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Pricing Strategy, Worthy of a Thought?

February 6th, 2009 | Pricing, Product Management

Source: Startup StudentsHad a great conversation this week with Larry McKeogh and Scott Sehlhorst that was directly about Predictably Irrational a book by Dan Ariely. Indirectly, the conversation centered on pricing.

After, I was left wondering about developing a pricing strategy. Apparently there are at least 17 different pricing strategies including cost-plus, premium, target and loss leader. Pick one and win right?

Not so fast. Your pricing strategy is a subset of your product strategy which is a subset of the corporate strategy. Therefore your pricing strategy needs to be aligned with your product strategy.

Let’s assume you have a product strategy to grow your user-base to one million users by December. What sort of pricing strategy do you need to achieve that? Maybe your product is free under a market penetration pricing strategy. Now assume you are looking to break-even this year as well as reach one million users. Maybe a cost-plus strategy is the right strategy, where plus equals zero to maintain a low price?

This is where it gets tricky. December isn’t really considered a long-term strategy. Add in another layer to the scenario by stating in year two (i.e. next year, which is always a lot closer than you think) that you want to achieve $1 million in profit. Now you need to determine whether your users will tolerate a price increase.

Your current pricing strategy has to support your mission. You have to be mindful that the price you start with may prohibit future price changes and will handcuff your longer-term product strategies. The rational (or irrational) behavior of people may prohibit price increases because they already have slotted your product into a value threshold.

I know what you are thinking, more features equals more value to the user therefore I am entitled to increase the price to reflect this. Think about that. Perhaps, they are expecting more features for the price they are paying today. Software as a service customer inherently expect free upgrades.

The other factor to consider is your technology. For example, are you able to slice your product into a tiered offering. Will it be easy enough for people to upgrade themselves to the pricier… I mean enhanced versions? Will it be compelling enough for people to upgrade themselves? My vision here, a situation where you have a free version today and a not-free version tomorrow. Your longer-term strategy may depend on people moving to the not-free version but your free version may prohibit that just because it is free. Does your product architecture support your pricing strategy?

No question, there is a science to deciding what the price is today. But equally important, is deciding what the price is today, that doesn’t preclude you from your mission. Think this through. Strategy alignment.

The Accidental Product Manager provides another perspective on pricing with the context of the same book. Read the post here: How Product Managers Price Products For Irrational Customers.

Image source: Startup Students
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    • I love pricing strategy! A few things to consider about your pricing strategy alignment with product strategy:

      What phase of the product lifecycle are you in?

      If you are in the introduction phase, the typical pricing strategies are skimming or penetration pricing. Examples of skimming are the iPhone and PS3 introductions where they were priced significantly high. This captures the value that the early adopters place on your new product while at the same time signaling the value of your product to the market. You are strategically targeting the early adopters and aligning your pricing strategy to be aligned with this. This market segment will wait in line to buy your product, even if it is twice as expensive as the next best competitor, just so that they can try it out and to be the first ones on the block to use it (assuming that you have a compelling product). They see the value of your product and you can price it based on their value proposition without much regard for competitive forces. These buyers will typically see past the warts and appreciate the best features that your product delivers and you can capture that value with a high price. The other option is penetration, which is pretty good if you are introducing a me-too product with little differentiation. This is aligned with a share growth strategy for your product.

      In the growth phase of your product's lifecycle, you will want to price competitively because you will be targeting the "majority" that doesn't value all of the features that your product has to offer. Pricing competitvely doesn't necessarily mean to match the competition. Instead, you can charge a price premium for the differentiating features that you provide. Flexibility is required here, because you will often be targeting multiple market segments and everyone will not have the same utility function.

      At the end of the lifecycle for your product, you might use clearance pricing to kill your product and eliminate stock or you might increase pricing to capture the value from buyers who need continued support of older technologies because their switching costs are too high to replace it with something newer.


      How do you handle transfer pricing and commissions?

      Transfer pricing rules, sales compensation, and commissions can affect the motivations of your channel to sell your product at the highest price possible. If you have oppressive transfer pricing rules and misaligned sales compensation, your channel will optimize their local performance in opposition of your product strategy. Straight commissions are great if you have a penetration strategy, but they can also drive your sales force to sell at any price and erode the profitability in the market.
    • Another thanks for the sales commission point - adding that to my list of considerations!
    • I really like this last point, the sales commissions are an important factor to consider when pricing your product. Thanks for pointing this out.
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