Pricing 101: Shortfalls of Common Pricing Strategies
Original post on wellmode.com.
The following four pricing strategies are widely implemented across the wellness space and beyond. Even though not always bad, it’s good to understand their shortcomings and pitfalls.
Cost-based pricing
This is probably the most prevalent pricing tactic across industries. It means that you sum all your costs, add a margin and charge that to your customers. I hear you thinking, what is so bad about that? It ensures that you cover your costs and keep some of the profit. The catch is that your costs as well as your demand are very likely not stable, but fluctuating. Think of your varying monthly electricity bills. You also have many costs that are not attributable to one customer but have to be spread out over all your customers. A good example is rent. Your rent is the same each month. If you have 10 customers 1 month and 100 customers the other month, it’s difficult to allocate the costs month over month. Finally, and maybe most importantly, cost-based pricing does not take into account the value you create. Imagine you help someone recover from depression with your offering, that is worth something, right?
Competitor-based pricing
This second pricing strategy is very popular as well. You look at other companies’ prices and set your price based on them. Most often people tend to price lower than their direct competitors, in the hope to attract more customers. It’s good to know what others are charging and take that into account when setting your price. But once again, it ignores the unique value proposition you are bringing. Even more, have you ever thought about the reaction of your competitors if you charge prices slightly below them? They might launch a new discount or deal, undercutting your price. Repeat this a few times and you end up in a lose-lose situation. These price wars are very common in pharmacies and supermarket chains. One of the unwanted consequences is that we as consumers are trained to get discounts and low prices, lower than the actual value of what we’re buying. Do you ever buy a shampoo for the full price? Or do you wait till there is another discount on? I know I do.
Customer-based pricing
The third pricing strategy we often encounter in the form of “pay as you wish”. Customer-based pricing encompasses a strategy where you set the price based on what customers want to pay. Learning what customers want to pay can be done through interviews, questionnaires, or via “pay as you wish”. Anyone who’s ever experimented with pay as you wish has probably experienced that people wish to pay much less than you’d wish them to pay. Customers are often unaware of what something is worth. Let alone in today’s world, where there is so much “free” stuff available (the majority is not actually free, since we’re paying with our data and information). Think about all the fitness classes on YouTube. Many of them are not great, but how should your potential customers know if they’ve never really watched them? They just know that there are $0 classes out there. It’s up to you to educate your customers on the value you’re providing them. To be able to do this, it is important that you understand who your customers are, and what different types of customers you have. The willingness to pay (be aware that this is something else than what they may wish to pay!) and what they expect in return might be very different for different customer segments. A college student might have a low willingness to pay but is satisfied with lower quality products or services. Whereas a new mom might have a much higher willingness to pay but in return expects high quality and personal attention.
Freemium pricing
The final very popular pricing strategy is the freemium model. Giving customers a few free products or services, and then charge them when they want more. Freemium pricing has been made very popular by the software world. The rationale behind the freemium pricing plan is that you give people a taste of what your product or service does, and then charge them when they want the full suite, mostly on a subscription model. Why this model became so popular in software is because the products are often difficult to explain, you need to experience it. And once you’ve experienced it, the switching costs are high. The freemium model creates a lock-in that makes it a hassle to switch to another company. Think of having all of your documents saved on a free drive in the cloud and suddenly your free storage is full. The paid version starts at $3 per month. For only $3 do you really want to transfer all your files to another drive? Most of us won’t. And over time that $3 turns into $10 turns into $20. They lock you in. Imagine being a yoga teacher, and let’s think about your class. Freemium is great because it can show students who you are and what your classes are like. They can experience you before they invest money in you. However, if you offer a lot for free and there is no lock-in, students might just freeride with you and other teachers and never buy anything. So when considering a freemium strategy, it is important to think about your goal and your strengths. It is good for marketing and growing your customer base, but anticipate that it will be hard to convert them into paying customers. Again, it is not a bad strategy, but have a solid plan about how you are going to convert users to become active paying customers: what locks your users in, what makes them want to come back to you, and pay for what you’re offering. What makes you unique!
In this pricing 101 series, I rely on concepts learned in MIT Sloan’s pricing course by Prof. Tucker. If you’re interested, most of her lecture notes are available online. Next blog, I will dive into conscious and unconscious customer behavior.
More in this series:
Pricing 101: Why talk about pricing?
Pricing 101: Shortfalls of Common Pricing Strategies
Pricing 101: Customer Behavior
I’d love to hear from you. So don’t hesitate to ask questions or comment below.
Are you a wellness entrepreneur (e.g. a yoga or pilates teacher) wishing to create more and better online content? Are you a student looking for a unique wellness series to do at home? Check out wellmode.com!
