When it comes to subscription product pricing, you’re not just guessing…are you?
A while ago, an HBR study famously claimed that a 1% improvement in price would increase operating profit by 11%, making it the most effective thing you can tweak for increased business performance.
Pricing is important. It’s also one of the most difficult Ps of marketing for folks to wrap their heads around. It can be one of the more technical aspects of marketing.
Then, when you bring subscription pricing models into the mix, things get even more complex.
First Thing’s First: How Do You Determine Value and Price?
However, you can’t just ask your customer, “what would you like to pay for this?” (well, you could, but the Pay What You Want strategy is a whole-nother article). Instead, a variety of research techniques have been developed and used through the years. Here are four popular ones:
- Gabor-Granger technique
- van Westendorp Price Sensitivity Monitor
- Brand Price Trade-off
- Conjoint Analysis and Discrete Choice Analysis.
Note: if you’re a startup, these techniques might be overkill. Ryan Farley from LawnStarter mentioned that getting on the phone with customers and gauging reactions to priced proved to work well in the beginning…
That said, if you’re in an established market, these four techniques are popular and effective:
1. Gabor-Granger Technique
The Gabor-Granger Technique is a simple technique based on asking people the likelihood of their purchasing a product at different prices.
To simplify it, the technique involves asking a series of questions like, “would you buy (product) at (price)?” The price will then go up or down depending on the response to the first question. The series will continue 2-3 more times, until the consumer won’t go higher or lower on their interest price.
Here’s a sample chart based on Gabor-Granger data:
In this way, you can clearly visualize what percentage of people would buy at a given price (in the chart above, 3% of people would buy at $41), and you can determine which price would maximize revenue.
Use this technique to figure out the maximum price people would pay and to see the optimal based on amount of people willing to purchase, as well as the maximum revenue produced.
2. van Westendorp Price Sensitivity Analysis
In the van Westendorp Price Sensitivity Analysis, respondents are asked 4 questions:
- At what price would you consider the product/service to be priced so low that you feel that the quality can’t be very good?
- At what price would you consider this product/service to be a bargain—a great buy for the money?
- At what price would you say this product/service is starting to get expensive—it’s not out of the question, but you’d have to give some thought to buying it?
- At what price would you consider the product/service to be so expensive that you would not consider buying it?
In this way, it’s more indirect and can determine price elasticity as well as an accurate range of effective pricing for a product.
According to Greenbook.org, this strategy is often used during new product development, and can help determine which pricing strategy is best:
“Whether a client is contemplating an aggressive entry price strategy or a premium skimming approach to price, the van Westendorp PSA can help determine which strategy is best. Established brands will use the PSA model to guide pricing for re-positioning or other pricing decisions, often as input to a test market.”
Here, the data shows an optimal pricing point:
And it can also show a pricing range:
This technique is perfect for subscription products with multiple tiers.
3. Brand Price Trade-off
Brand Price Trade-off (BTPO) is a statistical technique used to measure your relative ‘brand value’ or ‘brand equity’. Basically, it does this by modeling the relationships between your brands and the prices they command in relation to other brands and the prices they command.
More than other techniques here, it answers how much your market is willing to pay for your brand in relation to similar products from other competitors – which makes this technique a competition-based pricing technique.
According to B2B International, “It is suited to categories where products and services are relatively similar to each other, and where brand is a strong determining factor behind decision-making.”
Here’s an example of a BPTO exercise:
To reiterate, use this is product categories with little differentiation and where brands make a huge impact on pricing.
4. Conjoint Analysis and Discrete Choice Analysis
Conjoint analysis is a statistical technique used in market research to determine how people value different attributes (feature, function, benefits) that make up an individual product or service.
Discrete Choice analysis is similar. The difference is, in conjoint analysis, respondents evaluate the product configurations independently of each other, whereas with discrete choice analysis, they simultaneously consider the options.
The purpose of both of these is to “yield a measure of the relative importance of each attribute, and a measure of the strength of influence of each level of each attribute. This is how Greenbook.org explains it:
“Perhaps the most commonly-performed simulation today is to calculate an attractiveness rating for each of all possible product configurations, and then sort the configurations by their attractiveness ratings. This allows us to identify the most preferred configuration (of all possible). In addition, if price is one of the attributes, and cost information is available, the most profitable combination of features can be identified.”
These techniques have wider applications than just pricing, but can nonetheless determine the values of certain product attributes and inform pricing.
Subscription Pricing Plan Tiers
Nathan Barry described a huge problem he almost made in pricing: the mistake of having “only one price for your product.”
As he explained, you should price based on value, but the value derived by two different sets of customers can be totally different. On that same note, he relates the study Wlliam Poundstone told on beer prices with different tiers…
In the study, researchers first offered participants two different beers: premium beer for $2.50 and bargain beer for $1.80. Roughly 80% chose the more expensive beer.
Next, a third beer was introduced, a super bargain beer for $1.60, in addition to the previous two. Now 80% bought the $1.80 beer and the rest $2.50 beer. Nobody bought the cheapest option.
In that case, the seller actually lost revenue through bracketing because he bracketed his price down.
However, the third time around they removed the $1.60 beer and replaced it with a super premium $3.40 beer. Most people chose the $2.50 beer, a small number $1.80 beer and around 10% opted for the most expensive $3.40 beer. Some people will always buy the most expensive option, no matter the price.
Determining How Many Pricing Tiers You Should Offer
But is three pricing tiers the ideal offering? It would seem that way looking at most SaaS pricing pages. However, how many tiers you offer actually depends on a few different factors. Here’s Patrick Campbell on the topic:
Once you’ve aligned your customer personas to different tiers, you can use one of the pricing research strategies listed above and optimize from there.
For more information on customer personas, check out this post on how to create them with actual data.
Which order is best?
Should you list your pricing from low to high or high to low? There are examples of successful companies that do both, of course. Here’s Freshbooks, low-to-high:
And Crazy Egg, high-to-low:
So, which works better? It turns out that, generally, high-to-low works better. According to Lincoln Murphy, “all things being equal (and equally good), the left to right, high to low approach seems to provide a statistically significant lift every time.”
A Quick Note On Freemium
Freemium isn’t really a revenue strategy, but rather a customer acquisition strategy.
As Patrick Campbell put in on his GH AMA, “You need to think of a freemium tier as a really expensive e-book. I know that’s a trite comparison, but when you think about it as lead-gen, then you’re starting to think about it correctly.”
Changing Your Subscription Pricing
Once you set your prices, that’s it. They are set in stone until your seed funding runs out and your company collapses…
…kidding, of course. In fact, Patrick Campbell recommends that should re-evaluate your pricing’s performance every three months, even if you’re a huge company. As far as changing pricing goes, he says you should make changes about every 6-9 months, more if you’re a smaller and more nimble company.
As for how to change prices, it’s a similar qualitative/quantitative research process that we outlined above for establishing prices. Here’s how Patrick explained it:
How much of a price hike is too much? While there is no magic number, Weber’s law shows that it is approximately 10% where customers begin to become aggravated. But you’re going to do the research anyway, of course.
Annual Pricing Plans
Every subscription product should offer an annual plan.
Why? Look up the Time Value of Money. If you’re too lazy, think about it logically from a cash flow perspective – more cashflow upfront allows you to invest that in whatever ways you choose, while not worrying about losing that customer for at least a year.
According to a Price Intelligently study, only about 1 out of 5 SaaS companies are offering both monthly and annual plans. The article then says that “monthly payments may be the lifeblood of your business, but annual subscriptions secure you more business upfront, increase cash flow, and reduce churn.”
Annual plans will also usually better active usage and retention than monthly plans. The individual made a bigger investment in the product upfront, so they are more invested in the product overall.
How To Implement an Annual Pricing Plan
Price Intelligently recommends discounting your annual subscriptions 15-20%, but it all depends on your audience’s price sensitivity. Use one of the pricing research strategies above to accomplish that.
Another point: Patrick Campbell noted in his GH AMA that, usually, saying something like “1 month free” or “2 months free” works much, much better than saying a certain % off.
One mistake to avoid is measuring your yearly members as MRR for the month they purchased. Instead, make sure you divide your yearly plan by 12 for your MRR.
Some companies even push it so far as to only offer annual plans (good for them, annoying for us).
Pricing Tricks and Tactics
To be clear, psychological pricing tricks should be a secondary thought to your fundamental pricing strategy. Patrick Campbell calls it the last 5%, all of which you could still test for greater revenue:
Still, to round up, here are a few popular and effective pricing plan tactics:
- Decoy pricing is now one of the most popular pricing studies. Dan Ariely showed that adding a ‘decoy’ can help prod people into making the choice that you really want them to make (So if you add a slightly worse option that is similar to A (call it A-), then it’s easy to see that A is better than A-, hence many people choose that.)
- What’s the best way to sell a $2,000 watch? Put it next to a $10,000 watch. Anchoring is a strong mechanism (it’s the reason restaurants will put a drastically pricier food or wine option on the menu).
- Eliminating dollar signs (24 vs $24) has been shown to increase spending at restaurants. Does it work with SaaS? Not sure.
- In eight studies published from 1987 to 2004 charm prices ($49, $79, $1.49, etc) were reported to boost sales by an average of 24% relative to nearby prices. End your prices in 9s.
- Some studies suggest consumers perceive a sales price to be better valued when it’s written in a smaller font. Physical magnitude correlates to numerical magnitude in our minds. Try using smaller font sizes for discounts.
- Researchers found that more syllables make prices seem much higher (e.g. $1,499.00 sounds much higher than $1499). Use less syllables.
If you want to go down the rabbit hole in psychological pricing plan strategies, there is no shortage of good resources:
- Pricing Psychology: 10 Timeless Strategies to Increase Sales
- Pricing Experiments You Might Not Know, But Can Learn From
- 7 Psychological Pricing Hacks to Double Sales
- 10 Examples of Great Pricing Strategies
- Predictably Irrational by Dan Ariely
Well, Can You A/B Test Pricing?
You can, but most people don’t recommend to A/B test pricing. To set up a controlled experiment where you offer the same product for different prices to different people opens you up to potential PR blowback.
Even functionally, though, A/B testing isn’t always the best way to determine pricing. Patrick Campbell said that “A/B testing for optimizing your pricing structure and determining your true price point is a terrible idea; it’s a downright awful one.” And as Eric Yu from Price Intelligently put it:
A/B testing can cause some adverse anchoring effects. In addition, it is iterative and contextual, not absolute. Even if B beat A, that doesn’t mean B is the optimal price point for your product.
However, there is one potentially effective way to A/B test subscription pricing.
That is, you can split test two different prices (say $29 and $39 a month), but when the customer reaches the checkout page, you charge the same price ($29) for both variations. This way, you can test price elasticity without any PR blowback or adverse anchoring effects (by giving them the lower price as the final price, they won’t be aggravated that you ‘tricked’ them to the checkout).
Pricing strategy is hard. It’s also of utmost importance, so putting effort into optimizing it is well worth it. A few quick tips:
- Don’t guess.
- You actually have to talk to customers to get good data. There are tried and true market research methods to determine accurate pricing.
- Offer multiple tiers for your different customer personas. Price them based on the research you’ve done within each persona.
- Don’t do long term or drastic discounting. That anchoring thing works both ways.
- In most cases, don’t hide pricing or keep it secret.
- Evaluate pricing every 3 months. Think about changing it every 6-9.
What do you think? Have you any experience, victories, or defeats with subscription product pricing? Let me know in the comments.