/or terms of any offer. Explore traditional tactics like the “one-day sale” or the mes- saging of “while supplies last.” At the very least, be sure to dis- play “offer ends on <date>” prominently in the offer creative.

To demonstrate the greatest value, many have found that at lower price points a percentage savings generates the most buyer interest, and as prices rise the total-dollars-saved met- ric makes a bigger statement. The latter is particularly compel-

ling, given the ease with which the buyer values the savings; knowing the value of the offer in concrete dollars is hard to beat.

Promotional Discounting A good reason to offer discounted pricing is to generate new accounts and potential repeat purchasers. Consider the bounty of discounts that come to the new homebuyer; these discounts are prescient in their aim to capture the loyalty of a neighborhood newcomer and can afford to be aggressive.

Of course, remember to quantify the value of such discounts over the long term. If you take a short-term loss, be sure you know how to measure the long-term gain, to ensure that pro- motional discounting is working for your business.

Creative promotional discounting approaches have been on the rise, aiming to generate pass-along value or viral growth characteristics. The goal in these cases is to create an offer that rewards the buyer directly but only if and when the buyer brings another potential customer into the fray. A new service may give account holders a web link (bearing a coupon code) for the account holder to pass around to friends. Those friends who act on the link and create accounts of their own receive, say, $10 in credit, while the original sharer receives the same. Such promotional approaches can be tremendously success- ful, particularly when a business has made customer satisfac- tion a priority above all else; in addition to being incented to share the service, the account holder will testify to the product

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or service’s value personally, dramatically increasing the value of the offer in the prospect’s eyes.

Long-term value perception Any time a company decides to charge less for what it offers it runs the risk of devaluing these core assets. In order to safe- guard against the deterioration of perceived value, keep some of the following heuristics in mind.

• Don’t offer discounts for long periods. Remember to retire your offers after they have served their usefulness. Maintain credibility with your buying audience by retiring of- fers in line with the published schedule. Failure to do this will result on your customers archiving offers for future considera- tion. When this happens you have failed to introduce urgency!

• Vary your offers. Offers that are too consistent will cre- ate a rhythm that will once again undermine your efforts to in- troduce urgency. Whenever you give your buyers a reason to wait, they will.

• Guard your value. Above all else, remember that dis- counting communicating that you are willing to sell for less – be mindful of the dynamics that you introduce, or quickly your buyers will come to value your offering less highly.

Exercises For this section, consider these questions on the left, writing 2-3 sentences in response to each.

QUESTIONS

1. What is one example of your business offering promotional discounts? What is the cost of these discounts, and what is the long-term gain?

2. Name three ways your business could create urgency in the buying cycle, by using discount- based offers.

3. Name one business that has tarnished its brand or product value in the public eye by offering consistent, aggressive discounts.

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CHAPTER 5

Conclusion

We hope that this introductory guide to pricing was useful to you and your com- pany and represents a valuable first step toward developing a robust, validated pricing strategy. If you found this eBook helpful, or if you had hoped for more in- formation in a certain area, please visit http://www.priceintelligently.com and we will do our best to meet your needs in

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