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Building your pricing model - what matters

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Over the past few years, more and more people have come to realize that the most important part of pricing is the design of the pricing model.

Yes, the pricing model is based on insights from customer segmentation, where emotional and economic value drivers were uncovered and used to frame the market opportunity. And once you have designed your pricing model, you will need to set and optimize prices. Pricing is not a once and done sort of thing but it is in the pricing model that all the parts come together. It is also where you have the most opportunity to innovate..

Pricing models are designed. They are not set or chosen, but designed. What does this mean?

"Design is the creation of a plan or convention for the construction of an object, system or measurable human interaction" (from Wikipedia, this is actually a pretty good article if you want to go deeper into how people currently think about design). So the design of your pricing model is the construction of a system that supports interactions on pricing. System and interactions are key words here. 

 

Value Metric and Pricing Metric

The basic material that you will use to build your pricing model from is value metrics. Value metrics are the unit of consumption by which your user gets value. That sounds a bit abstract, so let's give some examples.

Paint - the pricing metric is the surface are covered

Jet Engines - the amount of time the engine is working to power the plane 

Advertisements - the level of attention attracted or the response to the call to action

Most solutions will have more than one value metric and the first part of pricing model design is to uncover these metrics. You do this by brainstorming, conducting Jobs to be Done interviews and collecting lots of data. At the end of the day, you will only use one a few value metrics to construct your pricing metric (hopefully just one), but don't discard all those other value metrics, you still have use for them.

Function Value Pricing Packaging

In most cases, you will have more than one offer so pricing design and packaging go hand in hand. You are generally trying to design packages that will appeal to different market segments (the segments where you provide the most differentiated value). There are five interacting things to consider here.

  1. What segment is the package designed for? (A good segment is a group of prospective customers that get value in the the same way and buy in the same way.)
  2. What functions create value for that segment that are of less value to other segments? (Packaging should help highlight segment differentiation.) 
  3. What are the value metrics associated with the functions? 
  4. How are the packages meant to interact? (More on this below.)
  5. What pricing metric will track the value metric(s)?

There are three basic ways to think about packaging.

One can design packages that are meant to lead customers along a path from trial to adoption to expanded use. In this case, one has to track the path the customer follows and understand what drives or prevents conversions.

A second approach is to create very different packages for different needs. This is generally the best approach when different segments get value in very different ways. You see this on websites that first ask you about your business and then lead you to the most relevant offer for your needs.

The third approach is to bundle prices and packaging to capture different levels of willingness to pay. In this approach one generally has three-five tiers (including a free or trial tier and an enterprise tier. Pricing levels are set depending on one's beliefs (hopefully grounded in data) on the shape of the willingness to pay distribution (see What shapes willingness to pay?).

The design of your pricing will depend on which approach you have taken to designing your packaging. As with most pricing goals, it is important to have clarity on your design goal and not to try to two things at the same time. (See Testing the alignment of your pricing strategy.)

1. Lead customers along a conversion pathway - The pricing should encourage conversions and the fences should be designed like a fish trap, so that as one goes from one level to the next it is difficult to go back.

2. Support different segments with tailored pricing metrics - Use a different pricing metric for each package. Tie the pricing metric to the value metric that is of most importance to the segment.

3. Optimize across the willingness to pay distribution - design packages and pricing to capture the maximum willingness to pay and adjust pricing as you learn more about the shape of the distribution.

Ibbaka is an unique pricing advisory service in that we focus more on pricing design than pricing optimization. We do this by blending together expertise in market segmentation and value-based pricing with service design and design thinking. Underneath this, we have a deep data science layer that we use to understand how people understand value, when this understanding resonates, and how value is delivered. One has to follow all three of these strands to design pricing. Contact us at info@ibbaka.com to discuss how we can work with you to design your pricing.

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