Pricing vs Monetization
When launching a new product, a critical task is to “set the price”. This can be particularly difficult if you are launching into an unfamiliar market or if your new product is different from your current core offerings.
In the book Monetizing Innovation (Wiley, 2016), the authors Madhavan Ramanujam and Georg Tacke (who are pricing consultants) suggest that pricing is one of the largest determinants of a product’s failure or success and one of the biggest mistakes is leaving the pricing decision to the end of the product development cycle.
Their view is that a product should be designed around its price, determined by a “customer’s willingness to pay” and therefore considered at the front of the new product development process.
The experiences they outline in their book are consistent with mine as I have been asked to run pricing strategy sessions as the last step before a product launch. The request is often based on the erroneous assumption that I can a facilitate a one-hour meeting that will set a price before product launch button is pressed. I’ve seen this over and over again over the last five years.
In reality, coming up with a pricing strategy is not simple and when done properly it can take weeks if not months.
At a basic level, price is the “worth” placed on a product by its purchaser. It indicates what someone is willing to pay in exchange for the value the product creates. “Value” is a loaded word of course as someone can buy a $50 handbag at Walmart that serves the same function as a $5,000 Gucci bag. Presumably the Gucci owner sees additional value in the quality of materials, workmanship and associated social status when seen with it even though the functional value is the same as the cheaper option.
Interestingly, selecting a “price” is only half the battle as it turns out how you charge for your product is just as important as what you charge. This is what is known as the monetization strategy – and is what many product teams do not fully understand.
With this in mind, coming up a pricing strategy should be a two-step process:
Choose the right monetization model
Select the best pricing strategy
Monetization Strategy
For the first step, there are six general monetization models to consider:
A One-Off Sale is where a customer provides a one-off payment in exchange for a per-unit product and with limited or no follow-on payments. Examples include retail product sales or fixed or limited time contracts.
A Subscription monetization model is when a customer provides a periodic or automatic payment for continued delivery of (or access to) a product offering. It is best for when a product is used continually and can be helpful if a high upfront payment is a detriment to an initial sale. Examples include software-as-a-service (SaaS) products (Office 360), streaming services or even an annual Costco membership.
Dynamic pricing fluctuates based on factors such as the season, time of day and other considerations that impact a customer’s willingness to pay such as market demand and availability of supply. The price is continually adjusted based on these factors and can be a complex process requiring a lot of data and significant investments in technology. It’s best used for products with a fixed or constrained capacity and/or when demand is volatile. Examples include airline seat pricing or Uber surge pricing.
Market-Based pricing happens when an auction process is used to set a price based on a competition for goods or services. In this case, the market determines the price by bidding on a product and examples include art auctions or Google Ad Words.
Pay As You Go pricing is an alternative to per-unit pricing where the cost to the customer is based on usage or other factors. It can be very powerful when the use of the product is aligned with a customer’s performance and how they perceive value. If they are making more money while using your product, incentives are aligned and it creates a win-win scenario. Companies selling capital equipment such as aircraft engines or medical equipment will use this model as will utilities.
The Freemium monetization model is when your product has two or more tiers of pricing and one of which is free. The free pricing is used to attract a large customer base and a portion is converted into paid subscriptions (sometimes referred to as “land and expand” model - land with free offers and expand with paid ones). This model works best if there is a very low cost of production or low fixed costs related to the initial use of the product and this is off-set by a small fraction of paid customers. Examples would be Dropbox (first X GB of storage is free); Linkedin (where a certain number of users will subscribe for value-added sales or recruiting services) or free on-line games with in-app purchases.
Some of these may not make sense for your industry, company or product but they are all worthy of consideration. If you don’t consider their pros and cons, your competitors will and they may come up with an angle that creates a competitive advantage.
Pricing Strategy
Once you have determined what monetization model to use, the second step is to calculate a price point. There are four common methodologies for narrowing in on a price point:
The first is the Educated Guess which is based on gut feel and industry experience but is sometimes known as a WAG (or Wild Assed Guess). I don’t want to completely discount this approach but it is less than ideal. On the positive side, it takes into account industry experience, market knowledge and customer insights but it is usually biased towards perpetuating existing pricing methods – which means you might miss out on new opportunities to maximize revenues and profits.
The second way to narrow in on a price point is to look at Competitive Offerings. Competition can come in many forms - both direct and indirect. How competitors charge for their products will often define the boundaries for your pricing strategy. If your product is very similar to that of the competition, you might need to come in with a lower price to steal market share. On the other hand, if you are selling a superior product, you may be able to set a premium price. Whatever the strategy, the precursor step is to know your competition and who you need to supplant to be successful.
The third type of pricing model and probably the most common is Cost-Plus. The approach here is to identify and quantify all direct costs of production and then add a percentage mark-up (the “plus”) that will cover indirect costs and the desired profit. The danger of this bottom-up approach is that it does not address the customer’s willingness to pay. I’ve seen in some cases that customers are sometimes willing to pay multiples higher than the cost-plus price which leaves a lot of profit on the table.
A Value-Based pricing model is the best one to use but the hardest to figure out. The process is to figure out what quantifiable value your product creates for a customer (what pain does it reduce or what gain does it create in dollar terms) and then charge a portion of that as the price. This is easier said than done but information gathered on this can calculate an ROI value for the product which can be a tremendously powerful sales tool.
While I won’t go into too much detail, in addition to monetization and pricing strategies there are a few other things that should be considered:
One is Product Configuration or having different versions of your product available that match customer need and what they are willing to pay for. If done well, it prevents loading up too many or the wrong features for a particular customer segment.
The second is Segmenting and developing an in-depth understanding of customer types and their differences. The goal is to not default to a “one-size-fits-all” approach as some customers – who may look similar from the outside – may be more interested in a low price while others more influenced by features or availability.
The third consideration is Bundling which means selling multiple products and services together which if done right, can increase total revenue and profits. This can also improve customer satisfaction as it can make a buying decision much easier. As an example, think about something from Amazon and at the bottom of the page, there is a reference to “customers frequently bought these items together”. It’s based on an algorithm but there is a good chance the highlighted product will be of interest to you - and its a proven way for Amazon to generate incremental sales.
Willingness to Pay: Talk to Customers
Regardless of what monetization model and pricing strategy you choose, you are only making a guess. So, the logical question to ask is: “how do I know this is going to work?”
In this vein, there’s a great Richard Feyman quote:
“It doesn’t make any difference how beautiful your guess is.
It doesn’t make any difference how smart you are, who made the guess or what his name is.
If it disagrees with the experiment, it’s wrong. That’s all there is to it.”
What this translates to is that you have to test your pricing and monetization strategies with customers as your success will be highly dependent on your customers’ willingness to pay.
To test pricing, articulate a pricing hypothesis (a “straw man”) and start talking to existing and potential customers. From there run experiments, revise your hypothesis and keep iterating.
That’s a topic for another time but if you have any questions regarding this post, feel free to reach out.