How To Price The Second Version Of Your Product?

[tweetmeme source=”pricingright”] Previously I wrote about the costs associated with multi-version pricing, this time let me discuss a very simple case of how to price two versions.

Suppose you have just one version of your product(service) and you want to introduce another version of the same. How should this be priced? I was posed this question recently by a small business owner who runs a service business.  Unfortunately  it is not an easy question with pre-built answer, I ended up asking her a lot more questions than I answered. But the questions are about taking a more analytical approach to the problem than just going with what seems like the right answer:

  1. Goals:
    Why do you want to introduce a second version?
    Is profit growth or sales growth your goal because increase in sales  does not automatically mean  increase in profit.
    Can you look at your current pricing to see if there is an opportunity to achieve your goals?
  2. Needs of your current customers:
    What do you hear from your current customers?
    What do they say they are missing in your current offering?
    How many times have you had special requests from your customers?
    Every touch point you have with your customers, from their call to book an appointment to the time you say good bye there are many opportunities to find out what your customers value. Can you mine this data to see whether your customers are seeking a simpler or premium version or even drastically different version?
  3. Needs of future customers:
    These are the segments who are not yet your customers. Why isn’t your product attractive to them?
    Is it the features, price or accesibility?
    Where do these people buy and where do they seek information about products?
    If you introduced the new version, will these people know about it and decide to try it?
    Unlike current customers you do not have an easy way to find the information stated in the previous point. This  requires you stepping out and doing a market research which is not a DIY task. So more most small businesses bits  or atoms I recommend  (2) – serving the unmet needs of current customers before explanding their market.
  4. Cost of versioning:
    What are the costs of introducing a new version?
    I previously wrote about costs associated with multi-version pricing,  in this specific case the costs are minimal given the nature of the service and it is a simple case of moving from one to two versions. But costs are relevant to see whether the new version delivers incremental profits over a single version offering.
  5. Incremental Profit: When you introduce a new version you cannot assume that it will appeal only to new customers or only to the sub-segment of current customers you planned to target. If you have not correctly answered the question in (2) above you might end up giving up profits because your premium customers switched to the basic version. In the presence of second version, customers are not any more making choice in isolation. They will be comparing the benefit to price paid between the two and will be deciding. If either of this price is wrong for the benefits it delivers you may end up with lower profit.

As I mentioned I did not have a price figure to give to that small business owner. But the questions helped her go seek data that she may already be collecting or can collect to help make the right decision on pricing.

It is never a simple question of “How do i price my second version?”. But it is a problem that can be methodically broken down by using the framework I gave above.

Using Relative Price When Value Message Is Not Clear

Here are some questions I received from my colleagues and entrepreneurs who read my articles on pricing based on value.

Does pricing based on segmentation and value to segments apply only  for established enterprises?

Is value an irrelevant term for innovative new products  that aren’t just improvements over existing products and are truly different from anything that existed before?

Does pricing for  information goods (bits over atoms) require us toss out all our understanding of economics and look for a new one?

Pricing on value for the customer is tough when you are a startup with very low reference point to measure the true value. There are some direct value in using my product, and there are indirect benefits. How do you  measure/estimate all these?

These are valid questions, there are no pre-packaged answers for all.  But the basic premise of marketing remain unchanged even for startups and digital economy – segmentation and targeting.

Let me answer one of the questions – how to determine value to customer for new offerings – based on what I did in the past. The solution was a stopgap and served its purpose when the value to the customers was not clear. It was based on relative price – that is price relative to what customers pay for  products and services in the same class.

One of the clients had a product that was easy to explain but was difficult to define value to customers. The product was generic enough for customers of all sizes and verticals but it was clear not all of the customers had the same wherewithal to pay. Since the value was not clear neither was customer WTP and hence there was no demand curve. The product is bits not atoms and had no marginal cost. So it is fair to say this had all the complications raised by entrepreneurs.

What job is your customer hiring your product for: The first step I did is positioning the product – there are many definitions of positioning the one I mean here is creating a connection in the minds of the customer to a product/service they already know and use.  This is the hard part and the first one may not be the right one. One way to define this is by answering  “what job is the customer hiring your product for?” (Clayton Christensen). Position your products for those jobs. (Note that the usual marketing strategy is S-T-P, here it is P-S-T)

Segmentation: The second step is segmentation based on value. Since value is the undefined part here,  I looked at what is the total customer spend to solve those jobs. For instance if you are positioning your product for team collaboration, find out what different customers spend yearly on  alternatives they use. Dig deeper and find indirect costs  that are incurred due to inefficiencies of current solutions they use. Rank order the different segments based on their spend and other factors.

Targeting:  You cannot go after all segments. This is especially true for a startup with limited everything. The total opportunity size may look attractive but you need to identify those segments that are attractive in terms of opportunity size, ease of reach, other competitors serving those segments and  future potential. I chose the segment that  had the most annual spend and did not have a way to track the ROI on its spend.

Pricing to get a share of the budget: Then I priced it as a share of the average spend of the segment. For example for the team collaboration case if the  average annual spend by a customer was $1 million, I would have priced it as  0.1% to 0.5% for my offering.  As you notice, this has no relation to value but makes it easy for you to have a conversation with the customer by pricing it relative to what they pay for similar services. Your pitch could be, “for 0.1% of what you spend on X our product will help you achieve  results 1, 2 and 3”.

The net is I am not recommending this approach for everyone nor would I do it next time but this helps to illustrate the point that there are ways to price a new product when the value isn’t always clear. It was basically asking:

  1. Whose budget is this going to come from?
  2. What is the size of that budget?
  3. How can I get a tiny fraction of that budget?

What are your thoughts?