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.

How to price your garage sale items?

Do you sell your wares  in garage sale or through Craigslist classifieds? Before you read the rest of this long article see this on 4 things to consider.

Do you wonder how you can get the right price for the things you sell? One thing is for sure, you cannot price it anywhere closer to the full price you paid even if what you sell is like new and hardly used. People who buy at garage sale and through classifieds come to expect low prices and expect to pay lower than the best deal they can get elsewhere. Even if there are search cost, opportunity cost and transaction costs associated with purchasing a new item from another channel, the reference price (the price they expect to pay) is set by the context and the prices of many used goods people buy from garage sales.

Sellers tend to value their wares more than the buyers are willing to pay. There is proof in many previous works that show ownership increases perceived value and hence customer willingness to pay. Instead of these academic works you can read Dan Ariely’s Predictably Irrational or see his video on this topic. With higher list prices you will end up not making the sale and incur the cost of holding on to your “treasures” and running multiple garage sales.  That is a high opportunity cost. On the flip side you may end up yielding to the pressures of an aggressive buyer who quotes a low-ball price.

So what is the right way to price? Go ahead and set your price the usual way you will despite the fact that you will overprice it due to ownership issue, let us call this ‘H’. Then set an absolute minimum price below which you will not sell it, let us call this ‘L’.  Write down on Post-it notes (one on each) real numbers between (including) L and H. If you want to keep it simple write just the integers so it will be just few numbers to write. Have these Post-It notes folded and available in a box.

When a potential buyer walks in, quote your price as ‘H’. Your goal here is to prevent the buyer from low-balling and getting into pitched bargaining battle. She would probably ask for a price lower than that. If the price is not acceptable bring out the box and tell her  this, ” Your price is not acceptable to me but I will give you another chance. In this box are numbers written between ‘L’ and ‘H’. You quote me a new price and then draw a Post-It from this box. If the price you quoted is higher than the number you draw I will sell this item to you at the price you drew. If not no sale, no more negotiations.”

By this you have eliminated negotiations and any of your weaknesses in that front. You also introduced randomness with that t the possibility that a sale will not happen. The buyer cannot anymore rely on their hardball skills to mow you down to agree to a low price. So if the buyers are serious and really want the item they are incented to quote a price that is their true willingness to pay. If they quote less than what they value the risk is no sale may happen and it makes no sense to offer any more than what they value. At this point you may just make the sale at the quoted price and not bother with drawing numbers.

If you want to get really fancy and have the time then you can practice more sophisticated versions of this pricing. For example you can set a very high ‘L’ or skew to numbers on Post-It to be more on the side of ‘H’ for the initial few rounds. Then you run this procedure on a few buyers who walk by and then know the possible price you can sell your item.

Of course this makes sense for big ticket items and not the trivial items, also note that buyers are reading this as well, so they will not participate if they suspect your distribution is not uniform. So you may be better off using the random number generator from Random.org.

You can find the academic research behind this here.

You Touch It, You Own It!

Do you feel instant ownership of items you touch in stores?

Does touching objects and the ensuing ownership lead you to value the objects more than you would have had you not touched it?

Does that higher value translate into higher Willingness to pay?

A recent study by two marketing professors from Booth School and Anderson school finds that the answer to all these questions is yes. A less academic version of the research report is available in  TIME magazine.

Professors Joann Peck and Suzanne Shu, posed the questions

Does holding an object and imagining that it is yours influence how much the object is valued? More generally, does mere touch influence the feeling of ownership and the valuation of an object?

The core premise that ownership increases perceived value (endowment effect)  in itself is not new and the authors do state twenty years of research on endowment effect. What is innovative in this research is finding that touch as a way to increase ownership and directly relating it to higher willingness to pay.

What does this mean to you as a customer?

  1. As a tourist wandering the local streets for merchandise, resist the temptation to hold the item. Or have a partner and have them touch it while you negotiate.
  2. If you are buying a new car, do not negotiate after the test drive. In fact do your test driving with a completely different dealership and buy from another.
  3. If you are buying used car, do not negotiate right away or follow Tip-1.
  4. If you are looking to buy a house do not imagine, this will be my workspace, this will be the baby’s room etc. Be aware of your agent telling you, “imagine yourself cooking in the kitchen and your kid playing here …”. Be detached.
  5. At garage sales, don’t touch anything.

What does this mean to you as a marketer?

  1. Do not try to sell, do not talk price . Let the customers play with the items. Engage the customers first then sell.
  2. For new cars, make the customer test drive, take a picture of the customer at the wheel or standing with the car and give it to them.
  3. Same for selling used cars.
  4. If you are selling a house, buy Polaroid (do they sell them?) and keep them for use during showings. Encourage the showing agent to shoot pictures of the prospective buyers in the house and give the pictures to them. Make the visitors feel that they “own” it. This is the reason home staging works.
  5. At garage sales, encourage touching your wares.

What do you think?