7 ms·

Ten Years' Worth of Learning About Pricing

247 points by gk1 9y ago

paulsutter 9y ago
All Tom Tunguz posts are good, this one is even better. One question though, three part tariff is proven to be best, for what cases? Given how awkward it would be if everything were priced this way, there should be a clear division. > the 3 part tariff is proven to be best. It provides many different ways for the sales team to negotiate on price and captures the most valu
- zwaps 9y ago
  This is actually a argument based on the economic theory of pricing. To be quite fair, the statement that 3part is best is not entirely correct. The idea is he following: In a old-school normal market, where you sell one good to a whole bunch of guys each etc, and everyone wants just one good, you may just post one price. You will not do better, no matter what you know or do not know. But in most cases, posting a single price will not be optimal for you. This is because you sell multiple units to multiple customers, each possibly very different. And, you do not know what they would be willing to give you. You have asymmetric information. If you KNEW everything, you could tailor a contract for each customer. But you don't. In economics, we can tackle this problem using Mechanism Design. Using game theory and nonlinear pricing (the non-linear is important here), you may be able to set a menu of possible contracts in a way that the customer self-identifies by choosing the best option for him. The intuition of the problem is the following: Choose a menu of contracts that allows you, the company, to maximize profit, while also making the customer choose truthfully and thereby "tell you" what he is willing to pay. This is what the three part price may do for you. Now why is this not entirely correct? There is a (rather theoretical question) as to basically how far a two-part or three-part price is "nonlinear enough" for your set of customers. This is called implementation theory. An excellent book to get behind this mystery is Tilman Borgers book on mechanism design http://www-personal.umich.edu/~tborgers/ http://www-personal.umich.edu/~tborgers/ This was a free download for many years, so you can probably find the pdf.
  - ttoinou 9y ago
    Very interesting but hard to come up with different packages for different types of clients (here 3 I guess ? not counting people who pirate your product) if you're not running a SaaS
    - zwaps 9y ago
      If every customer is anonymous and purchases one unit of your product, you can not really do any of this. If you can identify features of the customers, you may be able to price discriminate on that. Customer usually really, really hate this. If your product can be differentiated, you can use non-linear pricing. Bundles and other things are known. x-part prices more generally work like this. I have mentioned in another reply many examples showing that companies usually try very hard to implement non-linear pricing and most people don't really notice...
  - paulsutter 9y ago
    Ok, but for most things you really don't want a three part tariff: rides on uber (SaaS!), gasoline, houses, employee salaries, health insurance, hotel rooms, container shipping. The customer would just be annoyed and go deal with someone else. So what is the magic slice of products for which 3part is a good idea? All enterprise software? Some enterprise software? Only enterprise software? The most impressive pricing I've seen is Salesforce.com. The pricing is simple but genius. Per seat pricing, where the cost per seat goes up with functionality. I was boiled like a frog: the cost went from $300 per year to $300K per year, and there was nothing I could do about it. How would a 3-part tariff help them?
    - tschwimmer 9y ago
      Are those real Salesforce pricing numbers? That's frightening. How much did your company grow during the same period?
    - zwaps 9y ago
      If you can not differentiate your product at all, it will be pretty hard to price non-linearly. You are right there: Customers will run away. It has happened on the internet (targeting), but people get very angry. Uber extracts from two sides of the platform, which is a more complicated matter. For the other examples, you are not exactly correct. Health insurance is clearly a two-part price, indeed it is a classical example. You pick your tariff and coverage. Whenever you pick, it's a nonlinear pricing scheme. Salaries are another thing. A base and a bonus are very, very common. That's two part. Also comissions and somesuch. Hotel rooms? Rate and extras? Minibar? Cars? Extras and bundling... All of that is non-linear pricing. So your point is basically correct. If the customer notices you get to extract all surplus, he might get annoyed. But a two part tariff most often seems beneficial to the consumer, because he gets to choose!
matrix 9y ago
While the article provides a basic definition of various types of pricing tactics/strategies, it doesn't address important questions such as which pricing strategies work best for which types of markets and products, and what kind of marketing/sales is required to support the choosen strategy. The best book I'm aware of on the topic is Nagle, but it's getting dated and is focused on older B2B business models. If anyone had recommendations for a more recent book on the topic, I'd love to hear it.
- caro_douglos 9y ago
  pricing w confidence is a book worth checking out
braindongle 9y ago
"Maximization is charging the most you can extract in each sale" Wouldn't that be the price that gets you one, or very few, sales? Isn't demand elasticity still a thing?
- zwaps 9y ago
  He is assuming you set individual prices per customer or basically that each customer has his or her own demand elasticity. What you are thinking of is a market demand, which is a useful approximation when the market is large and anonymous. Instead, he gets at the idea that each customer has an individual reservation price, upon which he will still buy your service or good. If you manage to ask exactly this price, you can extract the maximum profit from each customer. Edit: I could do a write-up of the details. I don't have a blog or something like that tho.
  - Teichopsia 9y ago
    I thought about helping you set a github/gitlab pages and writing the code in case you didn't know how, but you could set up a wordpress site using the free tier, which would end up being easier in the long run.
  - perl4ever 9y ago
    Isn't it common for people to have a gut reaction that price discrimination is wrong or unfair? People are generally unhappy, for instance, if they find out another person paid 1/3 the price for an airline seat. If I find out that I'm being charged multiples of what another customer is, I'm going to have an intense desire to punish and/or boycott that vendor. Failing that, I'm going to look for a way to be anonymous, such as paying cash to a middleman. Besides the risk of spreading ill-will, it also seems to me that price discrimination can be risky because there is no way to firewall it against a correlation with some legally protected class. Edit: Also something that occurred to me just now - price discrimination seems to me to lead to a reductio ad absurdam - suppose that it was absolutely perfect and captured all the consumer surplus; then doesn't that destroy the rationale for the transaction in the first place and make it purely exploitative? If it is not desirable to get to that place, then maybe splitting the surplus at least evenly between producer and consumer is the way free markets should work?
jkuria 9y ago
Good short post. Here's a Joel classic from 2004 that is still relevant. It is a little long though: https://www.joelonsoftware.com/2004/12/15/camels-and-rubber-duckies/ https://www.joelonsoftware.com/2004/12/15/camels-and-rubber-...
Lightbody 9y ago
While this post has some useful tidbits and definitions wrapped up an easy-to-read format, it is far from complete and I hope nobody views it that way. For example, you can't have a complete discussion about pricing without talking about packaging and fencing. So if you're interested in pricing as a topic, make sure you find another sources that go deeper in those areas.
bladewolf47 9y ago
"If you’re targeting 50% margins, just double your cost and there you are." Don't want to nitpick but wouldn't that be 100% margin?
- lukevdp 9y ago
  That's 100% markup. Margin is calculated on the sale price.
- Steve44 9y ago
  As /u/lukevdp said the article is correct. Part of my job involves pricing our products and working out rebates when we use 3rd party agents for example. It's surprising how many people struggle with understanding this isn't as simple as they think. For example if an agent wants a 10% rebate we need to calculate the markup from our standard selling price to accommodate this. If we sell a product for £100 then we'd need to invoice it for £111.11 because 10% of that brings our real selling price back to £100. If we mark it up by 10% we'd invoice out at £110, the 10% rebate to the agent would be £11 and we'd have sold for only £99. Comprehending that you don't use the same percentage up and back down is too much for most people here. They eventually get to understand that they can't do it that way, but actually doing it correctly is a dark art.
  - bladewolf47 9y ago
    Right, I had gotten markup and margin mixed up. Thank you for sharing that example, /u/lukevdp as well!
  - roel_v 9y ago
    I had a colleague once who bought a pack of cookies that said '10% free' or something like that. I turned out though that only 10% of the initial volume had been added (hope that explanation makes sense - it's a variation on the issue Steve44 is describing). Anyway so he wrote a letter to the company pointing that out, they send him back an apology letter and a box of free biscuits. Moral of the story: pay attention in math class kids. If you don't, one day you might have to hand out free cookies.
siruncledrew 9y ago
The 3 part tariff sounds like a familiar pricing model to car leases
CoVar 9y ago
There's lecture notes available from an MIT open course just on pricing that I found helpful. Below are all of the lecture notes [1], and the summary lecture note [2]. [1] https://ocw.mit.edu/courses/sloan-school-of-management/15-818-pricing-spring-2010/lecture-notes/ https://ocw.mit.edu/courses/sloan-school-of-management/15-81... [2] https://ocw.mit.edu/courses/sloan-school-of-management/15-818-pricing-spring-2010/lecture-notes/MIT15_818S10_lec08.pdf https://ocw.mit.edu/courses/sloan-school-of-management/15-81...
biocomputation 9y ago
This book totally changed my life: https://www.amazon.com/Strategy-Tactics-Pricing-New-International/dp/1292023236 https://www.amazon.com/Strategy-Tactics-Pricing-New-Internat...
thenaturalist 9y ago
One of the more detailed free resources available on this topic I know of is this one: http://www.priceintelligently.com/hubfs/Price-Intelligently-SaaS-Pricing-Strategy.pdf http://www.priceintelligently.com/hubfs/Price-Intelligently-... Note: I am in no way affiliated with Price Intelligently and do not in any way intend to promote their service. Just wanted to share this free PDF.

247 points by gk1 9y ago

All Tom Tunguz posts are good, this one is even better. One question though, three part tariff is proven to be best, for what cases? Given how awkward it would be if everything were priced this way, there should be a clear division. > the 3 part tariff is proven to be best. It provides many different ways for the sales team to negotiate on price and captures the most valu

zwaps 9y ago
This is actually a argument based on the economic theory of pricing. To be quite fair, the statement that 3part is best is not entirely correct. The idea is he following: In a old-school normal market, where you sell one good to a whole bunch of guys each etc, and everyone wants just one good, you may just post one price. You will not do better, no matter what you know or do not know. But in most cases, posting a single price will not be optimal for you. This is because you sell multiple units to multiple customers, each possibly very different. And, you do not know what they would be willing to give you. You have asymmetric information. If you KNEW everything, you could tailor a contract for each customer. But you don't. In economics, we can tackle this problem using Mechanism Design. Using game theory and nonlinear pricing (the non-linear is important here), you may be able to set a menu of possible contracts in a way that the customer self-identifies by choosing the best option for him. The intuition of the problem is the following: Choose a menu of contracts that allows you, the company, to maximize profit, while also making the customer choose truthfully and thereby "tell you" what he is willing to pay. This is what the three part price may do for you. Now why is this not entirely correct? There is a (rather theoretical question) as to basically how far a two-part or three-part price is "nonlinear enough" for your set of customers. This is called implementation theory. An excellent book to get behind this mystery is Tilman Borgers book on mechanism design http://www-personal.umich.edu/~tborgers/ http://www-personal.umich.edu/~tborgers/ This was a free download for many years, so you can probably find the pdf.
- ttoinou 9y ago
  Very interesting but hard to come up with different packages for different types of clients (here 3 I guess ? not counting people who pirate your product) if you're not running a SaaS
  - zwaps 9y ago
    If every customer is anonymous and purchases one unit of your product, you can not really do any of this. If you can identify features of the customers, you may be able to price discriminate on that. Customer usually really, really hate this. If your product can be differentiated, you can use non-linear pricing. Bundles and other things are known. x-part prices more generally work like this. I have mentioned in another reply many examples showing that companies usually try very hard to implement non-linear pricing and most people don't really notice...
- paulsutter 9y ago
  Ok, but for most things you really don't want a three part tariff: rides on uber (SaaS!), gasoline, houses, employee salaries, health insurance, hotel rooms, container shipping. The customer would just be annoyed and go deal with someone else. So what is the magic slice of products for which 3part is a good idea? All enterprise software? Some enterprise software? Only enterprise software? The most impressive pricing I've seen is Salesforce.com. The pricing is simple but genius. Per seat pricing, where the cost per seat goes up with functionality. I was boiled like a frog: the cost went from $300 per year to $300K per year, and there was nothing I could do about it. How would a 3-part tariff help them?
  - tschwimmer 9y ago
    Are those real Salesforce pricing numbers? That's frightening. How much did your company grow during the same period?
  - zwaps 9y ago
    If you can not differentiate your product at all, it will be pretty hard to price non-linearly. You are right there: Customers will run away. It has happened on the internet (targeting), but people get very angry. Uber extracts from two sides of the platform, which is a more complicated matter. For the other examples, you are not exactly correct. Health insurance is clearly a two-part price, indeed it is a classical example. You pick your tariff and coverage. Whenever you pick, it's a nonlinear pricing scheme. Salaries are another thing. A base and a bonus are very, very common. That's two part. Also comissions and somesuch. Hotel rooms? Rate and extras? Minibar? Cars? Extras and bundling... All of that is non-linear pricing. So your point is basically correct. If the customer notices you get to extract all surplus, he might get annoyed. But a two part tariff most often seems beneficial to the consumer, because he gets to choose!

matrix 9y ago

While the article provides a basic definition of various types of pricing tactics/strategies, it doesn't address important questions such as which pricing strategies work best for which types of markets and products, and what kind of marketing/sales is required to support the choosen strategy. The best book I'm aware of on the topic is Nagle, but it's getting dated and is focused on older B2B business models. If anyone had recommendations for a more recent book on the topic, I'd love to hear it.

caro_douglos 9y ago
pricing w confidence is a book worth checking out

braindongle 9y ago

"Maximization is charging the most you can extract in each sale" Wouldn't that be the price that gets you one, or very few, sales? Isn't demand elasticity still a thing?

zwaps 9y ago
He is assuming you set individual prices per customer or basically that each customer has his or her own demand elasticity. What you are thinking of is a market demand, which is a useful approximation when the market is large and anonymous. Instead, he gets at the idea that each customer has an individual reservation price, upon which he will still buy your service or good. If you manage to ask exactly this price, you can extract the maximum profit from each customer. Edit: I could do a write-up of the details. I don't have a blog or something like that tho.
- Teichopsia 9y ago
  I thought about helping you set a github/gitlab pages and writing the code in case you didn't know how, but you could set up a wordpress site using the free tier, which would end up being easier in the long run.
- perl4ever 9y ago
  Isn't it common for people to have a gut reaction that price discrimination is wrong or unfair? People are generally unhappy, for instance, if they find out another person paid 1/3 the price for an airline seat. If I find out that I'm being charged multiples of what another customer is, I'm going to have an intense desire to punish and/or boycott that vendor. Failing that, I'm going to look for a way to be anonymous, such as paying cash to a middleman. Besides the risk of spreading ill-will, it also seems to me that price discrimination can be risky because there is no way to firewall it against a correlation with some legally protected class. Edit: Also something that occurred to me just now - price discrimination seems to me to lead to a reductio ad absurdam - suppose that it was absolutely perfect and captured all the consumer surplus; then doesn't that destroy the rationale for the transaction in the first place and make it purely exploitative? If it is not desirable to get to that place, then maybe splitting the surplus at least evenly between producer and consumer is the way free markets should work?

jkuria 9y ago

Good short post. Here's a Joel classic from 2004 that is still relevant. It is a little long though: https://www.joelonsoftware.com/2004/12/15/camels-and-rubber-duckies/ https://www.joelonsoftware.com/2004/12/15/camels-and-rubber-...

Lightbody 9y ago

While this post has some useful tidbits and definitions wrapped up an easy-to-read format, it is far from complete and I hope nobody views it that way. For example, you can't have a complete discussion about pricing without talking about packaging and fencing. So if you're interested in pricing as a topic, make sure you find another sources that go deeper in those areas.

bladewolf47 9y ago

"If you’re targeting 50% margins, just double your cost and there you are." Don't want to nitpick but wouldn't that be 100% margin?

lukevdp 9y ago
That's 100% markup. Margin is calculated on the sale price.
Steve44 9y ago
As /u/lukevdp said the article is correct. Part of my job involves pricing our products and working out rebates when we use 3rd party agents for example. It's surprising how many people struggle with understanding this isn't as simple as they think. For example if an agent wants a 10% rebate we need to calculate the markup from our standard selling price to accommodate this. If we sell a product for £100 then we'd need to invoice it for £111.11 because 10% of that brings our real selling price back to £100. If we mark it up by 10% we'd invoice out at £110, the 10% rebate to the agent would be £11 and we'd have sold for only £99. Comprehending that you don't use the same percentage up and back down is too much for most people here. They eventually get to understand that they can't do it that way, but actually doing it correctly is a dark art.
- bladewolf47 9y ago
  Right, I had gotten markup and margin mixed up. Thank you for sharing that example, /u/lukevdp as well!
- roel_v 9y ago
  I had a colleague once who bought a pack of cookies that said '10% free' or something like that. I turned out though that only 10% of the initial volume had been added (hope that explanation makes sense - it's a variation on the issue Steve44 is describing). Anyway so he wrote a letter to the company pointing that out, they send him back an apology letter and a box of free biscuits. Moral of the story: pay attention in math class kids. If you don't, one day you might have to hand out free cookies.

siruncledrew 9y ago

The 3 part tariff sounds like a familiar pricing model to car leases

CoVar 9y ago

There's lecture notes available from an MIT open course just on pricing that I found helpful. Below are all of the lecture notes [1], and the summary lecture note [2]. [1] https://ocw.mit.edu/courses/sloan-school-of-management/15-818-pricing-spring-2010/lecture-notes/ https://ocw.mit.edu/courses/sloan-school-of-management/15-81... [2] https://ocw.mit.edu/courses/sloan-school-of-management/15-818-pricing-spring-2010/lecture-notes/MIT15_818S10_lec08.pdf https://ocw.mit.edu/courses/sloan-school-of-management/15-81...

biocomputation 9y ago

This book totally changed my life: https://www.amazon.com/Strategy-Tactics-Pricing-New-International/dp/1292023236 https://www.amazon.com/Strategy-Tactics-Pricing-New-Internat...

thenaturalist 9y ago

One of the more detailed free resources available on this topic I know of is this one: http://www.priceintelligently.com/hubfs/Price-Intelligently-SaaS-Pricing-Strategy.pdf http://www.priceintelligently.com/hubfs/Price-Intelligently-... Note: I am in no way affiliated with Price Intelligently and do not in any way intend to promote their service. Just wanted to share this free PDF.