Why Pricing Matters
The collapse of MoviePass was one of the top consumer internet stories in 2019 and is a cautionary tale for entrepreneurs about the importance of pricing structures and having the right startup pricing strategy.
The company went through several pricing structures until it settled on its last (and ultimately doomed) offering in 2017. It was offering a subscription package for $9.95 per month that allowed users to watch one movie per day. While this move created a sharp increase in subscriptions, it was also what brought the company down.
The founders were clear about the fact that the unit economics were unsustainable and could therefore not be the only stream of revenues for the company, but they believed that they could enter into deals for block ticket purchases and revenue sharing for concessions. This conviction was motivated by the belief that having a captive audience that had constant access to cheap tickets would be a sufficient negotiating tool with theater chains. What the company had missed, however, was that this model could easily be replicated by cinemas and that its product did not necessarily provide the customers with sufficient value.
A Timeline of MoviePass Pricing
So what are the key learnings from cases like that of MoviePass, and how should an entrepreneur think of setting their prices?
The Price Is Right
There are several common pitfalls entrepreneurs can fall into when trying to set a price for their product or service. The first and most common one is assuming that pricing is a static and mathematical exercise. The second is that it is preferable to set prices lower than the competition to gain market share quickly. Furthermore, they often forget that pricing in and of itself can be a means of communicating with their clients—pricing can also be used as a marketing and branding tool. Finally, the chosen pricing structure needs to be easily understandable and not too complex.
Ultimately, what is crucial is deeply understanding what component of your product is most valued by your customers, and then either adjusting the pricing or tweaking and improving your product. Overall, more sophisticated and “modern” pricing strategies, such as value pricing, are more suited to innovative companies such as software companies than traditional cost-based pricing.
Here, we will briefly cover the pitfalls of pricing and give some examples and tips on types of pricing strategy.
Static, Economics-based Pricing Can Be Too Simplistic
While understanding the contribution of each sale to the bottom line is clearly an important business priority, it is not the be-all and end-all of pricing. It is often said that pricing is part art and part science. A comprehensive pricing strategy will incorporate both quantitative and qualitative drivers. The most traditional pricing technique is cost-based pricing, an economics-based form of pricing where the price is set by calculating the cost of goods sold and then adding the desired profit margin to it to determine the product’s (or service’s) price. It is simple and directly related to the economics of the company, yet this approach is very simplistic and ignores more qualitative factors such as the customers’ willingness to pay and the relative positioning toward the competition.
Among the qualitative factors to include in a pricing strategy, it is crucial to understand how competitors price and position their products, how similar those are to yours, and how they contribute to your margins. More qualitative drivers are linked to the marketing of the product, your desired positioning, and how the customer journey develops and how you can influence it. For instance, at what point do consumers see the price? Often, for example, SaaS companies will have a range of pricing options, with a higher tier with custom pricing that requires prospective clients to make direct contact. This gives the idea of exclusivity and highly personalized service.
Not only, but often, entrepreneurs do not revisit pricing often enough or adopt a “one price fits all” approach. Two potential ways of avoiding reliance on a “static” price are either frequently collecting customer feedback and reviewing the pricing policy, or adopting dynamic pricing. Dynamic pricing means that prices will vary based on demand. This is a technique used, for instance, by Airbnb.
Crucially, an adaptive, client-driven pricing strategy requires a culture of client focus, excellent data collection, and an iterative process that allows for key learnings from customer insights and data analytics to be incorporated into business and product decisions. For example, the price of a soda can vary with the temperature outside. We see Amazon do this all the time—how often have you received a notification that something in your shopping cart has changed price?
Static vs. Dynamic Pricing
Pricing for Market Share Can Be a Drag on Revenues
Pricing for market share is another common pitfall that is particularly visible for fast-growing companies or during recessions. Companies underprice their products hoping to gain or retain market share, but this may not be sustainable in the long run.
Generally, there are three main approaches when companies are setting their product and pricing strategy:
- Maximization: maximizing the price the customer will pay
- Penetration: pricing low to win market share
- Skimming: charging higher prices for early customers and lowering prices over time to expand the target market
While it may be tempting to think that a lower price can attract more customers, many experts such as Madhavan Ramanujam believe that maximizing prices is the best startup pricing strategy for revenue growth. “You can build products, slap on a price and hope to monetize, or you can design your products around the price, and craft a thoughtful, successful launch…If your company’s innovation process is built on hope – a gut instinct before you bring your products to market that they will pay off – you’ve made the wrong choice,” Ramanujam stated.
It is also important to keep in mind that companies that have sustained exceptional profits over an extended period have done so by increasing operational efficiency to sustain lower prices. Walmart, for instance, delivers on its promise of “Everyday Low Prices” by focusing on volume, outstanding logistics, negotiating power due to size, and low overheads. Pricing has been the company’s key concern since its founding and the driver behind the organizational design.
Pricing Is a Marketing and Communication Tool
Companies like Starbucks, on the other hand, have chosen a different product and pricing strategy to that of Walmart, which is notorious for using value-based pricing, a maximization pricing strategy. Starbucks positions itself as a premium brand compared to its competitors like Dunkin’ Donuts. Thus, the most price-sensitive consumers will be discouraged from shopping at Starbucks, but the ones that visit it are attracted by its image of a premium product. This is created through many tools, of which pricing is one. Other examples are an attentive curation of the stores, a focus on music, etc. This effectively creates an almost inelastic demand curve, meaning that an increase in price causes a smaller decrease in demand, and therefore doesn’t negatively impact revenues.
Another example is Glossier, which sells premium-priced skincare products that appeal to consumers because of its trendy, fresh, and effective image and strong brand recognition. Ultimately, customers form an opinion of product quality from its price. It could be counterproductive to incorrectly give the impression of a poor quality product because of a poorly thought-out pricing strategy.
Inelastic Demand Curve
Confusing Pricing Can Discourage Buyers
Displaying confusing and complicated pricing options can discourage consumers and damage trust in your brand. For instance, to return to the example of MoviePass, the company tried to recoup some of the losses caused by the low, flat-fee, unlimited subscription by introducing blackouts (meaning that more popular movies or screening times would not be available) and surge pricing (price increases for similarly popular slots, much like Uber does). This created a lot of discontent among customers.
Mobile phone providers, who provide many bundles and pricing tiers, are notorious for confusing pricing schemes. Providers tried to combat this stigma with the birth of “unlimited” plans—although those too became confusing eventually as the practice of “throttling” (reducing the speed of transmission) became commonplace for aggressive users of data.
ClassPass, the fitness company that became the first unicorn of the decade in January 2020, ran into similar complaints when it adjusted its pricing structure, first by eliminating the unlimited option, and then by introducing a credit system. ClassPass did, however, successfully offset the complexity of the pricing by increasing value to the customers in other ways: improving their chances of accessing top-rated classes and improving their own product by offering workout videos for free and building personalized recommendations within the app.
Five Key Pricing Capabilities of Top-performing Companies
Having a strong and coherent approach to pricing can be key to the success of a company, particularly those serving consumers, as they have less negotiating power than enterprise clients and purchase with more frequency.
A study by Bain surveyed nearly 1,100 consumer companies across the globe and identified some clear trends that connect their pricing strategy to performance. Some 78% of respondents admitted that, even though their pricing processes and abilities had improved, there still remained ample space for improvement.
Insights from Consumer Company Pricing Study
A further in-depth study of the top 15% of the companies in the group by performance (defined as those that both made sound pricing decisions and increased their market share in the two years preceding the survey) uncovered that all of these companies shared five key pricing capabilities that set them apart from their peers:
- They were able to coherently and consistently understand the value proposition of their products vis-a-vis the products of their competitors and price them accordingly.
- They were subsequently able to design and maintain an appropriate product mix that served that value proposition. This means that they could satisfy their customer segments without cannibalizing them, or damaging their margins.
- They avoided promotions that could damage brand and pricing power. Luxury fashion houses famously do this. It is nearly impossible to buy a genuine Louis Vuitton, Hermès, or Chanel item on sale. This preserves the value of the items and their sense of exclusivity.
- They use psychology to drive the customers’ perception of price in a way that can at times differ slightly from reality. This is a very effective technique that utilizes tools such as anchor pricing (making use of the comparison of a standard product to a premium one to make the former appear more valuable). This technique can be difficult to execute properly, however—too far of a distance between perceived and actual value in either direction can either make the products appear inferior or create damage to company reputation.
- Finally, when appropriate, top-performing consumer companies use dynamic pricing. Dynamic pricing is becoming more and more commonplace, but it requires excellent data collecting and data-informed business decisions to be effective.
Key Pricing Capabilities
Finally, Don’t Forget Unit Economics
Ultimately, the objective of any company is that of making money for their shareholders while making products that consumers want to buy. Balancing this equation requires always starting from a clear understanding of the cost of producing an item or a service and of delivering it to the client. Toby Clarence-Smith has written a helpful and detailed analysis of the importance of unit economics that is worth a read. Understanding unit economics should always be the starting point of any pricing strategy.
Understanding the basics
What are the three pricing strategies?
There are three main approaches that can be followed when pricing a product: maximization - maximizing the price the customer will pay; penetration - pricing low to win market share; and skimming - charging higher prices for early customers and lowering prices over time to expand the target market.
Why is a pricing strategy important?
Having a strong approach to pricing can be key to the success of a company, particularly those serving consumers, as they have less negotiating power than enterprise clients and purchase with more frequency. In fact, a sound approach to pricing directly correlates to performance.
What is a dynamic pricing strategy?
Dynamic pricing is when prices vary based on demand. This is a technique used, for instance, by Airbnb. A dynamic pricing strategy requires a culture of client focus, excellent data collection, and an iterative process.