By: Anshu Sharma
Pricing without doubt is the most important decision a marketer makes. Pricing form an integral part of the marketing mix, thus having a strong bearing on how your product/service is perceived in the market. In context of markets like India, pricing assumes even more significance given the inherent price elasticity of most customer segments.
So how should a marketer go about making a pricing decision?
This short essay proposes 3 high level steps to pricing decision making:
1. Choose a Pricing Strategy 2. Select a suitable Pricing Model 3. Finalize the Pricing Method
Choose a Pricing Strategy
The first step is to define your pricing strategy. In simple words, what do you want your ‘Pricing’ to do for your business?
Existing research says, you can choose from four options depending on how to choose to play the PriceQuality game.
PREMIUM (High Price : High Quality)
- Applicable when a unique competitive advantage exists (e.g. Brand)
- E.g. BMW, Apple
SKIMMING (High Price : Low Quality)
- Applicable if the company has a significant competitive advantage. However the advantage may not last for too long. New players will come in to share the pie.
- E.g. Telecom players in the pre-Reliance Jio era. Deriving from the fact that ARPU has dipped almost by 50% post Jio launch.
PENETRATION (Low Price : High Quality)
- Low priced in order to gain market share. Prices will be increased beyond a certain penetration threshold.
- E.g. Uber, Flipkart
ECONOMY (Low Price : Low Quality)
- No frills, low price offerings typically for the mass market segment
- E.g. Maruti 800, Air Deccan
Select a Suitable Pricing Model
Once you have zeroed in on your pricing strategy, the next step typically is to structure your offering. In this regards, following are the most prominently used pricing structures in the software arena.
1. Flat rate pricing: Single product, a single set of features, and a single price usually billed on a
- Simplicity of the structure implies ease of communication and thus ease of selling to customers
- You might end up leaving money on the table, especially for large customers with higher than average usage. o Lack of options for customers to choose from.
2. Usage Based Pricing: Based on usage – e.g. number of API requests, transactions processed, or
gigabytes of data used, number of payrolls executed, etc.
- Revenue increases proportionate to the usage of the customer
- Reduces barriers to use for customers since they pay as they use
- Accounts for any unforeseen heavy usage by the customers
- Makes the value very transactional, as the customers now only care about the number of transactions they are paying for
- Makes it difficult to make revenue projections (since it is linked to usage)
- Makes it difficult for customers to predict their costs (since it is linked to usage)
- Costs for provider might not increase in a linear fashion with linear increase in usage. There might be bumps, for e.g. new server required for additional usage.
3. Tiered Pricing: Based on usage thresholds – e.g. Basic, Pro, Enterprise
- Helps marketers target different customer segments
- Existence of thresholds lead to higher value extraction
- Tiers act as potential upselling routes
- Too many pricing tiers can sometime be confusing leading to customer drop out
- Risk of revenue loss in case of incorrect configuration of thresholds.
4. User Based Pricing: Customers pay for each distinct user
- Easier for marketers to communicate and easier for customers to determine cost implications.
- Marketers can adopt a small pilot followed by an adoption based scale-up strategy with customers
- Easier to predict revenue for marketers and costs for customers
- By charging for user adoption, you are in a way penalizing customers for making your product more popular within their organization.
- Lack of adoption might lead to customer churn
- Provides an incentive to cheat – multiple customers sharing a single user subscription
5. Active User Based Pricing: Customers pay for each distinct active user
- Customers only pay for active users as against for all users in the previous model
- Customers can take subscriptions in bulk and still pay only for the users who actually use the product, thus decreasing risk of adoption/churn for the customer
- Typically works well only for large size organizations with deep pockets
6. Feature Based Pricing: New functionality is “unlocked” with each upgrade
- Customers have a strong incentive to upgrade in order to access additional functionality
- Generates true value for your product features
- Feature set selection can be a make or break decision – what do customers want?
- Might lead to a break in the customer experience due to an inaccessible functionality, thus leaving a bad taste for the customer
7. Freemium Model: A free-to-use product, supplemented by additional paid packages
- It’s one of the most popular foot-in-the-door strategy for marketers
- Especially useful if the value of your product increases with number of users e.g. LinkedIn, Facebook, etc. – The Network Effect
- You can learn a lot from free users as they would be willing to share data
- Dries up revenue – however revenue can be generated through additional means such as advertising, data mo
- It’s easier for the customer to switch due to the lack of any switching barriers
- Customers might not be willing to pay for a service they have been using for free
8. Platform Model: Offers a product as the basic platform and then users pay for additional services. . The platform model ensures stickiness as all the other paid services are hosted on the platform – so switching costs are significant.
E.g. Amazon Web Services
You can Mix & Match
While we have talked about the different pricing models in the previous sections, marketers have a choice of choosing to offer a combination of two or more from the above models. For example, combination of Consumption and Tiered pricing is quite prevalent in the market.
Finalize the Pricing Method
Now that you have zeroed in on the Pricing Model, the next decision is to come up with the magic number – The Price. Keeping in mind your chosen pricing strategy, you can use various methods to come up with the final price for your offerings. Let’s see the most common methods for pricing being used in the industry.
1. Cost-plus pricing: Your cost plus a margin that you would want to make as profits
2. Target return pricing: Your cost plus a margin basis your target ROI
3. Competitive pricing: Based on what your competitors are pricing
4. Value Based Pricing: Based on perceived (not actual) value delivered to customers as compared to alternative products.
5. Psychological pricing: Based on factors such as signals of product quality, popular price points, customer perception of a fair price, etc.
6. Demand based pricing: Pricing is based on the demand/supply dynamics in the market (price elasticity).
Pricing is where all your hard-work as a business actually bears fruit. The prices that customers pay, indicates the value that you generate from the value that you deliver. As marketers we should strive to bridge the gap as much as possible between value delivered and value realized. In this endeavor it is also important to keep away from pricing trickeries such as bait pricing, exploitative pricing in order to maximize value realization.