Pay What You Want Is Not Pricing Strategy

I have long advocated against Pay What You Want (or Pay What You Can) pricing. The lure of this however does not seem to go away. Recently it is back in vogue with Instpaper fame Marco Arment adopting this for his podcast app.  Predictably you see the social media latching on to this as a great approach. Had it not been for someone with the brand recognition of Marco, would anybody have noticed it?

Marco writes,

This year, with 2.0, I decided, for various reasons, to replace the “free with paid unlock” model with an “everything’s free, pay what you want” model.

His reasoning includes,

I’m trying not to repeat my mistakes, and one of the biggest mistakes I made was putting short-term gain from paid-app sales above long-term growth. I watched my biggest competitor clone all of my features, raise VC money, and hire a staff. I knew he’d go completely free months before he did. He wasn’t doing anything I couldn’t do, but I wasn’t doing it. I knew I was vastly outgunned, but I just sat back and let it happen.

I see Marco has clear understanding of alternatives available to customers, his competitor’s approach and that there is really no clear and defensible differentiation among the products in the minds of customers. So instead of competing on price he had adopted Pay-What-You-Want as is pricing.

One hand you might see this as perfect way to price – not leaving any customers. But the assumptions this is based on are just wrong because

1. We the customers do not know value of a products like these let alone the price to pay
2. Even if we did, the price we want to pay is influenced severely by the reference price (the price we pay for other alternatives)
3. We are easily influenced by nudges like Goldilocks pricing and signaling like high-low pricing

When we leave pricing to customers to decide we are telling them we do not understand their needs (the customer job to be done), value created by our product and why our product is the right candidate to do the job.

Some define Pay-What-You-Want as a great experiment. If it is an experiment, what is the hypothesis are you testing? These experiments have been done before. You should not repeat experiments expecting different results just because, “this time it is different”.

Some say Pay-What-You-Want is the only way they would have made any revenue. Once again that points to lack of understanding of customers and what job we want customers to hire our product for.

Segmentation, Targeting and Positioning are the Diet, Exercise and Sleep of staying healthy and fit. But like our predilection to opt for dietary supplements and quick fixes we gravitate towards methods like freemium and Pay-What-You-Want. I will leave you with the wise words of Berkeley and Google Chief Economist Hal Varian said,

Success in selling digital goods does not require a whole new way of thinking about business. Rather, it requires the same kind of smart managing and smart marketing that have always set apart the best companies. The real power of versioning is that it enables you to apply tried-and-true product-management techniques-segmentation, differentiation, positioning-in a way that takes into account both the unusual economics of information production and the endless malleability of digital data.

How to price premium and standard versions of your product?

It is time to repeat the old statement that I believe Pigou said but adopted by me

If one price is good, two are better.

In general, when customers’ needs are different, how they value the product are different and most importantly how they value  certain benefits of a product are different,  two prices are indeed more profitable than single price.

There is a performing arts theater in the Bay Area that rents outs its venue. For those segments wanting to hire the venue for events there are two options. Both are rented in three hour chunks. Read the brief product features below and think about the price difference between the two.

Version 1: Main Theater

Features:

1. Ideal for live performances
2. Steinway  (Model D, 9 ‘) concert piano on stage
3. Stage: 40 X 20 X 12
4. Outstanding acoustics
5. Seats 338 people
6. Dressing room with private bathroom
7. Portable P/A system with three microphones

The Steinway piano you see on stage has a usage fee of $150.

—

Version 2:

Features:

1. Perfect for small recitals, meetings and presentations
2. Steinway (Model B 7′) grand piano
3. Stage: 23.5 X 17.5 X 12.5
4. Intimate and ideal acoustics

The piano has a usage fee of $100.

Model B grand piano costs about one fourth the price of Model D concert piano.

Go ahead and compare these options as a product manager would and give an estimate of the price difference between the two.

Now think about these options as customers would and  give another estimate.

Since thinking in relative pricing is difficult let me give you the price for Recital Hall – it is $300 for three hours.

Do I have your answer?

My answer was 50% – 100% difference (I do not give single number estimate.)

The real answer it turns out is just $50. That is the Main Theater with all its benefits costs only $50 more than the $300 price for the Recital Hall. This is the same difference you saw between a $100,000 piano usage fee and $25,000 piano usage fee.

This is not so right pricing. While two prices are likely better than one price it is highly likely both prices are wrong – wrong in the sense of profit maximization.

Before I point out why it is wrong let me point out things that are done right

1. The two different versions differ nicely on many key customer dimensions – number of people, ambience, image, piano option and end use (customer job to be done)
2. The piano usage fee is additional – perfect unbundling since some may want it just for the scene while others may really want to use it.
3. The concert piano option is available only with Main Theater – if you value it more you cannot choose the Recital Hall.

(Note: Think of these three pricing levers for your freemium webapp – can you unbundle the right feature? can you think of a feature that will not be available in lower priced version? …)

All these are great but the price difference is wrong for these reasons

1. If the goal is to make it affordable to most then the lower priced version should be even lower. At just $50 difference it is not a huge discount compared to $350 version. Those who can afford $300, will most  likely upgrade to the Main Theater. This would leave to poor resource utilization and dismal monetization.
2. If the goal is to maximize profit the Main Theater is priced too low compared to the Recital Hall. Just  by the sheer number of audience it can accommodate,  stage and other benefits this offers lot more value to customers hiring it for performances. The theater is leaving money on the table.

The way to fix this is not just take my 50-100% number but study the customer segments – find out the jobs they are hiring the two auditoriums for, how they value the different features and come up with a price. (Can you say conjoint analysis? Or lean startup conjoint using weight allocation method.)

It is highly likely we are seeing a case of cost based pricing – the venue amortizing its mortgage and other costs over the two options rather than pricing these based on customers and value.

In that case, if one price is not good, two are not going to fix it.

 

Why is the 13″ non-retina MacBook Pro Still Around? To keep seat warm for MacBook Air Retina

Everyone has a theory and prediction about MacBook Air retina or the lack of it. While some use technology argument I used customer value perception argument to explain why Apple did not bother to offer you one in the last upgrade.

Here is what I wrote then

Apple seems to be able to capture almost all value it can from MacBook Air with its current pricing and by positioning it as  better portable with longer battery life. There is not much value gap left between the two models that Retina display can fill.

At that time the product price points – value map showed no space for a MacBook Air retina,

Apple chose to not give you retina display on Air not because of technology difficulties or cost reasons but because they have not yet figured out a way to extract their share of the value in the form of price premium.  The first step towards that value capture is value signaling and it is happening with the recent realignment of MacBook Pro models and pricing.

Apple eliminated 15″ non-retina, spinning disk (hard disk) MacBook Pro models but kept its 13″ brethren. The only logical reason for its existence is as a seat warmer for impending 13″  retina display MacBook Air.

You go into Apple store and they charge you a price between $499 and $929

Jimmy Kimmel, in his Late Night Show on Halloween, was making fun of iPad Air pricing. It went something like this (you can Google the video),

“iPad Air costs from $499 to $929. You go in the Apple store and they randomly charge you a price between $499 and $929”

Isn’t that close to a profit maximizing marketer’s Holy Grail? People walk into the store and each one pays a price that is specific to them – their price at which they are happy to get the product over keeping the money.

Granted we would like unbounded upper limit – not constrained at $929 and we do not want it to be a random price, we want each customer to pay precisely the exact price they are happy to pay to get the product.

That is impossible in practice and likely is illegal. You wouldn’t like it that I get to pay only $199 for iPad Air (because I am far too happy with my iPad2) and you have to pay $879 because you just pulled up in your Tesla.

I also will not like it when they pick a random number  and ask me to pay that price. Except of course if it is like a Becker-Degroot-Marschak method where they ask me to first write down my price between$499 and $929, then they pick a random number between these two.

If the price I wrote down is higher than the random number they picked, I get the iPad Air at the number they picked, otherwise I walk out losing my chance to be “awesome” and damned to eternity in Luddite world.

Since forcibly charging different prices for different customers or randomly asking them to pay different prices is not possible, Apple has the next best thing in pricing – making customers willingly self-select themselves to pay the price they want by choosing the particular product version they want.

That is why Apple offers 8 different iPad Air versions to spread the price spectrum from $499 to $929. In some sense Jimmy Kimmel is not all wrong in saying, “randomly pay”, you could argue arrival rate of customers is random and the version they will like and buy is also random. Only thing is customers willingly pay that price and the marketer enables this with multiple price points.

Do not for a second think the prices are different because of the cost. You do not believe it costs Apple $300 or even half that to go from 16GB to 128GB do you? Compare this to cost of going from hard drive to flash in non-Retina MacBook Pro and you will understand.

The prices are different because we are different and we all value products differently and willingly pay higher prices than others for the same product.

That is just versioning done right.

In fact the price spectrum for iPad is wider than $429 to $929.

If you include iPad2 it is $399 to $929.

If you include iPad mini and mini Retina is is  $299 to $929.

There is no one price to rule them all. You build and deliver products at multiple price points to let customers choose the price they want to pay.

Before you go and introduce versions at dozen different price points, see also 4 costs of versioning.

Appetizer Pricing and iPhone Lite

Take a good look at this menu. Play close attention to the listed items and prices. This menu is from Picante in Berkeley, you should go if you have not been there yet.

Before we proceed, a word of caution. Please do no bother writing to the restaurant about your insight or write a blog postabout it. I speak from experience. Business owners are busy running their business, serving customers and making payroll. They don’t have time to listen to our free advice.This isn’t about them.

Now that you looked at this, what stands out? The first five are variations of the same basic model – chips. Six, if you include the half size option. There is one that stands out. The $1 base model. We are looking at this price list after the fact, we do not know the reasons it was introduced. Nor do we know if this came first, at the same time as other versions, or introduced after the premium market was saturated.

Is it there to capture those low value customers who are not willing to pay for premium features like salsa and guacamole? Or is it impacting revenues and profits by tempting those who would have otherwise picked the premium versions had the $1 chips not there?

For every unit of $1 chips they sell their average selling price (ASP) goes down. You do not need to know exact cost accounting to see their margins from premium versions are going to be lot more than the $1 version. Besides the $1 version may incur them unseen costs like those consuming lot more of their free condiment sauces (guilty).

Wouldn’t it be great if all of the low value customers who will never buy the premium versions are the only ones opting for the $1 version? This will help them grow their profit despite the drop in average selling price and makes a case for introducing the $1 version.

After all who but the most price conscious will pick the $1 version? And if they take away the unlimited free sauces they offer, some may even upgrade to premium versions.

The same logic is under works for the rumored Apple’s iPhone lite. We know here they only have the premium versions. But they kept their past premium models around and sold them at much lower price points. That indeed had an impact on its iPhone ASP and gross margin. The ASP and profits took a hit because these phones are too good that some who would have otherwise picked premium version find greater value in the older models and choose them instead.

Applying the conditions for introducing $1 chips above, Apple will introduce iPhone lite if

1. Almost everyone who want the premium iPhone already have one
2. These will continue to buy only the premium model and won’t be tempted by iPhone lite
3. Even if they are tempted Apple is confident of its price fences – no Retina display, limited in wireless technology, flash capacity, data plans supported by wireless providers, etc.
4. They see a risk of perennial profit erosion as some some of these high value customers switch – Apple may want to offer them a down market edition rather than lose them to competition
5. Cost to produce and market these lite phones are much lower than keeping the older models around – not only these are most likely cheaper to make but will help Apple with better marketing story, it defangs competition’s criticism that these cheaper phones are ancient

That is simple incremental profit math.

Unless of course they found a way to convince us that we need both – one for each hand.

 

 

Snail Slime Facial Gender Based Price Discrimination

If "Live Snail Facial" is a product http://t.co/VwsKI6Ofuu how will you price discriminate for men who tolerate less pain? #pricing #puzzle

— Rags Srinivasan (@rags) July 21, 2013

Let us recap the news item. A spa in Japan offers Live Snail Facials – For $350 you can have five snails slink all across your face. It is a painful process even though it lasts only five minutes.

Who is the customer? Almost all women. Here is what the spa says about catering to men,

The service attracts a mostly female clientele in their 30s to 50s, and although men can also opt for the live snail treatment, none have done so yet. “I’ve observed that women will endure more pain and fright than men, if it’s for beauty,”

Let us set aside the fact that this non-scalable , one customer per day, service is not really the product. Let us ask, if this were a real product, if the spa would like to expand its market to men, what should it do?

Say men have less tolerance for pain when it comes to beauty. Could the spa offer lower price to men to help slime grease the wheels? That is overt and egregious price discrimination. A no no!

While price discrimination is good, gender based price discrimination is NOT. So how can it put to practice an effective and fair price discrimination?

Two options – none of these need any gimmicks – both are tried and tested and rooted in economic principles

1. Bundling – Offer couples package
   Remember bundled pricing works when customer preferences are negatively correlated. Set a price that represents the sum of the higher and lower value perceptions of women and men. Say a $550 couples package could work. The man would think his cost is $200 while the woman would think her cost came down from $350 to $275.
   Besides the couples package will help drive more customers as women bring their partners, like this Candy store CEO says.
   Sure you give some consumer surplus in cases where both people value it at full price. As long as that lost revenue is smaller than what is gained from serving more customers with the bundle you should do it.
   For complete fairness, you should offer the couples package to any couple.
2. More Product Versions
   Create an express version – 2 minutes for $200. That helps assuage men’s concern for pain and fright. And the lower price is attractive too. Brand it to signal something other than the best so women are less likely to choose it.
   As long as you are creating versions, create another premium version, there exist customer segments willing to pay more and you should capture that.

Both these options implemented together would work as well.

There you have it – Live Snail Price Discrimination done fair and square.