If One Price is Good, Two are Better – a Fallacy? Gross Generalization?

I end many of my posts with the line,

If one price is good, two are better.

It is written in the blackboard I use in my Twitter and WordPress profile pictures. Is it just a tag-line? Worse, is it a gross generalization or a fallacy?  In a previous article I wrote about the 1% price increase fallacy, and I frequently write articles on gross generalizations by other authors. Shouldn’t I look at my own tag-line  even if I don’t give it the same level of scrutiny I give to others?

First and foremost – Yes it is a tag-line and there are situations where it is not true.

Origins of this statement: It is rooted in price discrimination which was first written about by the economist Pigou.  He did not use these exact words. I am reluctant to claim full ownership of this statement. I am convinced I have read this before but my searches come up empty, so I own it for now.

The claim I make is weaker than the claim made by general price discrimination theory. My claim stops at two prices, requires that “one price must be good, i.e., there is a market for the product at a given price”, and does not imply scaling or generalization.

Pigou and later economists used more formal quantitative methods to prove the merits of price discrimination.  Pigou laid out three specific pre-conditions for price discrimination to be more profitable than a single price:

  1. Different customers must value the various versions differently. This means customers’ needs and the value they get from the product must be different.
  2. There must be no arbitrage opportunity.
  3. The products must not be commodities or easily substitutable – products must add unique value to customers.

It is easy to see why (1)  is true for most products.  If it is not true today then everyone will buy a product at any price. Since that isn’t the case we can accept (1) to be true.

For most products we develop and market there is no arbitrage opportunity. This is especially true for digital goods and webapps.

Finally, your product is a commodity only if you let it be.  The most common refrain I hear about webapps is, “if you don’t make it free your competitors will”. If your webapp adds no unique value or easily substitutable then  it is a commodity. But does it have to be that way? Isn’t that why we have marketing, value-messaging and positioning?

So for most of the cases the three preconditions for practicing price discrimination hold true, leading me to repeat,

If one price is good, two are better!


Note: You can read my articles on 4 Costs of versioning and how to design and price the versions. I offer three versions of these articles all priced differently.

Pricing Your Multi-Version Product

Note: This article gives basics of price discrimination, product versioning and consumer surplus that will help see the case I make on iPad2 sales.
[tweetmeme source=”pricingright”] How should a marketer set  prices for different versions? I wrote,

Set prices of your versions such that those who are able to and willing to pay higher prices will do so and are not tempted by the low priced version.

A slight variation of this statement was suggested by Chris Hopf,

Assort Value of your versions such that those who are able to and willing to pay higher prices will do so and are not tempted by the low priced version.

The difference is the value allocation but both statements are not only correct but also are complementary. To explain this we have to go to the very beginning of price discrimination – the Pigouvian economics.  For a marketer to adopt versioning strategy the following two conditions are necessary*:

  1. Different customers must value the various versions differently. This means customers needs and the value they get by hiring a version must be different.
  2. The products must not be commodities -products must add unique value to customers.

Together these two explain the value assortment argument. But it is not enough to just create value, a successful business model is not only about creating value but capturing a fair share of it. Pricing is the lever for value capture. This is what I said about setting prices for the versions.

Let us walk through an extreme case for simplicity. Let us say there are only two customers Bob and Alice. You, the marketer, create and sell shaving gel.

If both Bob and Alice value just the utility of the gel and hence do not value any other benefits there is no point in creating multiple versions, one for Bob and one for Alice. For instance, if Alice finds that she gets more from Barbasol, after all it is the same product as Pure Silk, then she  will pick Barbasol.

If Bob considers the gel just for its utility and has low willingness to pay (WTP) but Alice appreciates the scent and values how it works in the shower and hence has higher WTP then it makes perfect sense to create two version. The version for Bob is the simple Barbasol and the version for Alice is Pure Silk.

How would you price these two (given Bob does not value Pure Silk at all)?  You should price these two such that:

Value of Pure Silk to Alice  less  Price of Pure Silk

>

Value of Barbsol to Alice less Price of Barbasol

In other words, Alice, the high WTP customer, must get higher net value (consumer surplus) from Pure Silk than what she gets from Barbasol.  This means Alice will be nudged to self select herself to the Pure Silk version and not tempted by the Barbasol despite the lower price.

In reality there are lot more Alices, Bobs, Charlies, Davids, …

Some might  choose Pure Silk regardless of the price and at the other extreme some might always choose Barbasol. Some, if they didn’t know about lower priced Barbasol, would choose Pure Silk but when offered side by side would find higher value in Barbasol and choose it.

The general questions become  –

-What are the customer segments?

– What do they value?

-What are they willing to pay for that value?

-What is the size of each segment?

-What are the product versions and their prices that would maximize profits?

That is the core of strategic marketing.

Talk to me.

*Note: There are 3 conditions for practicing price discrimination (price harmonization) but the arbitrage is not relevant to versioning strategy.