How to correctly price a product has always been a bit of a black art for most product managers. The goal is to not price a product so high that nobody is willing to buy it, while at the same time not pricing it so low that you end up leaving money on the table. It turns out that the correct way to price a product has to do with its parts, not with its cost…
What Do Your Customers Value?
Pricing for a product comes down to two things: what are your customers willing to pay for the product and how satisfied will they be with the amount that they ended up paying for it? In order to create a price that will meet both of these customer expectations, product managers need to find the best way to present their product’s benefits to their customers.
This is where the problems first show up. All too often product managers spend their time (often at the request of their senior management) focusing on the cost of their product when instead they should be worried about communicating the product’s benefits.
The correct way to go about pricing your product is to view it not as a complete product, but rather as a collection of components (product, accessories, support, configuration options, documentation, etc.). Each component does not have the same value to your customer. This means that product managers need to take the time to carefully price each component so that it closely matches the value that the customer places on that particular component.
What Customer Pricing Experiments Show
Researchers Dr. Rebecca Hamilton and Dr. Joydeep Srivastava have studied how customers value different components of a product. They used auto repairs as the product that was being offered and they identified three different components of this product: parts, labor, and shipping (of the parts).
In their studies, the researchers discovered that customers valued parts more than labor, and parts more than shipping. The take-away from this research was that customers assigned a higher price to those things that they viewed as providing them with a higher benefit.
An important lesson for product managers came from the second part of the researcher’s study. Here they dropped the price for labor to nothing. That made customers nervous — somewhat surprisingly they preferred to pay at least something for this component. Clearly, dropping the price of a product’s component below an accepted threshold doesn’t make the product more attractive – it actually makes it less attractive.
The end result of the studies were the creation of three guidelines for product managers who are getting ready to price their products:
- It’s All About Needs: Product managers need to make sure that they fully understand their customer’s needs. If your car battery needs to be replaced, you will be willing to visit a store and pay full price for a new battery and a big discount on the motor oil that you’ll need later instead of visiting another store that can offer you a small discount on both.
- Bundles Work: : The researchers found that product managers who can combine both high-value and low value components together in packages do the best. They also caution that a product manager should only take the step of offering low-value components for free if that is what the current market will allow.
- Value Is In The Eye Of The Beholder: : If a product that you are responsible for has a benefit that you think that customers should be placing a greater value on, then it is the responsibility of the product manager to do something about it. Specifically, you need to find ways to clearly communicate the value of that component to your customer in order to boost its value.
What All Of This Means For You
In the end, what your customers are going to be willing to pay for your product is going to depend on how valuable they view it as being. Product managers need to understand that their customers don’t see their product as a blob, instead they see it as a collection of multiple components that they place different values on.
In order to price a product correctly, product managers need to break their product up into the components that their customers see. Then those components need to be matched to your customer’s goals – what do they really value? Finally, high and low benefit components can be grouped together in order to boost your customer’s willingness to pay for the product.
Nobody ever said that pricing a product correctly was going to be easy. However, taking the time to understand how your customer views your product and the value that they put on the different components of your product is the key to doing pricing correctly. Get this right, and you’ll have found the secret to being a successful product manager!
Question For You: When do you think is the best time to offer low-benefit product components for free?
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What We’ll Be Talking About Next Time
Product pricing? How boring. Working with development teams? Yawn. Mixed Martial Arts fighting inside of an 18′ chain-link fence — bring it on! I recently had a chance to watch the Ultimate Fighting Championship’s (UFC) broadcast of UFC 128 – a pay-for-view fight between 10 different men. In the end, I had seen a lot of punches, kicks, blood, and important lessons about product management. Do I have your attention now?