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