How to Use Product Differentiation to Optimize Your Pricing Strategy?

Each time when some new gadget is about to be released people discuss not only its features but also its future price. The same thing was with Apple when they were about to release iPhone 5C: Many bloggers published posts about what features this new device will have and mentioned pricing parameters. At the same time many users expected that Apple will release a low-cost iPhone model with a limited set of the most important features and probably with quite simple design.

Such people were in for a big disappointment: the new 5C model turned out to be a typical iPhone made by Apple in bright plastic cases at the price of $550, which is just $100 less than the price for their flagship 5S.

Although many people criticize Apple marketing experts and engineers for too high price for iPhone 5C, and while these people predict that this model won’t manage to win significant market share in the developing markets, Apple’s CEO, Tim Cook, explicitly indicated that Steve Jobs’ brainchild “does not produce second-class products», and that company has no intent to get in good with those buyers who are too price sensitive. Mr. Cook inherently said the following: We decided to offer a little bit less expensive version of iPhone that will still not be associated with a cheap brand.

Whatever the case, but it’s obvious that this is an overt attempt of Apple to get the piece of a pie in the mobile industry segment where people are not ready to pay a lot of money for the new iPhone version. However, it’s worth examining Apple’s price strategy, where they offer “downsize, lower-quality” versions of their products.

Such price policy will best suit the companies providing SaaS (software as a service) solutions and willing to have efficient price strategy for their products.

Why you should work with people who are ready to pay less

It’s clear that not every brand can successfully apply price lowering and at the same time still maintain relatively high prices – Apple can afford it because of its strong brand. However, the vast majority of business models allow significant increase of revenue by covering those customer segments that are ready to pay less.

Anyway, you can always test whether in your concrete case it is reasonable to provide inexpensive services that include only basic features and whether it will considerably increase your revenue via aggregate sales amount increase and turnover increase (even Apple decreases prices occasionally to get more customers). However, we can additionally note that if a company ignores the segment of price sensitive customers, it chucks away at least two obvious benefits.

Benefit 1: base price can remove price barrier

Any service company (including SaaS solutions) has quite a lot of opportunities to differentiate their product by several price levels. Price increases will usually depend upon the scope of available features, types of user licenses, scope and amount of projects to be implemented etc.

In this situation it is strategically important to set a balanced, reasonable base price. Don’t worry too much that a minimum set of features will make your offer unappealing or useless— there is always a category of customers that will be glad to pay for some basic features. Otherwise these people will not be able to step over the premium price barrier.

Here’s an example from another industry of how New York Times differentiates its services and builds its pricing policy.

Its sales department is aware that more and more people prefer to get information in a digital format. Taking this into account and also willing to optimize all sources of financial benefits to their full extent this newspaper offers monthly subscription at the price of just $15. For this fee their subscribers get access to a limited amount of publications that can be viewed in a digital format only on their website or on a mobile device.

Other subscriptions cost several times more, and the closer your subscription option is to a real paper edition, the higher the price is. Although it’s not worth cloning this model completely, this is still a very good way not to lose readers who esteem NYT publications but are not ready to pay the whole range of traditional subscriptions.

Benefit 2: customers that are not ready to pay more can change their mind

Instead of ignoring the whole customer segment and treating them as those who are not ready to pay forever, you can offer them a less expensive version of your product. In this way you can reserve the right to later nurture them and upgrade to a more expensive plan (or purchase a more expensive product) in the future.

This model, however, should not be confused with a so called freemium plan (free + premium), when you initially get free services with an option to use paid premium plans indefinitely.

Price differentiation model has advantages of a freemium model (provision of a service at the discounted price) and doesn’t have disadvantages of freemium plans (you get not much money for a light version of your product, but you still get some income right here and right now).

If you as a SaaS provider give your potential customers an option to use free version of your product, maybe it’s not worth setting too big price gap between free and paid options (let’s say $50/month); instead, you can offer less expensive option (with a limited functionality) at the price of let’s say $25/month. Such pricing policy allows reaching 2 important goals at once:

  • It builds a solid foundation for future migration from a free plan to inexpensive paid plan;
  • It establishes business relations between a company and a customer that can gradually transform into trusting relationships and as a result willingness to pay premium price for a full-featured service.

These two things often bring positive results for one simple reason: while using inexpensive option of a service your consumers develop their businesses to the next level. Current limited functionality is not enough for them anymore, and in such a natural way they gradually upgrade to more expensive plans.

But what about cheapening the brand?

It may seem that provision of less quality products or inexpensive options will inevitably lead to concerns regarding dilution or cheapening of the brand itself.

For example if we speak about attacks on less expensive iPhone model, there are people who already compare Apple’s price policy with a stillborn branding of Burberry. This company developed their own textile patterns and started selling the license for it to anyone who was ready to pay for it. With the time this tactics led to the fact that most people didn’t associate Burberry with prestige. However the difference between Burberry and Apple is obvious – Burberry tried to sell itself to any volunteer, and Apple offers iPhone for just a little bit reduced price.

5C differs from the flagship 5S model just with several features (no Touch ID (fingerprint scanner) option, plastic case, etc.) and at the same time it remains fully committed to all Apple traditions. That is why it is logical to assume that a mobile device with fewer features should cost less, although this fact doesn’t give the right to claim that 5C is not Apple iPhone anymore.

Another quite real danger related to this topic may be self-eating of the brand. However, this unfortunate marketing phenomenon happens when there is a big discrepancy between product differentiation and its price. In other words the pricing plan of $25/month should contain the amount of features that is worth this money. As a result if the service with a pricing plan of $50/month provides two times more features, there will be no self-eating by the brand.

Besides further to our example with a SaaS provider, it would be not logical to offer a pricing plan of $50/month to those people who have hardly paid the service at the price of $25/month. It is also reasonable to assume that this state of affairs will not prevent the company from promoting its premium services to a corresponding category of people who is ready to afford it.

Product offers at discounted prices — an opportunity for growth for the buyer as well as for the seller

Of course a cheaper version of your product or service is no panacea for all business situations. However, if you think that the base price of your basic product makes selling harder and prevents your business from further growth, then you should thoroughly consider the matter described in this post. The process of developing an efficient pricing policy is not static and needs experimenting with price differentiation and with further analysis of how these price changes affect your potential customers’ behavior.

At the same time please note that offering your services at discounted prices facilitates acquisition of new customers who have real potential for further growth. And it means that with the time they will inevitably get a need for a wider range of features (of course at a higher price).

May higher conversions be with you!

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