Your Pricing Models dictate your business success

Many businesses underestimate the power of a clever Pricing Model. I’m selling a new product at the moment (we’re helping schools teach children to program), so pricing models occupy a lot of my head right now.

Startups are so unsure of what model to use that they often say “anything, so long as we get sales”. They usually focus on simplicity (with a “new” product, a complex pricing model can tip people over the edge and make them “give up” on buying).

Which is fine, but a cunning pricing model can work wonders.

Example: server hosting

Today I got an annual renewal notice for our server-hosting. Changing your “hosting provider” is technically simple but – in practice – a huge pain in the ass. We’ve used the same provider for 7 years, and in theory it’s unlikely we’d ever change.

$1,000 / year for dedicated server
* 7 years = $7,000 to date
* 10 more years? = $10,000 to come

Nice business if you can get it, right?

This is from a dedicated-server company. Bear in mind that, by comparison, Amazon EC2/S3/etc is some of the most expensive hosting available. Think how much Jeff Bezos is raking in…

Service

With hosting, you rent a physical server. An actual chunk of metal. They can’t upgrade that thing (generally speaking: they bought the best thing they could, in the smallest package – the “costs” of hosting come largely from the physical space to store it).

In theory, I’m still using the same server I had 7 years ago. In reality, I negotiated an upgrade a few years back – they were able to put some more RAM in the case (but I suspect it’s maxed-out now).

Pricing

The renewal offers

Pay the same this year as you did last year
Receive the same this year as you did last year

But if you go on their website as a new customer today – with no special offers! – you get:

Pay 1% more than I’m paying already
Receive 300% more performance

I can, of course, buy a “new” server and stop paying for the old. Transferring the data from one to the next is a standard procedure. But … transferring to a new server with this provider is no less effort than transferring to one with a new provider.

Net effect of pricing model

Every time they come to collect their annual, guaranteed, easy cash from me, they scream “SWITCH TO OUR COMPETITORS, WHO’LL GIVE YOU A MUCH BETTER SERVICE THAN IF YOU PAY US TODAY”

Their pricing model is actively driving away customers. And not just any customers: the best customers, the one’s who’ve been paying longest, who are cheapest – and hence: most profitable.

Fixing this pricing model

Ideas?

Let’s start with a recap of the constraints (we can’t change these; these are fundamental to the business. Pricing cannot change reality ;))

  1. Any direct increase in value (a new/better server) will cost the customer time/effort (they have to migrate their code/data), and push them to stop paying
  2. Any direct increase in value reduces the company’s assets (the old server has zero re-sale value, and no-one would pay for it these days. While this customer pays, it has value. When they stop, it becomes landfill)
  3. For a single customer, the longer they remain “loyal”, the worse this problem gets

I see an obvious way out of this:

For ongoing customers, reduce the renewal price periodically

Key notes:

  1. Price reduction doesn’t need to be annual. After 1 year, a server that was “a good price” is merely “a weak price”, not a “bad price”.
  2. Switching to a new provider costs the customer. So the value of switching is:
    • VALUE = (CURENT_POWER – COMPETITOR_POWER) + ($CURRENT_PRICE – $COMPETITOR_PRICE) – SWITCHING_COST
  3. Each year, if switching provider gives an increase in POWER and decrease in COST that – in total – are less than the increase in PRICE … you don’t need to lower the price yet.
  4. As soon as a customer switches away, they lose the benefits forever. Switching back to you resets their “discount counter” to 0 years. Free lock-in!

Conclusion

I’d love to try this change out. I’ve emailed my hosting provider (they’re decent guys, I’d like to help them) with this suggestion. It needs testing, but … I’m confident this would increase their profitability.

And how much effort did it take? Did we have to write code, buy assets, license software?

Nope – inventing pricing models is something you can do entirely in your head. The reward per cost is enormous.

Changing an existing pricing model isn’t free: usually you need to update your advertising and sales materials. However, in this case, it would be “very nearly free”, since we’re not changing the public-facing prices. We’re only changing the prices that are emailed / invoiced to existing customers – that means changing some numbers in an Accounting package. Very simple.

Pricing Models. What’s yours? Is it working for you – or against you?

9 thoughts on “Your Pricing Models dictate your business success

  1. Mika Hirvonen

    Cell phone operators have had this kind of a pricing problem for years. When it was time to renew my contract, the salesperson actually recommended to sign me up as a new customer and send me a bundled phone. In addition, the contract had a huge quota for minutes and text messages, and I’m never going to use more than a small fraction of those. But.. it was still cheaper than my old contract and cheaper than the competitors’. The business model is so twisted that they’re competing on everything but usage-based fees.

  2. adam Post author

    Interestingly, cellphones are different.

    Because they use contracts, it works against them as well as for them: they are not allowed to withdraw services / pricing deals / etc.

    So they always want to kill old contracts, simplify their admin and pricing headahes. But cant until you all quit.

    Or so I’ve been told.

  3. Mika Hirvonen

    My current contract allows unilateral changes that harm the customer when:

    Contract, pricing or customer service systems are renewed or unified (like in mergers)
    Production costs change
    Subcontracted services change
    The company decides to stop providing a feature in the service or the whole service
    Peering agreements change
    The network or the service are updated
    Changes are meant to improve privacy or financial confidentiality
    “Technical systems are renewed”, which can be pretty much anything
    The amount and/or structure of traffic significantly changes unexpectedly
    The state of the market or the demand changes substantially and permanently
    Changes are meant to ensure the continuity of business or to ensure the level of service

    I’m pretty sure that this is just boilerplate legalese that is used by all local cellphone operators. The companies do get a fair bit of leeway. But if they do these kinds of changes, the customers have an escape clause that allows them to terminate the contract without consequences within one month of the change being made.

  4. Steve Malsam

    “Transferring the data from one to the next is a standard procedure. But … transferring to a new server with this provider is no less effort than transferring to one with a new provider.”

    I can’t quite agree with this. Switching providers introduces a large amount of risk. There’s a lot less risk upgrading your setup with a current provider, as ideally they won’t have your old stuff taken down until the new stuff is working. And they have the hard drives sitting right there to transfer data.

  5. adam Post author

    Thats not how it works in my experience. I’ve always found:

    1. No matter where you move to, you would always keep the old upuntil new was tested and verified working. There is no in rease in risk

    2. A fully configured server should get no advantge from the hard disk of a different server being nearby: you should be installing from backups, not cp’ing data across, and using whatever strategy you already have for hot backup/restore.

    Ideally the process is fast and easy – but itll be just as fast/easy to a new provider. Assuming you’re not doing somethig functionally huge like changing OS, of course.

  6. Mika Hirvonen

    I think “ideally” is the crucial word here. Ideally, you have your setup fully documented with no one-off-but-critical configuration settings missing from it so that you can just hand over the documentation to the new provider. Ideally, they’ll make the necessary changes without forgetting anything or messing things up. Ideally, you’re already familiar with the new provider’s procedures, policies and key personnel so that necessary changes are discussed, approved and implemented promptly. Ideally, your backup is small enough that it won’t take days or weeks to ship it or transfer it over the ‘net. Ideally, you’re able to set up mirroring/log shipping/whatever so that the new host can quickly catch up and remain at parity with the old host. Ideally, you have the budget to pay for both old and new hosting for the duration of the migration. Ideally, you have a comprehensive suite of UA tests that no lingering issues are missed.

  7. Adam

    When I talk about hosting, I would never allow the provider to be doing setup. It sounds like your talking about outsourced server admin – I’m talking about servers where you hold the root account, and no-one outside your org has any involvement.

  8. Mika Hirvonen

    The providers I’ve worked with usually draw the line at the base OS. Everything above that is yours to manage as you see fit, but that leaves huge chunks of the overall setup outside of your direct control. Physical hardware,, network configuration, firewalls, load balancing, DNS and so on. A problem or a misconfiguration in any of those can leave your services unreliable or completely inaccessible.

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