We are occasionally asked by clients or prospective clients to help them simplify their pricing. These requests are usually the result of the company struggling to manage the myriad prices they offer, but also often include a desire to make it easier to engage customers, or a desire to improve the margins on the lowest priced customers. In all cases, the companies want their overall profitability to improve. Unfortunately simplifying pricing is often not a good idea and can lower a company’s profits.
In my view, the decision boils down to comparing the lower cost of managing a simpler pricing structure with the benefits of more precisely capturing what each specific customer will pay. Stated more directly, if you can make more money by managing a complex pricing structure than you can save by simplifying, don’t simplify.
When we are asked to help with simplification, the most common assumption is we can group products or services that are essentially the same thing, and group customers who are similar, then move everyone toward the average prices of those groups. The assumption is that overall gross margin will stay about the same from moving customers toward the average, and costs of managing prices will decline.
Before concluding that you can move customers toward the average price with margins remaining relatively flat, it is important to peel back the layers of details that led to your complex structure. If you offer customers a lot of options of products or configurations to choose from, and each of those options has its own price, are the options needed? There is ample behavioral evidence that too many options confuse customers and may even lead to fewer sales. If the options are mainly design or cosmetic differences, that may be true. In that case, fewer options may be simpler for customers, and you can converge the prices without losing any volume.
What if the different options you offer to customers are driven by different business needs? If some customers need very precise tolerances or many advanced features, while others do not, product or service offers that address their specific needs are important. Descoped products or services, with fewer or less-advanced features address a segment of customers who would not pay as much as customers with more advanced needs. If you remove products or services that are targeted at specific segments, you must then convince those segments to buy something that has either more or fewer features than they need.
That leads to the next question – how are customers likely to react when you change prices? Sometimes a complex pricing structure is not the result of too many product or service options, but the result of segmenting the customers according to their willingness to pay. Airlines and hotels have a wide range of prices they charge for something that is essentially common – a flight between two points or a room for a night. However, they enable customers to segment themselves by choosing to pay extra for better seats or rooms, easier access, the ability to cancel or change a reservation, use wi-fi, etc. If those airlines or hotels reduced their number of price points, it would be easy to lower the prices to the customers paying the most, but much harder to convince the price-sensitive travelers who pay the least to now pay more.
When you offer many permutations of a product or service to address the different business needs of customers, it will be easy to lower prices to the customers with the most advanced needs, as long as you still meet those needs. Those customers will be thrilled with lower prices. It is also easy to eliminate the lower-spec products or services and provide the higher value options to customers at the low end. However, it will be much more difficult to get those customers to pay more for features and benefits they do not need. In that case, you would run the real risk of margins deteriorating, by lowering high-end prices without any increases to offset them.
As with most things in life, there is no simple answer. The decision to manage a complex pricing structure or simplify it depends on the circumstances. Recently, GoSquared simplified their pricing structure, and they believe it is beneficial to them. And, of course Amazon Prime has always had a simple structure and it has been a huge success. I usually find that profitability is greater with pricing strategies and structures that capture the amounts each customer is willing to pay, but I recommend you let your data guide you. If you can clearly define and articulate value propositions at multiple price points, you can establish data-driven rules regarding who pays how much and why. Then manage to those rules. If you can’t do those things, simple might be better.
Leave a Reply
Want to join the discussion?Feel free to contribute!