Far from being a math problem that relies solely on the concepts expounded upon in classical economics, pricing is a problem whose solution is part art and part science and relies on both marketing and human psychology in addition to economic theory. This tutorial covers strategies that will aid you in your quest for increased profitability and happier customers by helping you figure out how to price your product.
While pricing, according to economic theory, is a simple problem that posits a producer will go on producing a good until they don’t lose money on the last item produced, the theory doesn’t translate well to the business models of technology companies — especially SaaS companies. For such companies, the marginal cost of delivering an additional unit of the good to the end-customer is essentially zero. Therefore, following the theory will lead one to price the good for free and make it impossible to recoup the fixed costs of production.
While most companies enter markets with some competition, a lot of technology companies produce new and innovative products and have no direct competitors. This precludes us from using the other textbook approach to pricing — benchmarking our offering against the competition’s.
Given these constraints, it’s important to form hypotheses to set prices. From the starting point, one can start A/B testing and other analytical methods to arrive at a finer estimate. In addition to gathered analytics, it is also important to get feedback from customers and partners on their view of the competitive environment and to gauge their willingness to pay. Pricing is a complex problem that involves competitive analysis, a judgement of the customers’ maximum willingness to pay, and hypothesis testing.
The following strategies may be employed to determine the price of your services:
- Ascertain perceived value: While a company’s incentive to sell is determined by the difference between the price at which they can sell the product and the amount it costs to produce, the customer’s incentive to buy is determined by the difference between their purchasing price and the value they ascribe to the product. With a better estimate of the perceived value, one is better positioned to price the product they’re selling.
- Use price to tell a story: The price of a product has an impact on its perceived value — people are known to assume that a $1000 iPhone is better than a $400 smartphone; price is often used as a proxy for quality.
- Decoy pricing: When faced with deciding between three subscription packages to The Economist magazine — $59 for digital, $125 for print, and $125 for print+digital — individuals overwhelmingly went for the print+digital option. In an experiment, one in which the $125 print-only option was removed, a majority of individuals went for the cheaper $59 digital option. Such decoy pricing options can be used to up-sell customers, since the option that you don’t want to sell will provide an anchor to increase the perceived value of the pricier option.
- Know customers’ pinch points: Identify the reasons for which customers feel emotionally inclined to pay for certain features — their pinch points — and charge them accordingly. For instance, Apple charges customers $200 to double RAM and in excess of $300 for processor upgrades on most of its Macs.