Practical Business Comparison to Conventional Methods
A Recap of Notable Pricing Strategies
Current strategies are failing us, and FairPay promises a more win–win solution. Here we consider a selection of pricing methods that are in wide use, plus some less common alternatives that have interesting features.
A fundamental problem of all conventional methods is that they do not price effectively for a value that varies from person to person and from time to time. For example:
Unlimited or “all you can eat” (AYCE) underprices to heavy users, and overprices to light users.
Set prices of any kind underprice to those who most value an item or are most able to afford it, and overprice to those who find limited value or have limited means.
This results in a deadweight loss to our economy—a loss to society. The set price excludes the large numbers of potential customers who would gladly pay less, and thus would (1) obtain value, and (2) contribute a profit to the seller. This is partly a matter of usage volume. Pricing for usage has always been a problem (think of long-distance phone bills and cellular data), but now it is far more widespread and problematic for products and services that involve significant costs of human creation but low cost of replication. AYCE is especially painful to the creators of content (musicians and authors) who find themselves getting pennies for their hard-earned work (as has been much in the news for services such as Spotify and Amazon Unlimited).
Table 17.1 compares some notable pricing strategies (the rows) for five important attributes that have been discussed throughout this book (the columns). For each attribute, there are one to five squares, intended to serve as a visual bar graph that is suggestive of the strength of that strategy with regard to that attribute (in fuzzy terms, and of course dependent on particular situations). Some background on each of those strategies follows in Table 17.2.
The attributes are:
Post-pricing (versus ante-pricing)—All are ante-pricing in more or less pure form except for some of the participative alternatives (see the further explanation that follows the table);
Customer participation—Most widely accepted strategies allow no customer participation in setting prices (other than buying a given volume/selection or not). The participative alternatives offer participation that can range from shared with the seller to full control by the buyer (Bertini and Koenigsberg 2014);
Perceived value tracking—The extent to which a customer is likely to feel that the price paid corresponds to the value received. As discussed, this is essential to effective pricing;
Relationship/loyalty—The extent to which the pricing strategy is likely to help build a meaningful relationship and feelings of loyalty from customers, including perceived value tracking, and other factors, such as a sense of partnership, responsiveness, and control; and
Commercial acceptance—The current level of use by businesses, especially in markets for digital services (but also other experience goods/services). (Empty squares are shown for value-based pricing to reflect that it is well accepted in B2B markets, but generally not applied to B2C markets.)
This chart shows the significant weaknesses of most conventional methods, and the appeal of the alternatives. It also shows how FairPay promises to be superior in all of these attributes.
Table 17.1 Pricing strategy comparison
Pricing strategy |
Post-pricing (vs. ante-) |
Customer participation |
Perceived value tracking |
Relationship/loyalty |
Commercial acceptance |
Sub scrip tion- orien ted |
|
|
|
|
|
Freemium subscription (AYCE) |
■ |
■ |
■ ■ |
■ ■ |
■ ■■■■ |
Tiered subscription (multiple price levels) |
■ |
■ |
■ ■ ■ |
■ ■ |
■ ■ ■ ■ |
Hard paywall subscription (AYCE) |
■ |
■ |
■ |
■ |
■ ■ ■ |
Usage-priced subscription—flat per unit |
■ ■ |
■ |
■ ■ |
■ |
■ ■ ■ |
Usage-priced subscription—volume discount |
■ ■ |
■ |
■ ■ ■ |
■ ■ |
■ ■ ■ |
Bundled subscription—pre-bundled |
■ |
■ |
■ ■ ■ |
■ ■ |
■ ■ ■ |
Bundled subscription—post-bundled (new) |
■ ■ ■ |
■ |
■ ■ ■ ■ |
■ ■ ■ |
?? |
|
|
|
|
|
|
item-oriented |
|
|
|
|
|
Item unit sale—flat |
■ |
■ |
■ ■ |
■ |
■ ■■■■ |
Item unit sale—volume discount |
■ ■ |
■ |
■ ■ ■ |
■ ■ |
■ ■ ■ ■ |
Item unit sale—bundled |
■ |
■ |
■ ■ ■ |
■ ■ |
■ ■ ■ ■ |
Item unit sale—personalized by seller |
■ ■ |
■ |
■ ■ |
■ ? |
■ ■ ■ |
Mi cropay ments |
■ ■ |
■ |
■ ■ ■ |
■ ■ |
■ ■ ■ |
|
|
|
|
|
|
Participative alternatives |
|
|
|
|
|
Pay what you want (PWYW)—ante |
■ |
■ ■ ■ ■ |
■ ■ |
■ ■ |
■ ■ |
PWYW—post |
|
|
|
■ ■ ■ |
■ |
Value-based |
■ ■ ■ ■ |
■ ■ ■ |
|
|
□□□□ |
Fair Pay (new) |
|
■ ■ ■ ■ |
|
|
????? |
To clarify post-pricing, it can be viewed as relating to a spectrum of degrees of “late binding” of price to usage, as determined after the fact. The essential aspect of post-pricing is that the price rate schedule is not pre-set, but determined after use.
Pure ante-pricing sets all aspects of price up-front, such as with AYCE subscriptions or simple item pricing.
Simple usage pricing is a form of ante-pricing that has some dependency on actual usage—the price rate per item is still set in advance, but the price total depends on the number of units used.
Volume-discounted usage pricing is still ante-pricing, in that the price rate schedule is pre-set, but the applicable unit rate depends on the actual volume used.
Pre-bundling or package pricing is a variation on volume discounting, with the bundles or packages pre-defined by the seller (possibly with a menu of options).
Post-bundling (as proposed in other chapters), applies pre-set bundle/package rates to packages that are composed by the customer on-demand, and then totaled after the fact based on pre-set bundling discount rates.
True post-pricing, as used in this book, occurs when the price rate, itself, is set after the usage, thus including all of the degrees of freedom just listed, plus the ability to adjust the rates, themselves, after the fact.
Post-pricing is late binding, in that it is a form of real options strategy—it delays the pricing decision, and thus enables better tracking to value as realized in use. Late binding can reduce predictability—so when done just partially, and without adequate customer transparency and control, it can lead to unpleasant surprises. That can be a consumer acceptance/fairness issue, such as with simple usage pricing, and to a lesser degree, with volume or package discounts. But when done with customer participation (plus seller protections), as with FairPay, it can most closely approximate win–win value setting.
Table 17.2 adds some commentary on each of the pricing methods in Table 17.1.
Much additional background on most of these strategies and how they compare to FairPay is in other chapters, and more is online (see FPZLink). This chapter concludes with some further discussion of freemium (and we delve deeper into PWYW in Chapter 20).
Table 17.2 Pricing strategy commentary
Subscription-oriented |
Freemium subscription (AYCE) (paywalls) AYCE at a set price, time-limited, split between a limited free tier, and a paid tier, usually just one. This has become very popular as perhaps the best solution readily available for many digital services, such as Spotify, newspapers (metered or “soft” paywalls), and many others. But freemium is still a form of AYCE, with all its inefficiency, and it still has a set price, so the challenge of what price, at what level, remains (see FPzLink). |
Tiered subscription (multiple price levels) Tiers add some correspondence to value, to better segment the market, but still the tiers and prices are pre-set, and do not adapt to the fact that value varies in many dimensions other than just quantity of usage. |
Hard paywall subscription (AYCE) This is the original form of subscription, prior to freemium, and is still widely used. The correlation to value for light users discourages use to the point of hostility to that segment. |
Usage-priced subscription—flat per unit Unit-pricing in subscriptions was common for communications services (voice, mobile, data) but tracks so unpredictably to perceived value (fear of the “ticking meter”) that it has largely given way to other strategies (notably volume discount or AYCE). |
Usage-priced subscription—volume discount This improves on flat unit rates (and reduces fear of the “ticking meter”), and is now common for many communications services. |
Bundled subscriptions—pre-bundled Similar to a volume discount, but for seller-constructed bundles (packages), common for cable TV channel bundles. |
Bundled subscriptions—post-bundled (new) A variant I have proposed—a simple combination of bundling discounts, based on pre-set volume discounts but computed after the fact, based on actual usage. For example, a cable TV offering priced at a bundled rate, for whatever mix of channels/programs was viewed that month (see FPzLink). |
Item-oriented |
Item unit sale—flat Essentially AYCE at a set price, of a single item, forever. This is simple and easy, and works for those who want to make full use of a given item (song, book, video, app, etc.), but tends to make it prohibitive to use very many different items less fully. |
Item unit sale—volume discount Volume discounts generally improve the correspondence to perceived value, and encourage increased purchases. |
Item unit sale—bundled Similar to a volume discount, but for seller-constructed bundles (packages), common for software and games (and of course music albums are bundles of tracks). |
Item unit sale—personalized by seller Seller-side personalization (dynamic pricing) can track better to value as the seller understands it, but is generally poorly received by customers, as being non-transparent, discriminatory, and exploitive. |
Micropayments Small set prices for each small unit. This variant of usage-related pricing has a long history of conceptual appeal and repeated attempts, but is unforgiving, with the fear of the “ticking meter,” and typically does not provide volume discounts. |
Participative alternatives |
PWYW—ante (or Tipjar/Microdonation) This has proven successful in some markets such as indie music, games, and e-books. while it has been well established that most people will pay, and many will pay fairly or even generously, it is still very iffy as a sustainable business model. Its success so far has been greatest in special promotions. (A limiting factor has been the single transaction setting, unlike FairPay.) |
PWYW—post (or Tipjar/Microdonation) Post-pricing has been little used, but has a big advantage in that it encourages the customer to set a more generous price because they need not fear disappointment—and it signals greater trust and confidence from the seller, to further encourage generous pricing. (one older variant is shareware, but with a choice between a set price or zero. Again a limiting factor has been the single transaction setting.) |
Value-based (performance-based, outcomes-based) Collaborative post-pricing based on actual results of use, using pre-agreed criteria—Near the ideal of pricing for value with perfect price discrimination. As currently done, this has been impractical in consumer markets, but it has proven (Shapiro 2002) very effective and efficient in B2B, where the parties can agree on how to measure value and share in the value surplus that the product/service creates, and can do the analysis that takes. Big Data is making this more feasible and effective (Iansiti and Lakhani 2014) in a wider variety of businesses. |
FairPay (new) As explained here—participative post-pricing with a balance of buyer and seller powers, over a relationship (thus unlike PwYw). Applicable to both subscriptions and item sales. It adapts to the fact that value is not just how much you eat, of what and when, but how good is it—a particular and ever-changing mix of how tasty, exciting, nutritious, timely, sustaining, and so on. |
Beyond Freemium
Freemium AYCE subscription is increasingly the dominant model in digital services for consumers, because it has been seen to best address the challenges of free replication and expensive creation. Its combination of a free tier and a premium tier (free + premium) has proven more successful than most prior strategies across a wide range of businesses—as was well described in the 2009 book Free by Chris Anderson (Anderson 2009).
But, while freemium works better for digital, it still has fundamental issues. With regard to the problem of inefficient set prices, freemium just kicks the can down the road a bit, without really solving the problem. A business still has to decide where to set the boundary between free and paid, and what price to set for paid. That is impossible to do efficiently across a wide range of customers—and even optimizing that on average is no easy task.
FairPay takes the driving objective of freemium—exploiting “free” to move toward a profitable relationship over time—and makes that the driver of a dynamically variable boundary between free and paid tiers. FairPay moves the strategic question of what to exchange at what price from a pre-set seller decision to an emergent, dynamic process that balances the interests of the seller and each individual buyer. That provides more nuance and flexibility than freemium’s gross segmentation into just two (or a very few) set tiers (free or paid).
“Making ‘Freemium’ Work” by Vineet Kumar in Harvard Business Review (May 2014), nicely sheds light on companies’ real-world experience with freemium. It highlights the challenges of making it work, and suggests how companies can tune it to get good results. Building on that, we consider how the more individually adaptive techniques of FairPay can be applied to get better market reach and profit, and to build deeper and more profitable long-term relationships. Kumar poses six questions as being critical to making freemium work effectively. FairPay provides a systematic method for answering all of them—by applying a very different logic.
What should be free? With freemium, this is a very visible static parameter that is hard to guess right, and hard to change. With FairPay, the boundary is soft and dynamically individualized.
Do customers fully understand the premium offer? FairPay is built around a structured dialog about offers and value received, and lets customers in good standing try both basic and premium offers whenever they want, and then determine the value they see in it. The process is structured, but lightweight, informal, dynamic, and intuitive.
What is your target conversion rate? Freemium centers on a single all-or-nothing boundary between free and paid. That makes it costly to guess wrong, and either miss much of the market or leave money on the table (by undercharging good customers). With FairPay, “free” users are permitted to pay zero percent of suggested price, while paying users can pay whatever seems fair—the conversion process is one of nudging customers up the pricing curve, and getting them to try (and pay for) more valuable features. This dynamic multivariate optimization process is more complex, but even simple heuristics can offer far more nuance and flexibility than the hard boundary of freemium.
Are you prepared for the conversion life cycle? Early adopters are less price-sensitive than others, and are often people for whom the value proposition is unusually compelling. Freemium has no way to adapt to such variations over time, except to move the boundary for everyone. The core process of FairPay is driven by ongoing dynamic adaptation to different price-sensitivities and value perceptions.
Are users becoming evangelists? Free users can have value as evangelists and also as a target for advertising (a key revenue source for many services), and viral marketing can be very important. FairPay can please customers all along the Long Tail of Customers, not just the free tier, so that they share that with others, and it can also attract large numbers of price-sensitive customers to accept ad-viewing as a way to compensate for a low subscription price.
Are you committed to ongoing innovation? Freemium is very focused on customer acquisition, but does little to address retention. FairPay is designed to do its adaptive work throughout the life cycle, as usage and understanding of the product matures and changes over time. It sets prices dynamically, in accord with current perceived value, and continually drives the seller to make more desirable offers, based on detailed, real-world customer preference data. Retention is always inherent to that.
This chapter seeks to briefly contrast the new logic of FairPay to conventional methods, complementing discussion in other chapters. If additional grounding in prior methods and the general issues of pricing in the digital era is desired, two works are suggested. Extensive coverage of freemium and how to manage it is provided in Seufert (2014). A broad grounding in the basic principles of the network economy is provided in Shapiro and Varian (1999).