Your pricing strategy must manifest in more than an arbitrary set of tiers or a “promotional” discount. It must be more than a plain analysis of the closest competitors that have stamped their price in the market. To succeed, you must not base your price on the cost of manufacturing (which starts to make little sense as you venture into the wonderful world of licensed software and even littler sense as you sway towards cloud services). So what, then, should you base your pricing strategy on?
The answer is simple.
Your pricing is an indication of the value your product will bring your customers. And your pricing strategy must be based on this.
The simple equation is this:
Perceived value of the product < Price : Customer will not buy your product
Pricing indicates the value of the product to the customer.
There are two core components to building a good pricing strategy.
Setting the price
Successful products have prices that, in plain english, make sense to the user. Whether you have multiple pricing tiers, varying value metrics, or a growth based pricing scheme, the biggest point of friction in the purchasing step is when the customer has a hard time understanding the relationship between the price of the product and the value it will provide them.
Cost-plus pricing fails most of the time because of this very reason. As a buyer, I don’t care about the cost of the product, I only care about how the product is cheaper, faster, or better, and that information is what I use to determine how much the product is worth to me. So as the seller, you must think of this as a first principle when you’re deciding how much to price the product at. It is only the buyer’s perception that matters in terms of driving the sale.
The price needs to be aligned, in a simple way, with the perceived value of the product. The perception is what’s important. In order to make a sale, the customer must perceive the value of the product to them as one that is aligned with the price you have set. In practice, this is not easy. This requires an effective messaging strategy that helps the representatives of your company to communicate the rationale behind the price of the product to customers. At the point of sale or leading up to it, the conversation must be about the value provided by the product, and not about the price. An effective salesperson will center the conversation around value, and once the customer has understood the value, the price conversation becomes a lot more straightforward. Conversely, an effective price haggler will intentionally attempt to drive the same conversation towards the actual, absolute price, and how it is “too high” or “out of budget”.
Take the case of enterprise software. There may be thousands of sales reps and channel partners in the field, all of whom will need to effectively communicate the value of the product to the customer at the point of sale. Product managers can add a lot of value here by creating collateral and driving the messaging of the pricing strategy across the company.
For cloud based software services, in which customers land up straight on the pricing page, communicating the value of the product on the same webpage where the customer views the price gets even more tricky. That is why a lot times the pricing page will list the price towards the bottom of the page, rather than just the number at the top.
In the real world
While the rationale behind value-based pricing may seem obvious, the truth is a lot of products out there do not have their prices aligned with their perceived value. Take for example, the Oracle database. Everybody has heard of Oracle, they are a monster in the software industry. Yet, the word around the enterprise industry is that companies are choosing to use other databases primarily because of how complicated the licensing experience is, and how expensive it is. Microsoft SQL server and open source technologies like PostgreSQL and MySQL are getting mind share because of this simple, but crucial, aspect of Oracle’s business strategy. Clearly, the perceived value of Oracle is not higher than its price, given the viable alternatives that are available.