Confessions of the Pricing Man: How Price Affects Everything

by Hermann Simon

I recommend to consider unbundling under these conditions:

Opportunities for a higher margin:

Market expansion:

Increasing standardization and compatibility

A shift in the value chain

Multi-person pricing means setting a price for groups of people. The total price will vary by the number of people.

Multi-person pricing takes advantage of the maximum price s of each individual in order to achieve higher profits.

The result depends on how the volume discount is structured.

Sellers should choose incremental discounts whenever possible.

Time-based price differentiation is one of the most important and widely used methods to go from the profit rectangle to the profit triangle

The driver behind successful time-based price differentiation —as with the other forms we discussed—is the fact that individuals at different times have different levels of willingness to pay

Not the demand level as such is relevant for optimal dynamic pricing ; it is the way customers respond to different prices at different times, in other words: the price elasticity

But in my experience, in many cases it is wise to avoid the practice of last-minute pricing.

A particularly complex form of time-based price differentiation is what many companies refer to as “revenue management ” or “yield management

Models, data analysis , and forecasting techniques play a key role.

This simple example reveals the core problem of revenue management . The unsold capacity is “hard” data which puts downward pressure on prices. The untapped willingness to pay of hotel guests on a given night is “soft” data with a high level of uncertainty.

low-income consumers prefer EDLP retailers and those with higher incomes prefer Hi-Lo retailers.

repeated exposure to Hi-Lo strategies really does make consumers more price sensitive. They learn that there is always a bargain price available somewhere, and that searching for it pays off.

Penetration strategy means that a company sells the new product at a relatively low price, in order to achieve a high market penetration quickly and ignite a contagion effect as positive feedback about the product spreads.

The low introductory price helped ease the Lexus’s market entry and helped it both gain attention and start building its enviable reputation.

Using a penetration strategy is recommended for experience goods. These are products which require a consumer to gain some experience with them in order to understand their true value.

The price of $599 signals high technical competence and quality as well as prestige.

“versioning,” the ongoing introduction of new versions. Each new version offers superior performance compared to the previous generation, which allows Apple to keep the prices for its devices relatively constant.

no one should doubt that the high art of pricing lies in intelligent price differentiation

We’ll now take a short look at the most severe challenges and problems. Well-thought-out price differentiation requires much more detailed information than one needs to set a uniform price

Price differentiation requires a thorough understanding of the underlying theories, a very systematic collection and analysis of the right data, and the selection of the right differentiation models.

successful price differentiation requires the ability to separate customers effectively according to their willingness to pay

Price differentiation makes sense only when fencing works.

Fencing is effective when the value difference between the two price categories is sufficiently large and the seller can control access.

Effective fencing requires adequate gaps in value across the price categories.

It is not the maximum price differentiation that is optimal, but rather the extent that strikes the best balance between value and costs.

This also implies that when going from the profit rectangle to the profit triangle covering the entire triangle is not worth the effort, once we start taking the costs of differentiation into account.

This can severely restrict location-based price differentiation , which traditionally relied on spatial distance as an effective fencing mechanism. It will become more and more difficult to implement differentiated prices for identical products and services.

Instead of charging a price for the product, a manufacturer or supplier can charge a price for what the product actually does. That is the basis for innovative pay-per-use or pay-as-you-go price models.

Freemium fits very well to experience goods, whose full value only becomes apparent when customers have had a chance to use the good.

The key metrics are conversion and the customer lifetime value of the premium customer s.

A customer pays one fixed price per month or per year, and can then use the product or service as much as he or she wants in that period.

The industry as a whole has done itself a disservice with flat rates.

If consumption or usage is not constrained by some natural or artificial limits, companies should be very careful with flat rate s. It is critical to have detailed information about the distribution of light vs. heavy users and to run rigorous simulations. Otherwise, one can experience a nasty surprise with flat rates. If the number of heavy users is large, flat rates put profits at considerable risk.

The system has advantages both for seller and buyer. Because the customer has paid in advance (by loading money on the card), it eliminates the seller’s risk of nonpayment. The buyer knows how much he or she is spending and this precludes the risk of exceeding one’s budget.

a customer would make an offer, and then the seller would decide whether to accept it. Whether it is called “name your own price ,” “customer-driven pricing ,” or “reverse pricing,” the process rests on the hope that the customer will reveal his or her true willingness to pay

Either these sites attracted only dedicated bargain hunter s, or consumers intentionally hid

their true willingness to pay and instead tried to get products at extremely low prices. Either way, the model was not a lasting success.

“The Name Your Own Price ® service uses the flexibility of buyers to enable sellers to accept a lower price in order to sell their excess capacity without disrupting their existing distribution channel s or retail pricing structures.”

The “pay what you want ” model takes customer-driven pricing one step further. Under this model, the buyer determines the price, but the seller is obligated to accept it.

In such situations, the seller may indeed see a certain number of customers pay prices that cover costs. Other customers will take advantage of the opportunity to pay little or nothing.

the hotels and especially the restaurants incur high variable costs which make the “pay what you want ” model even riskier.

I am not aware of any case in which this model has established itself as standard practice.

One middle ground is the “suggested price ,” a practice used by some museums in New York and Washington, DC. This is “pay what you want” with a hint.

But even in those cases, the operators or owners depend entirely on a customer’s goodwill. Whether a customer pays—and how much—is entirely up to that customer, with no other obligations or conditions. In short: businesses should avoid “pay what you want ” systems.