The Price is Right — Pricing Strategy (Part 2)

Setting the right price is hard. Here are a few tips to help you set the right price and drive revenue for your business.

Welcome to the second week of pricing strategy! Last week, we discussed the inputs you should consider when coming up with a price, particularly the value of your product to your customers. We then used the price elasticity of demand to figure out how customers will react to any changes you make in that price.

However, you probably don’t have a single customer persona that is using your product. In order to maximize revenue across all of these personas, you’ll want to offer a different price for each customer segment. This is called tiered pricing, and will be the topic the next two days.

Another way companies often try to segment customers via price is by offering discounts or promotions. I’ll wrap up our discussion of pricing strategy by talking about the pros and cons of these pricing initiatives.

Like last week, we will look at a theoretical example using my hypothetical company, Doug’s Desserts, which sells its baked goods online and has a subscription service that it sells.

Specifically, we will cover:

• Part 2 — Tiered Pricing (Theory)
• Part 3 — Tiered Pricing (Example)
• Part 4 — Discounts & Promotions (Theory)
• Part 5 — Discounts & Promotions (Example)

Tiered Pricing (Theory)

Last week we talked about how value-based pricing should be the cornerstone of your pricing strategy inputs. Today we are going to expand on that concept and discuss how there are typically multiple types of customers that fall within your ideal customer profile. For each customer segment, you can tailor your product and tier pricing, i.e., charge a different price for each tailored product, for each scenario, to maximize revenue. In order to effectively tier your prices, you will need to understand your product’s usage and value.

Product Usage
In order to create tiered prices, you will first need to understand the customer segments that are using your product. In addition to thinking more granularly about your ideal customer profile (e.g., what is the customer’s industry and how do you reach these customers), you should also answer questions, such as the following, to explore how you could potentially gate your product:

• Which features are customers using the most? The least?
• How many users are logging in from each customer?
• How many times a day is your product being used by each user?
• How much data is being processed by your product?
• What level of customer support is being used by each customer?

While the exact questions will depend on what your product does, these questions provide a starting point and guidepost as you explore your customer segmentation. You should be able to collect this information by tracking what users are actually doing with your product.

Product Value
The second part of tiered pricing is understanding how much value each of the gated features is worth to each customer segment. This value determines how much each customer segment is willing to pay for the product tailored to her / his needs. This data is collected via the approaches we discussed yesterday.

Putting it All Together
Once you’ve quantified your customer segments, you’re ready to construct your pricing tiers. When doing so, remember to keep the options clear and simple in order to make it as easy as possible for your customer to make a purchase. You want to help your customer choose the product / price combination that fits her / his needs as quickly and simply as possible. Paying close attention to how many different pricing tiers are offered is critical for streamlining tiered pricing. Though the number of tiers can vary based on metrics like your number of customers, you want to make sure there are enough to meaningfully differentiate your product but few enough that customers do not get frustrated and just buy the cheapest option or give up all-together.

Let’s see how tiered pricing might work for Doug’s Desserts’ online subscription service. The goal of this product is to provide bakers with delicious recipes and tips. But do all bakers need or want the same level of service? Originally, I planned to price the product at around $2.00 / month based on the earlier pricing inputs I identified; can I tailor the product for different types of customers and charge them each a different price?

Product Usage
By using a website tracking tool, like Google Analytics, I can view how my customers are using my site to see how many users are coming in each day and what parts of the site are most popular. With a site like this, there are a few ways in which I could gate the customer experience, for example:

• The total number of recipes to view per day or month
• The number of logins per day or month
• The ability to use advanced features, like menu planning
• The level of customer support, like phone versus email

After analyzing the customer usage statistics, I decided on three tiers:

• Newsletter: One recipe emailed to you per week.
• Individual: These users will be allowed to have full access to my website. Once a customer has decided to pay, I’ve decided to not further restrict access to the number of recipes she / he can view. Also, these users will be able to email a chef to ask questions.
• Family: The focus of this option is providing the advanced menu-planning feature, plus allowing more members of the family to share a subscription.

Product Value
Now let’s think about how much each tier is worth to a customer:

• Newsletter: A recipe a week adds nominal value to a customer so free is a reasonable price. The newsletter allows me to engage customers and encourage them to buy a subscription by showing them the value of my product. Even if they don’t, I’ve included advertising to allow me to make revenue.
• Individual: We have lots of great recipes that customers will have unlimited access to and the ability to email a chef is a value add that differentiates the product; $2.00 / month makes sense from my earlier product value analysis and is competitive with my competitors.
• Family: The primary value of this product is the menu planning and the ability for each family member to have their own profile. There might not be as many customers who want these options, but $6.00 / month seems like a great value if the two hours a month of menu planning (valued at $10.00 per monthly customer) went almost to zero!

Putting it All Together
Your goal is to make it easy for the customers to see the costs and benefits you are offering. Summarizing the information in a table can be a great way of communicating this information.

Now that we’ve quantified our customer segments and created tailored product and pricing tiers, let’s discuss how we might further incentivize customers to buy our product. A common incentivization strategy is to discount the price of a product via a temporary price drop. Typically businesses discount their prices because they want to engage potential and former customers who are not currently engaged, presumably because their prices are too high. But when is this a risky move and when can it be effective? And are there alternatives to discounts that have similar objectives?

Risks of Discounting
Discounting for the wrong customer segment can mean that you are giving a discount to a someone that was willing to pay full price. As a result, you do not drive new sales or attract new customers. A common example that I frequently encounter is the use of “Promo Codes” on e-commerce checkout sites. Even though I’m ready to submit my payment, I’ll take 30 seconds to search for codes, and most of the time I find one that can be used!

An additional risk, and this is a concern primarily for e-commerce, is the ability to resell your product. If you discount the product, can someone easily take advantage of an arbitrage opportunity by buying your product and quickly reselling it to others on a secondary market at a higher price?

Finally, discounting is related to the larger concept of customer engagement. In e-commerce and SaaS, you engage with the same customer repeatedly and discounting trains these customers to expect discounted, lower prices, making it harder to convince them to pay full price in the future.

E-commerce Discounts
I’ve found that the best e-commerce discounts are ones that are not scheduled, last for a limited time, have a limited supply, and are tied to your product in a way that can help you advertise aspects of your business.

SaaS Discounts
Customers using SaaS products are typically on a recurring monthly payment plan and giving the first month at a discount as an incentive to try your product might not be enough to retain them in the second month — all you’ve done is train them that there is a lower price out there. If you are trying to overcome the challenge of getting customers in the door to try the product and see its value, I recommend offering your product for a limited time as a free trial and then full price thereafter. By employing this strategy, the customer has the opportunity to experience the value of the product before committing to the full price.

Another place where discounting can make sense for SaaS products is on the payment schedule. If a customer is willing to pay for a full year’s subscription in advance instead of month-to-month, then a bulk discount can be effective. Similar to the concept of the free trial, the bulk discount is best offered as a free month instead of the equivalent value as a discount on the monthly rate so that the customer never sees a lower per month price.

If you are finding that discounting is the only way you think you will can generate business among a certain group of customers, then you might need to re-think your pricing tiers, as we discussed yesterday. There might be a new, low-end tier that makes sense for you to offer.

Promotions
Promotions, where you are providing something extra, can be a good alternative to discounts, which involve giving the same product for a lower price. This strategy can entice customers without decreasing the value of your product. It also can serve to introduce them to a new product that they might not have tried otherwise, but may like and purchase in the future.

Measurement
Given all of these risks, how do you measure the effectiveness of a discount or promotion? The key metrics to consider are the number of new customers you’ve engaged with and their churn rate, compared to the cost of running the promotion. If you are not able to reach new customers and sustain their engagement with your product via a discount or promotion, then it is not worth doing!

Discounts
Doug’s Desserts is turning five years old! To celebrate, I will offer $5.00 coupons to the first 500 people who like my Facebook post. In this example, the discount is unexpected (so customers aren’t trained to wait for it), creates a sense of urgency (because of the limited time and availability), and generates buzz around my business being around for five (hence $5.00 and 500 people) years. There is a small risk of arbitrage, but I’ve limited the quantity and the $5.00 discount is small enough it is probably not worth someone’s time to do.

For my online subscription service, as standard policy, I will offer a 14-day free trial for any of the Individual or Family plans to allow customers to see the value of my site before paying for a subscription.

Promotions
To promote my baked goods to existing customers, I will include one random cookie flavor with every cake order that I make to broaden my customer’s experience with the variety of baked good options I have available.

In order to drive more subscribers, I will provide a holiday menu planning guide to each current subscriber who refers a new paying subscriber. In this example, the promotion grows my customer base with limited cost to me. Also, I’ll provide a 10% discount for customers that pay a full year’s subscription instead of the month-to-month plan.

Measurement
If I’m selling my chocolate chip cookies for $6.00 per dozen and my COGS are $4.00 per dozen, then I lose $3.00 per dozen on the discount, or $1,500 (500 customers * $3.00 / dozen). Suppose that of the 500 customers, 80% were new customers. Of those, 400 customers (or 75%) loved my cookies so much that they bought a dozen a month for the next three months. Then I’ve made $1,800 in profit (300 customers * $2.00 / dozen profit * 3 months) on these customers, or $300 more than the cost of the promotion. Because it made more revenue than it cost and I’ve avoided long-term risks of devaluing my product, the promotion should be considered a success!

You can always adjust your discounts or promotions in the future. For example, suppose I was finding that the vast majority of my customers are buying the discounted annual subscription compared to the monthly subscription. This might be because my 10% discount is too generous; I could try discounting by 5% and see how customers respond.

Pricing Strategy Wrap-up
Thanks for joining me on this pricing strategy discussion the past two weeks. Because your company’s objectives and the environment in which you operate is continuously changing, you should repeatedly revisit your pricing decisions multiple times per year. If you have any questions about pricing, or just want to talk baking, I’m always here for you.