Also related is that you should aim for 3 tiers of product at 3 tiers of pricing. What will generally happen is people realise the bottom one tells the world they are cheap and skimping on product, and the top one tells the world they spend too much money and are getting too much product, so the middle one seems the right fit.
An apocryphal story about this is Wendys having 3 burgers with 1, 2 and 3 patties respectively. Not many people were buying the 3 patty version so they decided to get rid of it. The sales of the 2 patty version then declined because consumers had been using the existence of the 3 patty burger to justify purchasing the 2 patty one.
You'll notice that the iPad, iPod Touch and iPhone all come in 3 different different memory capacities. I can't find any sales figures by model, but I'll bet the middle ones are what sells the most.
This "3" approach also means you can still sell to the lower and higher end customers so you don't have to get your pricing perfect.
By similar principle, the second-cheapest bottle of wine in a restaurant is invariably the biggest seller. Nobody wants to be a cheapskate, but few customers actually know what kind of wine they want or how much they should spend. Restaurateurs know this, which is why it invariably carries a disproportionately high mark-up.
It applies whenever you are spending money - you consider the alternatives, but humans do not do so rationally. By how you frame your 3 options, you can push people to buy the one you want. Here is an other example from Dan Ariely, a behavioral economist, showing three options:
I wonder how this would work for 4 categories instead of 3? When looking at something like backpackit.com, I really like how their packages feel like there are more options to get in at different price points.
I agree with this post - asking customers what they'll pay isn't always the best way to price your product.
However, if you do ever find yourself asking a customer what they would hypothetically pay for your product, never ask them "What would you pay for a solution like this?"
Instead, ask them "What do you think a 'fair and reasonable' price would be for this product?" It's a variation on the "what would you pay" question that tends to get a much more thoughtful, honest response.
Just a tip for HN from someone who has been in consumer insights and research for 10 years and has done hundreds of customer interviews around new products and pricing...
I would have used wine, rather than water, to illustrate Principle #1. At least with water, people generally agree that it's all the same and the $2 bottle is a ripoff. But with wine, you often hear about things like blind taste tests, where the cheap wines often come out ahead.
But it's more complex than that. People who buy wine may have other motives and will want a more expensive wine for whatever reason (special occasions, showing off, etc.). What's more is that one's experience of something like food depends on how you feel about the food. And price contributes to how you feel.
In other words, you might rerun the same taste test you did blindly before and have people pick the expensive wine the next time. So quality is complex: there may be both real and imaginary parts and which item people will pay more for depends on how it gets compared to the alternatives. And that's not even getting into things like branding, where people feel a certain way about a brand and that contributes to their enjoyment (or lack of enjoyment) of a product, etc.
I'd disagree and say with wine you'd have to explain a lot more (as you did). We know from the existing bottled water market (in the U.S.) that a viable market exists at both $0.50 and $2.00. $2 might be a ripoff to you but it's what some customers always purchase which leads to Principle 2.
I live in Arizona. I don't know of anyone buying $2-$3 water because of the quality, mostly we buy it due to convenience. In short, because it's 116 F and they want water right now.
Sure, maybe there's Evian or whatever, but at least for me, it's well outside of my normal experience. Most of the expensive water we buy is pure convenience, because we'll buy from the guy with $2 water instead of $3 without thinking, given the chance and all the common brands are blurred together (Evian is really the only one that sticks out).
So... yeah. I'll agree that it's a proper example, it's just not something where quality is a major consideration, at least in these parts. YMMV.
I live in Arizona also, and I know people who would swear on a stack bibles that <insert brand> tastes better. Despite repeatedly explaining to them that it is filtered tap water, and showing it to them on the label where it says "filtered tap water" , they insist. In any convenience store there are multiple brands of water at multiple price points, each with their own fans. weird.
Discount Tire also uses the good-better-best philosophy, with the middle choice being most popular.
This theoretically true statement "There is no reasonable economic justification for a customer to offer anything but a low-ball figure. " can, in practice, be irrelevant.
So unless you are a savant, following the OP's advice in enterprise sales can result in you leaving hundreds of thousands of dollars on the table. Because customers (especially at the early stage) often have a perceived value for something that is far more than you realized, or they have a budget, and their price is the budget. Steve Blank has great examples of these situations throughout his career.
The OP's advice makes sense for consumer sales (and I think he should clarify this).
Way too few startups use price anchoring strategies when presenting their prices - the iPad intro is definitely not the first, but possibly the most well-executed anchoring I've ever seen.
If your product is disruptive in the sense that it potentially can replace a more expensive existing solution, you should simply point out the math - the higher the original number, the better, as even the higher price points you've been thinking up for your product will seem small.
Interestingly, anchoring can also work outside of mere price comparisons. That is, sometimes it's enough to just present high numbers to effectively prime customers towards higher price points. The most famous example is Kahnemann's classical experiment on using subjects' (obviously random) social security numbers for anchoring:
"...an audience is first asked to write the last two digits of their social security number and consider whether they would pay this number of dollars for items whose value they did not know, such as wine, chocolate and computer equipment. They were then asked to bid for these items, with the result that the audience members with higher two-digit numbers would submit bids that were between 60 percent and 120 percent higher than those with the lower social security numbers, which had become their anchor."
http://en.wikipedia.org/wiki/Anchoring
Yes, but this kind of anchoring is "artificially" manipulative. It's possible you convince a customer to accept a higher price at first, but pretty soon buyer's remorse will set in and you're screwed.
I do believe you want to pick "valid" anchors and sometimes be more selective (as-in the iPad case) but the comparison has to stick.
Not necessarily. Take our case of the iPad. It came out at a time when netbooks had created a new low for computer pricing. The iPad lacked a keyboard, a proper/large HDD, had a processor that was even slower, ran a smartphone OS that couldn't even multi-task properly, and had a screen resolution right out of 1995. The 'logical' price for this would have been $200-300; pretty much the only hardware that was not a cost reduction on a netbook was the (low cost) touch layer. Yet it had excellent customer satisfaction. They created perceived value- lacking USB, storage expansion and replaceable battery were all practical disadvantages-- but these weren't things that created desire like the buttery-smooth operation provided by the GPU and capacitive touch, the large viewing angle from the IPS screen, the sleekness from having just one button etc, and the light and slimness gained by forgoing so many features available in even a netbook.
And it's not just something like apple does. Think of a tech 'consultant', or a fashionable web-design company. Chances are you see their prices and think 'WTF are they smoking'..I could have better than that done for me for 10x less. but their clients, i bet are pretty happy. Because of the value they offer-- some perceived, some reality.
The context here is for products where one would sell a product or service directly to customers e.g. SaaS, enterprise. Crowd-sourcing is a different model. So are multi-sided and marketplace models.
I don't agree with this–or maybe I do. It's hard to tell without knowing what he means by "testing your price with customers".
I think asking customers "what would you expect to pay for this?" should be part of your initial usability or beta test with potential customers. 2 Reasons for this: (a) your target market has certain price expectations for products and (b) you might "tell them" what to pay and still be too low.
I just did this with a new product we launched. My lowest plan was priced at $9/month. We did a usability test with our target market and ask them (at the end) what they expected to pay for a product like this. Only 1 person said a number lower than $20/month–and they went as high as $100/month.
"I just did this with a new product we launched. My lowest plan was priced at $9/month. We did a usability test with our target market and ask them (at the end) what they expected to pay for a product like this. Only 1 person said a number lower than $20/month–and they went as high as $100/month."
However, that doesn't imply that they WOULD pay that for a product. The conclusion they might draw (validly or otherwise) could be "I'd expect to pay a lot more for this product, so I won't even consider it an option - it's out of my range."
I might expect to pay $1,000 for a table for 4 at one of Gordon Ramsay's restaurants. I might be pleasantly surprised to find the average bill around $600. That doesn't mean I'll pay $600 for that, though.
In the next post, I'll cover my approach to not only how to test price with customers, but how to get them to want to pay.
Yes, pricing is a conversation but you need to lead the conversation because if you pause and think about it, there is no rational justification for your customer to offer you a fair price.
They are either clueless on value and don't know
OR
they'll low-ball you because they want a good deal.
"The fair price for your product is usually higher than what both you and the customer think".
There's another way of looking at pricing that comes up more and more in my thoughts on starting a new business/product. I've been calling it "pricing in reverse". I'll blog about it soon in more detail, but the gist is...
As a new startup or business, it's likely you have no audience, no fans, and no customers. You are going to have to go get them. One method, that can be very effective to get them if you do it right is online advertising through pay-per-click ads on places like Google/Facebook/LinkedIn.
Assuming you pick some niche with X searches, those ads are Y per click. And the per unit revenue of my product is Z.
Making bold but average assumptions about your conversion rates you can say something like let's assume 1% of searchers click on my ads. So my ad cost is going to be searches * CPC * 0.01.
Assuming I can get a 1.5% conversion ratio the revenue I'll bring in is searches * 0.01 * 0.015 * Z.
Set profit to zero and solve for Z. Get searches and CPC from the Google adwords tool.
You'll now know your product NEEDS to cost Z to break even doing pay per click ad campaigns.
Sometimes this is going to be an eye opener for you. You'll realize that you probably need to charge a ton more and so maybe your product needs to have a much more powerful feature set to warrant that higher price.
This example and thinking was inspired from Tim Ferris' Muse Math:
Cost plus pricing. You should definitely know you numbers like the customer acquisition cost etc. I agree with you there. But relying on the cost to come up with the price point usually leaves money on the table. Price based on the value for the customer, not your cost.
The video embedded in the article is great. Steve jobs literally gets the crowd to cheer for "unbelievably low price" point of the ipad at 499. Brilliant
The brilliance is picked an externally accredited source (pundits) for a product twice in price. Another alternative was positioning the iPad as a better (bigger iPhone) but that obviously would not have worked as well.
Its fascinating. These 'pundits', lets remember (beside the question of whether it was even accurate or significant-- enough pundits and someone will have said anything), we didn't know what the iPad was going to be. The possibility that it would be a powerful, fully-fledged OSX running computer was considered very real (remember the slamming people gave it as just a big iPhone).. if the question had been 'what do you think we will charge for our iPod touch with a bigger screen', not even the most hardcore apple pundit would have said '<$1k'.
Then he lingers on this issue-- talking about how much they have accomplished for the price-- almost making a value proposition for it at $999. After about a minute of $999 up on the screen he announces that '[apple] have met our cost goals'. I think this phrasing is very interesting-- he doesn't say 'we have beaten our goals', 'met our aggressive goals' or 'achieved a low cost'-- nothing to remove from the perception that it could be $999. At the point at which your expectation is highest that he is going to announce that the goal they met was a $999 ipad, and he has built tension, they dramatically drop in the real price.
Even the fact that they managed to manipulate their audience is in turn a suggestive indicator that this is great value, a shock, at this price. This can have a big effect when you consider that the press are not immune from this manipulation-- who then present this device as highly desirable and of great value.
That reminds me of a story I read years ago (pre-consumer-internet days), where a particular Office suite was priced at $99, but didn't sell well. They then released a "professional" version, sold it for $399, and it flew off the shelves. If I remember right, I think it was something by Borland. (Exact details are a bit fuzzy).
An apocryphal story about this is Wendys having 3 burgers with 1, 2 and 3 patties respectively. Not many people were buying the 3 patty version so they decided to get rid of it. The sales of the 2 patty version then declined because consumers had been using the existence of the 3 patty burger to justify purchasing the 2 patty one.
You'll notice that the iPad, iPod Touch and iPhone all come in 3 different different memory capacities. I can't find any sales figures by model, but I'll bet the middle ones are what sells the most.
This "3" approach also means you can still sell to the lower and higher end customers so you don't have to get your pricing perfect.
Edit: two additional links about this
http://www.asymco.com/2010/10/07/the-cognitive-illusion-that... (perception of alternatives)
http://www.wiglafjournal.com/pricing/2004/07/framing-the-pri... ("price framing")