Why you should not hard code non-linear pricing

Take a look at this very nicely done price estimation tool of Dropbox business edition.

Dropbox Single User

The entry price is $795/year – either you want 1 or 5 users you pay that single price. Clearly it makes no economic sense for a 1,2 or even 3 member team to pay for this version. However if there exists such a team that values the features available only in the Business edition they would pay. But Dropbox decided not to unbundle it any further and make $795 the entry price for a 5 member team. Makes very good sense as it assures a floor price and makes sure the revenue is aligned with fixed cost to serve these business customers.

Then it gets tricky and complex. Having adopted  $795 as the base price Dropbox has created multiple price tiers based on different number of users. While it possible to license for any arbitrary number of users past 5, the tiers act as price boundaries. After 25, 50, 100 etc. users the price per user drops.  Take a look.

dropbox-non-linear

 

The price per user that for all practical purposes starts at $159/user starts sloping down and reaches the lowest value of $127/user with three other price points in between ($132, $128 and $127).

This is classic example of non-linear pricing where the total price does not increase linearly with units but curves down as volume increases. You have seen this from cereal packages you buy to the group discounts you get when you register for conferences. Non-linear pricing is great but it introduces operational complexity to marketer and cognitive complexity to customer.

For what these costs mean let me take you back to my article from four years ago – 4 Costs of Versioning. The many different choices you offer to customers at different price points introduce four different costs (some on you and some on your customers). These versioning costs should not be confused with costs to make and serve the customer. These costs are incurred in completing the transaction.

If the non-linear pricing requires two (or three) price tiers then most of the versioning costs are manageable. But  after two tiers the  costs to customer starts to go up. As a refresher customer cost means-

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.

I do not mean here Dropbox should not practice non-linear pricing by reducing unit prices for larger customers. There is no need however to programatically (buying program that is) hard code the multiple price tiers to explicitly state the non-linear price curve. Far from helping customers with that decision it will only complicate their choice.

Dropbix could easily provide better pricing to these high volume customers if the customers were to call and ask for it(or provide the sales discount hierarchy for the sales team). That is leave it up to the customers to ask there by making it a better form of price discrimination. Why give programmed discount when customers do not ask? Why complicate pricing with all the hardcoded discounts?

As a contrast I would like to point you to another business that is very close to Dropbox – Box.net (for business customers both Dropbox and Box.net are trying to address the same jobs the customers are trying to get done and hence they are  alternatives).

box-pricin

Box pricing starts at $45 base ($15/user but the minimum users is 3). This is very similar to Dropbox’s minimum limit of 5 users.

Before you compare the two prices please note Dropbox prices are listed on yearly basis while Box lists per month price. Regarding which option is better, that is for another day.

 

After the minimum, Box provides very simple scalable model of $15/user/month up to 500 users. No other pricing tiers in between keeping it simple. But I bet if you are signing up 200 users you will negotiate a better price than $15/user. It is just not hard coded non-linear pricing.

If we did per month pricing for Dropbox, the price difference from non-linear pricing does not even seem significant for all its versioning costs.

When it comes to non-linear pricing, by all means do it as long as it keeps your multiple editions simple to manage and simple for customers to choose. Anything more than 2, don’t hard code. Leave it up to your customers to ask for it.

 

The New MacBook Air Pricing – Not just the iOS UI is seeing flattening

Two years ago I presented you with the following analysis of MacBook Air pricing.

In summary, there are two prominent choice dimensions – screen size and disk capacity. There are minor differences in CPU but the two dimensions Apple wanted customers to focus on were clear. I showed you why there was a 11″ MacBook Air in the pre-configured models.

One thing you would have noticed in the last line up was the multiple levels and gaps.

Perfect Price Diagonal

With yesterday’s announcement at WWDC there is a new much cleaner product lineup.

Slide12No more 8 possibilities with 4 holes but a complete 2×2 with no gaps. This is a result of two standardization decisions

  1. No more 64GB model. With prices of SSD continuing to fall, Apple found they cannot maintain their price premium. Instead of keeping 64GB version and lowering ASP they simply moved to 128GB that protected their ASP and likely their gross margin (due to decrease in SSD costs)
  2. Single CPU model – 1.3GHz, dual core Intel I5 processor. While this likely reduced the ASP because of elimination of $1599 model, they likely kept their margin because of lower marginal cost.  The $1599 model was likely losing volume anyway as it shoots past  13″ MacBook Pro that offers Retina display ($1499).
    Furthermore for those who wanted customization they do get to capture $150 in incremental revenue from CPU upgrades.

Another point you would have noticed in the previous line-up is both the 11″ models were priced below the lowest priced 13″ model. That is no longer true. Gone is the perfect price diagonal and in its place a zig-zag pattern.

This is because of the price premium they were able to charge for the 13″ over 11″. It dropped from $200-$300 to mere $100. And this is something they likely found using conjoint analysis (don’t believe those who say Apple does not do customer research).

The perfect price diagonal is now replaced with another simple pricing rule

– Move along X axis, price changes by $100
– Move along Y axis, price changes by $200

So not only is the iOS seeing design simplification (or flattening), their pricing is also going through simplification. Every model that is there now is there to serve a specific segment and not as a ploy to sell another model.

Compare this to MacBook Pro models (HDD models configured as 8GB RAM for comparison)

13-retina 15-retina

 

If I make a prediction for what is ahead for new MacBook Pro models, similar model flattening and simpler pricing.

MacBook Pro

 

Amazon Price Discrimination Done Well

I wrote a while back about price discrimination and its bad rep. It is actually not all bad. My attempt to rebrand it as price harmonization did not catch on. The right kind of price discrimination is offering multiple versions at different price points so customers will self-select themselves to the version they want to pay.

Like you pick retina display with MacBook Pro or SSD disk over HDD. This is second degree price discrimination. With price discrimination, as long as you do not restrict customers from choosing certain versions and let them choose any of your versions then it is perfectly acceptable.

The success of second degree discrimination also depends on packaging and pricing the cheapest version such that it helps bring-in low-end of the market without being attractive to those who would gladly pick the higher priced version had there not been the cheaper version.

Amazon has a product that very nicely executes second degree price discrimination, while also capturing a little bit extra consumer surplus from one of the genders. (Yes, pure gender based price discrimination is bad but I will show you why in this case it is not the case.)

Take a look at the 3 versions of the same model of GPS watch.

The first version

base-gpsThe base model without heart rate monitor costs you $147.35 (at a discount of $52.64). If you want heart rate monitor to go with the black model, it is sold separately for $45, bringing the total to $192.35.

Now the second version

red-gpsIt is the red model with included heart rate monitor, priced at $184.91. That is $7 cheaper than black base model plus heart rate monitor add-on.

Why is the drab base model priced such that its combo price is more than buying bundled red model? Because they are targeting the base model  at low-end customers with lower willingness to pay.  And if some of those insist on heart rate monitor with that color they likely value it more hence have higher willingness to pay and should pay $7 extra over the bundled red model.

Also note the list prices of the base and red models – $199.99 vs. $229.99 – a difference of $30. But how they are discounted is much different from the $30 difference. You would expect discounted price of red model to be just $30 over black base model. Instead it is $37.56 over base model. In other words the amount Amazon has to discount to make the sale goes down as they move up the model.

That is $7.56 in profit from effective pricing.

Finally, the pink one

pink-gpsThe pink model, arguably a choice targeted only at women, is $1.22 more than the red model. But still cheaper than black combo.   Nothing prevents men from buying it so the pink model pricing is not at all a gender based price discrimination. But helps to capture additional consumer surplus from women who most likely will buy it. (I am succumbing to stereotype here! Sorry!)

So is $1.22 a big deal? For the razor thin per-product margin Amazon operates at and the volume it does, it most likely does. The $1.22 flows directly to their net-income.

Overall a very fine management of pricing.

But don’t attempt this at your business – most businesses, especially small businesses and startups do not have the volume, data and computational wherewithal to fine tune pricing to this level. Worse, most are not even in the right zipcode to attempt any such fine tuning.

Ask me what your business should do instead!

 

 

 

You can’t let your past cannibalize your future – Note on iPhone 5 Sales

Image representing Apple as depicted in CrunchBase

You most likely know by now that Apple is cutting back its demand for iPhone 5 components. Analysts who did the supply chain check attributed to the slowing iPhone 5 sales. And among the many reasons they quote the one that stands out (and probable) is

The less-expensive iPhone 4 and 4S is eating into iPhone 5 sales. With a two-year contract, the iPhone 4 is free and the iPhone 4S is $99, and they might be popular enough among consumers that not everyone is opting for the iPhone 5, which costs $199 with a two-year contract in the U.S.

The number to watch out for in Apple’s earnings report is the average selling price (ASP) of iPhone line. We have seen similar drops before when Apple decided to keep its $399 iPad 2 product. Now it appears it is iPhone’s turn.  (By the way, you can learn a lot from earnings reports.)

This is basic second degree price discrimination – when offered multiple versions at different price points, customers self-select themselves to the version that offers them the most consumer surplus. But to execute effectively on the multi-version strategy the business must raise appropriate version fences such that those who have higher wherewithal to pay and prefer the higher priced version are not tempted by the lower priced version and switch down.

In case of iPhone 4 and iPhone 4S, these are extremely very well done products that offer lot more value especially when combined with the lower prices they are being offered at. And these older (yet superb) models are cannibalizing iPhone 5 sales.

Most people say, “it is better your products cannibalize your own than others doing it to you”. While no cannibalization is good, that statement would make sense if newer higher profit generating models replace your older models before your competitor does that to you. You can’t however let your past cannibalize your future. It also says something about your future product pipeline.

I also don’t believe we have seen the end of iPhone downturn. Here is what I wrote in GigaOm about effect of iPad mini (before it was released)

iPhone: The crown jewel. It is harder for most to see how a smaller tablet could threaten the iPhone. Consider this in the context of total cost of ownership of an iPhone over two years: At $100 per month for mobile service fees and at $199 for the device, it costs $2,500. Mobile service providers are moving towards just one bundle of voice and data at $100 per month. If there were a $299 4G iPad Mini, some may consider a regular phone for occasional talking and the iPad Mini with $40 data fee as an iPhone replacement.

Is Apple, a company that is unusually excellent (here, here and here )in multi-version pricing strategy, starting to stumble?

When customer demand is known, go for multi-version pricing

Market Place reports on the multiple different ways one can watch the new Hobbit movie.

Burbank AMC 16: You have the IMAX 3D which is in the High Frame Rate, regular 2D, ETX 3D which is not High Frame Rate but it is mastered for Dolby Atmos, and then you have regular 3D.

Previously we have seen about movie theater pricing and how they do not have a way to charge different price for different movies nor do they have an easy way to charge more for the rabid fans and less for others. The choice dimension that customers value different seem to be – time, place, or format and not content. Hence we see the different pricing for different show times, different theaters, 3D, IMAX etc.

Hobbit producers are employing the different content dimensions to offer different experience to customers at different price points.  If one price is good, four seems to be better.

Does that mean every movie producer can take advantage of this and offer four different ways to watch their movies?

The answer is in the same Market Place story

in a case like “The Hobbit,” a movie that people are going to watch no matter what, it makes smart business sense to offer a range of viewing experiences at different price points.

That is there exist demand for the content and the producers have validated this and are simply maximizing profit by allowing customers to self-select themselves to the format they want to experience and pay for. If there is no demand, adding versions that differ on a choice dimension won’t cut it.

Now about those pricing pages that list three editions. Without an understanding of your customers and without validating customer demand for the product, simply introducing three or four editions (versions), modeling after some other popular business will not create instant demand for your product.

Where do you start for your pricing?

 

 

Pricing Inconsistency in 13-inch and 15-inch MacBook Pro Retina Display

Take a look at the following two charts. These compare the price premium Apple charges for Retina Display when you keep everything else constant (including 8GB RAM).

With 15-inch MacBook Pro you pay $200 less to get Retina Display, keeping everything else the same.

With 13-inch MacBook Pro you pay $200 more to get Retina Display, keeping everything else the same.

If you know the answer engrave it on back of iPad min taped to back of 13-inch MacBook Pro and send to me.

Hint: it is in how much value Apple believes customer assigns to flash and its size that is causing this distortion.