If you have ever called a large company customer service hotline and reached a live human being, then you probably heard the representative furiously hammering away at their keyboard. In service industry parlance, they are logging a ticket that includes your contact information and your complaint into a sophisticated help desk software application. For many years, the expense of such systems meant that only the largest companies could manage customer relationships this way. However, in recent years, the Internet has served as a great equalizer allowing small and midsized business to get in on the action too. Serving them are a host of smaller help desk software vendors that provide lower cost but still reasonably powerful Internet-based solutions.
On the evening of May 18, 2010, one of these emerging players found themselves in an epic (for them) pricing pickle. The 5,000 or so loyal customers of Zendesk, whose motto really is ‘Love Your Help Desk’, received an email from CEO Mikkel Svane. The communication began innocently enough extolling a set of new features inspired by customer feedback. The next few paragraphs delivered the shocker. Though Zendesk’s smallest customers with only one license would see no price change, everyone else would experience a minimum fifty percent and maximum two hundred percent increase! The customer uproar was, understandably, swift and scathing. Smelling blood in the water, competitors immediately went into attack mode. Not realizing the gravity of the situation, Mr. Svane commented innocently on a prominent social network that “I hope all the new sexy Zendesk features don’t drown in today’s noise.”
In one badly calculated pricing action, Zendesk shattered the trust of their loyal early adopters. Though the company ultimately did the right thing by grandfathering pricing indefinitely to all existing customers, the damage was already done. The company survived, albeit with mud in the eye.
Pricing strategy is as much art as it is science. However, a few key guidelines will get you pointed in the right direction.
Unless you are selling a pure commodity, you should strive to launch products with high initial pricing. Many people, particularly small business owners, make the mistake of overestimating the impact that low introductory pricing will have on demand. In most circumstances, your earliest customers will be willing to pay more to get first crack at the unique benefits of your offering. Moreover, high pricing may actually stimulate demand by signaling that you are providing a premium product. If you miss the mark on the high end, then it is easy to adjust and lower prices. However, if you price too low at the beginning, then you may find yourself in the no-win situation that Zendesk faced.
Avoid radical pricing changes
It is important to get pricing as close to right as possible at initial launch. Radical changes to pricing strategies almost always end in disaster. A major change is likely to have one of three inevitable outcomes. Those clients that can pay less will take advantage of the opportunity. Those clients that must pay the same will continue on unaffected. Those clients that you expect to pay more will not. If you are lucky, those in the final bucket will simply give you a mouthful. More likely, many will vote silently with their feet and abandon you for your competition. The net result of all three behaviors is that you will lose money.
Certainly, there are exceptions to every rule. In some rare circumstances, there may be a significant untapped buying center that is unable to purchase your product without pricing strategy change. Most examples of this are of companies that offer variations of their products packaged in lower quantities or with reduced features. For instance, when Tide laundry detergent was launched in India in mid-2000, its manufacturer needed to adapt to lower household income relative to the United States. To address the opportunity, Tide was offered in a variety of sizes including single use packets targeted at rural areas. For most companies employing such a strategy, the price of the ‘inferior’ product should be less attractive on a relative basis as compared to the larger, full-featured offering.
Factor in costs, customers, and competition
Though you must be careful not to anchor yourself, the first thing that you should consider when setting a price point is your average total cost. Average total costs should factor in not only the variable cost of your given good or service, but also the fixed costs that you incur in the course of running your company. Average total cost establishes a minimum price point that is the dividing line between life and death for your business.
Once you establish a price floor based on costs, it is time to consider your customers. When prospects think about buying from you, the first thing they consider is the potential value they can realize. However, customers typically will not pay the full value they expect to gain from your offering. They require compensation for the risk they take in buying from you.
To make this more concrete, consider a purchase decision that companies face every day. Most businesses, whether selling to consumers or to other businesses, spend considerable dollars to buy lists of prospects that are fed into direct marketing campaigns. Though figures vary widely, a typical response rate to an unqualified prospect campaign is about one percent. However, just getting a response is only a small part of the battle. Of prospects that respond to a phone, post mail, or email offer, perhaps five percent of them will actually make a purchase. If the product sells for $2,000, then the value of the contact information for a single unqualified prospect is $2,000 times one percent times five percent. That works out to a value to the customer of just one crisp dollar.
Since the list buyer made a number of assumptions based on typical industry standards, their willingness to pay would be a decent amount lower to account for the very likely possibility that response rates and conversion rates will turn out lower than expected. Recalling the work of Kahneman and Tversky from the chapter on change management, most people require a factor of two times return on investment. Hence, in this example, the list buyer’s willingness to pay for an incremental unqualified set of contact information is likely a mere fifty cents.
Now that you have considered your costs and your customers’ willingness to pay, there is one more thing to factor in to your pricing decision – the dreaded competition. Though companies hate to admit it, there are generally a few competitors lurking in their waters that offer a more or less fungible solution. This is true for both goods and services. To keep yourself in business, you should carefully monitor your competitor’s list prices as well as their realized effective prices.
When most people perform competitive analysis in the context of pricing strategy, they stop at examining external competition. However, to avoid devastating errors, you should also look at the impact that a new product or pricing action will have on other offerings in your portfolio. Take care to set a price that will not cannibalize your existing business.
Here are the concepts you can immediately apply to become a skilled pricing strategist:
- Start high
- Avoid radical pricing changes
- Factor in costs, customers, and competition