4 Costs of Versioning

[tweetmeme source="pricingright"]Versioning is about delivering multiple product (service) versions at different price points for targeting different segments. Since not all customers are alike and their needs and willingness to pay are different, versioning helps to reach a larger customer base. It is the right step in the direction of profit maximization. Pigou said, “if one price is good, two are better”, and I have echoed the same in many of my posts on the need for versioning. But how far can we take this?

  1. Are 3 versions better than 2?
  2. Are 4 better than 3?
  3. How about infinite versions  or one version per customer for each purchase occasion? (the case of different price per customer for the same version is First degree price discrimination and is impossible in practice)

While versioning is the right step in the direction of profit maximization it is not without costs.

I classify the costs into four main types:

  1. Product Costs: Is your product amenable to versioning? What is the incremental cost of creating and packaging each additional version?  Can the new versions be produced on the same infrastructure? If not what are the capital needs? If you are a bootstrapped tech startup or a cash strapped small business (like Crispy Green) it is almost impossible to find the resources to invest in versions.
  2. Sales and Marketing Costs: It is not enough that your product is versionable at low costs – you need to invest in building the brand, marketing, training the sales team (if you have one) and the channel partners. What is the sales learning curve? How fast and easily can you train your sales team on the different versions, their target market and price? If your sales team has high churn then you will incur these costs over and over.
  3. Menu Costs: These are the costs associated with creating the SKUs, price lists and operationalizing the pricing strategy. Arguably these costs are lower for information goods (software and information services) and use of pricing software will help those selling physical products. Nevertheless the costs exist in creating, maintaining and updating the many different price lists.
  4. Customer Costs: This is the cost incurred by your customers in understanding all your many different versions to make a choice. These are also the costs you have least control over. The costs may not be incurred in the form of dollars but there are definitely cognitive costs and opportunity cost to the customer. Worse, the effects of these costs do not end after version selection. Theoretically, after the customer spends the time to make a selection those costs should not matter to their continued use of products (because those costs are in the past and hence are sunk). But research published in the Journal of Management Information Systems Winter 2007-08, show that cognitive costs are sticky – customers remember and associate these costs with overall product experience.

All these costs mean there are real limitations to the number of versions that can be developed and marketed. Product Costs, Sales & Marketing Costs, and Menu Costs mean, even if the versions can find new customers the incremental profits from them must justify the additional costs incurred. Is there adequate ROI on these additional investments from the incremental profits and how does this ROI compare to other opportunities available?

If resources are not a issues and breaking even each month is not a problem you struggle with everyday (for example P&G) you can afford to make those investments. But what about cognitive costs?

Researchers, Iyengar and Lepper say in their work in Journal of Personality and Social Psychology (2000)

Customers are more likely to make a purchase when offered a limited array of options than a wide range of choices. Subsequent customer satisfaction is higher if the selection choice set is small.

If a marketer can achieve clear separation of the segments and target them with exclusive versions, they can reduce Customer costs.

The net is there are limitations to versioning strategy and the number of versions that can be offered to customers.

What is the ideal versioning strategy?

How do you know when to version?

What is the right number of versions that will delight your customer?

Should you create vertical or horizontal product line versions?

How can you profitably operationalize your versioning strategy?

I will be happy to talk to you.

23 thoughts on “4 Costs of Versioning

  1. Very interesting once again Rags!.
    As Tim was saying, for SaaS or web-based companies versioning is not too much of an issue as you can really flip a switch to allow one or another feature.
    S&M cost are not that trivial though: you take up real estate on your site to market the product and require users to stay longer on the site (tough), you take up time during sales meeting (often limited) to explain the different version instead of selling the value proposition, and you have to split up your brand marketing in the Ads you buy online on other sites.
    The customer cost is probably the biggest issue. Look at Microsoft’s licensing compared to Apple licensing for the OS.. It’s just crazy and builds up a lot of frustration. Am I buying the right version? what if I realized I missed a feature that I need? will the upgrade cost be more than if I had bought the right version right away? I have seen sites that will show 3 or 4 versions and will highlight the middle one saying “Most popular” to help decision making, making it kind of the “default” option. I’m sure this is pretty effective actually and pushed users to not buy the smallest, but the middle offer. Later one, it’s a matter of up selling strategy..

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  2. Tim
    I looked at your pricing at http://recurly.com
    Even though there are three versions listed this will not pose a decision problem for your customers. They simply pay different rates based on the volume transacted and get the same set of features and service for all three levels. This is a case of non-linear pricing.
    One short-term change I will recommend for you is to offer block pricng, i.e., first $50,000 are charged at 3% regardless, between $50,001 and $90,000 at lower level and so on.
    Long term, I will charge a setup fee regardless.
    I also will look at providing differentiated services, based on customer research, for a truly silver, gold, platinum editions.
    -rags

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  3. Great points to consider in product development. Determining product cost early for segmentation is crucial. If you’re a SaaS company who can take one codebase and limit features to create separate “versions”- your segmentation costs might be small to minimal. If you have to maintain separate codebases, this could be a huge limitation as the startup (and branching codebases) separate.

    In my experience, limiting the customer costs (the intangibles) is the most difficult to get a hold of because quite frequently, you can’t quantify this in metrics or dollars and cents (if you can, please share your tips!🙂 ). For my latest startup (Recurly), we’ve done a lot of user testing to try and determine how to keep these intangible costs down- but any other suggestions on how to do this are greatly appreciated. Thanks again for the great post!
    Tim

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