Earlier this year, 280 Group released our Product Management Skills — Benchmark Report. After surveying more than 1,650 product managers, we found that product managers reported pricing as one of their weakest skills. You can check out this blog, which has some great tips for addressing the three weakest skills. This article will dive further into some other practices that can help you be more confident about your pricing strategy.
There are many ways you can price your product, but the end goal is usually the same: to maximize profits! Granted, there can be short-term corporate objectives that influence pricing — such as gaining market share. But a great long-term pricing strategy should maximize profits to support reinvestment in the product and continued value creation for the customer. Value is the key point here. A customer’s willingness to pay is tied to their perceived value of the product. If the price is lower or equal to the perceived value, then the customer should be willing to purchase the product. If the price is higher, then the customer will likely pass or find an alternative. Great pricing strategies seek to maximize both the unit economics and sales volume of a product by understanding the perceived value. But not all pricing strategies are successful at this.
Here is an overview of pricing strategies and how they work with dimensions of value:
Cost-based pricing simply means you start with the cost of inputs of a product or service, and add a margin that supports your business needs. Cost-based pricing focuses on inputs rather than outputs, so it does not take customer value into account. If a pricing strategy does not incorporate dimensions of value, product managers may fall victim to some bad practices, such as prioritizing the wrong features, not investing in the whole product offering and leaving money on the table.
Another pricing strategy, called competitive-based pricing, sets prices relative to similar products out in the market. Since customers are likely to compare products during their buying journey, competitive-based pricing does communicate relative value in that analysis. This pricing strategy may be utilized to achieve a corporate objective, such as gaining market share by being less expensive than a competitor. But competitive-based pricing is still not ideal, since the point of reference is the competitor and not the customer’s perceptions of value. Product managers who follow a competitive-based pricing strategy may still have the same challenges of poor prioritization and now run the risk of coming up with a “me too” product rather than innovating on customer problems.
The final pricing strategy is based on a deep understanding of the benefits your customers really value and is called value-based pricing. Value-based pricing is the most difficult to do correctly and requires both a deep understanding of your customer needs and a willingness to experiment. This is the pricing strategy we will focus on in this article.
How to pull off value-based pricing
The first step to a value-based pricing strategy is to start with understanding your customer. Luckily, customer understanding is one of the strongest skills in product management, according to our benchmark report. Even so, here are some suggestions for how you can deepen your customer understanding.
Make a list of your product’s dimensions of value
Your product has two categories of value: objective and subjective value. Objective values can be easily measured. For example, your product may help a business lower its costs, increase revenue or reduce customer churn. Subjective values are more difficult to quantify. These include values such as being environmentally friendly, having a fashionable design, safety or ease of use, and brand. The goal of this exercise is not to create an exhaustive list, but rather to select and investigate the dimensions that are most relevant for your customer. Don’t forget — if your product is missing a key feature another competitive product has, you must also include the negative value associated with the missing feature.
Get out of the building (GOOB), and test your assumptions
Once you have identified a list of values for your product, your next step will be to quantify the benefit, as well as its relative importance to the customer. It is best to work with a market research specialist to ensure you are leveraging the right insights. If you don’t have a specialist available on your team, then watch out for common pitfalls. For example, if you are interviewing a customer without also watching them use the product, be careful of hearing what the customer says they value — their answers may not tell the whole story. Try to ask the same question multiple times to get closer to the truth. Also, look for value not just in the product itself but in the whole product offering — including aspects of its support and delivery. For example, if you are in e-commerce, your customers may value an easy way to return the product if they don’t like it. You may choose to offer free return shipping and capture the value of this added service at a higher price. To identify or quantify customer value, you must spend time with your customers conducting interviews and focus groups, and watching how they use the product.
Accelerate your learning with tools
Once you have developed a theory on what really matters to your customers, it’s time to test that theory with quantitative analysis. You need to confirm that a statistically significant number of your customers agree with the values you think matter most. Fortunately, there are powerful tools that allow you to engage quickly with a wide audience. You can conduct an online survey, or use a new breed of direct-engagement tools, such as Alpha’s rapid consumer feedback platform. Alpha enables product managers to gain measurable feedback from within your product in real-time, by inserting direct customer questions and tests of how your customer is actually using the product. With these techniques, you can quickly ask the customer’s opinions and observe use cases. With this information, you’ll know which values your customers care about and develop a more effective pricing strategy connected to these values.
Other things to remember
- Pricing does not stop: Just as our products are ever-changing, our pricing strategy should also change. If you are investing in new features and benefits for your product, your value creation may warrant a higher price. Learning more about your customers may even enable you to create new product lines. Remember Uber before Uberpool, UberXL or UberBlack? By taking away or adding dimensions of customer value, Uber implemented various pricing strategies across different types of car shares.
- Don’t forget cost: An unprofitable pricing strategy is not a strategy. If your product does not produce enough customer value to be profitable, then that is a red flag. Either it is time to uncover other sources of value or to stop production altogether.
- Learn to say “no”: It is just as important to identify the dimensions of value you are not willing to invest in. Southwest Airlines is a great example of this. They offer great customer service, and they charge no fees for luggage or changing the ticket. But they do not offer features such as seat selection or first class. They can keep their base prices low by not investing in these features, and provide pricing upgrades in different dimensions of value, such as charging a higher fare to earn more mileage points or paying a small fee to get a better spot in the boarding line.
Experiment with pricing
Product managers who feel uncertain about their pricing decisions, take hope — you can leverage your customer understanding to unlock pricing information. After all, pricing is not done in a vacuum; it is informed by value creation and should be considered throughout the product life cycle. Just like customer research helps make prioritization decisions, it should also be used for pricing. But unlike feature-set decisions, remember this: Pricing decisions can be easy to change. If you feel the pricing is wrong, there are many ways to test your assumptions: temporary sales, discount coupons, bundling or volume pricing, for example.
Focus on the value you are creating for the customer, and be bold: Charge accordingly!
About the author
This blog post was written by Rina Vernovskaya and Roger Snyder.
Rina Vernovskaya is CEO of 280 Group, the world’s leading product management training and consulting firm. We help companies and individuals do GREAT product management and product marketing using our Optimal Product Process™.