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Strategic pricing for product managers

Overview of basic pricing techniques for Software and SaaS product managers

Strategic pricing for product managers

  1. 1. Strategic Pricing for Product Managers By: Rama Ghanta Key Source: “The Strategy and Tactics of Pricing”, 5th Edition, Thomas Nagle, John Hogan, Joseph Zale 1
  2. 2. Objective  Understand the basics of pricing process and the role of Product Management to successfully drive the product pricing strategy Topics Covered:  Need for Strategic Pricing  Economics of Pricing  Pricing Techniques  Identifying Willingness to Pay  Role of Product Management 2
  3. 3. Recognizing Need for Strategic Pricing • Companies that grow profitably in changing markets often break the old rules and create new pricing models • Spirit Air unbundling of passenger air travel, leading to 16% operating margin1, highest in US airline industry • Apple’s pricing per song instead of album, moving firm to market leader • Adobe’s successful business model transformation – from license to SaaS based pricing • Most companies make pricing decisions in reaction to change rather than in anticipation of it • According to ValueScan Survey, effectively executing value-based pricing strategies earn 31% higher operating income • Product Managers are key to identify the business model changes and value drivers to successfully drive the pricing strategy 1. Bloomberg.com, “The Most Hated U.S. Airline Is Also the Most Profitable”, April 2014 Developing pricing tactics to address business model, customer and competitive forces proactively and implementing pricing changes to maximize profits What is Strategic Pricing? 3
  4. 4. Economics of Pricing 4
  5. 5. Product Pricing through Basic Economics • You are planning to launch a new product, how do you identify the price point? Demand per Month PriceperUnitperMonth 10k 20k 30k 39k 50k $0 $100 $150 $200 $250 $300 Total Revenue of $5M per month 100k 10k 20k 30k 39k 50k $0 $100 $150 $200 $250 $300 100k PriceperUnitperMonth Demand per Month  Plot estimated demand at a given price point, typically provided by product marketing  Total revenue is the area in the shaded region  Assuming that the demand goes down as price increases Total Revenue of $6M per month Total Revenue of $3M per month Estimating demand of 50k units at a $100 price point 5
  6. 6. Product Pricing through Basic Economics - 1 2 3 4 5 6 7 0 20 40 60 80 100 120 0 50 100 150 200 250 300 350 0 20 40 60 80 100 120 Demand Cure – shows the quantity of goods consumers are willing to buy at a given price Pricing for Maximizing Revenues – A Price point where revenue is maximized due to the demand Revenue Maximizing Price at $200 Demand per Month PriceperUnitperMonth Demand per Month Each data point indicates the demand at a given price point Product Demand Curve RevenueinMillionsperMonth Each data point indicates revenue based on the demand • Identifying the price point through Revenue Maximization 6
  7. 7. Product Pricing through Basic Economics 0 50 100 150 200 250 300 350 0 20 40 60 80 100 120 Demand in Thousands Price($)PerUnitperMonth Demand Cure – shows the quantity of goods consumers are willing to buy at a given price Revenue Maximizing Price, $200 PEPM  What about customers who are willing to pay less than $200 PEPM? • Are there specific product features that are not valuable for these consumers? • Can a new entrant with lower cost structure capture that market?  What about customers who are willing to pay more than $200 PEPM?  How can we capture value in Consumer Surplus? (showed in the Green shaded region) A single price strategy may not be an effective tactic. An Offering Structure with different price points for various customer segments can capture the most value from the market Consumer Surplus Based on Demand Curve, $200 per unit will maximize the revenues 7
  8. 8. What are some other Challenges…. • Several other factors influence the Strategic Pricing • Corporate goals, for e.g., pricing to gain market share • Competitors pricing and their reaction to price changes • Customers willingness to pay/ perceived value • Market characteristics – Emerging, Growth, Maturing • Fixed and variable costs So what techniques do companies use to pricing products? 8
  9. 9. Pricing Techniques 9
  10. 10. Common Pricing Strategies do not Address Challenges…  Pricing is derived based on a fair return over fixed and variable costs of production  Historically, the most common pricing mechanism  Typically driven by Finance  Unit cost becomes a moving target  Leads to overpricing in weak markets and underpricing in strong ones  Customers don’t “care” about cost of production  Achieved by pricing based on customers willingness to pay (WTP)  Similar to value based pricing  Driven by Sales or Product Management  Sophisticated buyers are rarely honest about actual WTP  Customers may not realize the true value of product, so WTP may reflect perceived product value  Raising customers WTP by communicating true economic value is key  Pricing based on competitive conditions  Pricing is a tool to achieve sales objectives or corporate goals  Reactive pricing based on changing market conditions Cost Driven Pricing Customer Driven Pricing Market Driven Pricing Source: “The Strategy and Tactics of Pricing”, 5th Edition, Thomas Nagle, John Hogan, Joseph Zale 10
  11. 11.  Although more than one strategy can achieve profitable results, successful pricing strategies embody three principles:  Value-based: Pricing reflects the actual value to customer  For e.g., Adjusting pricing based on the value derived by customers  Pro-active: Anticipate disruptive events and develop mitigating strategies  For e.g., Spirit Air unbundled the elements of passenger air travel – charging separately for baggage, select selection, beverages  Profit-driven: Evaluate success through long term profit metrics rather than market share  For e.g., When Alan Mulally took charge as Ford Motor Company he declared that Ford would focus on selling cars profitably, even if that meant losing market share What is Effective Pricing Strategy? Source: “The Strategy and Tactics of Pricing”, 5th Edition, Thomas Nagle, John Hogan, Joseph Zale Identifying key product features and their true economic value to customers should be driven by Product Management 11
  12. 12. Steps to Identify True Economic Value of Product to Design Offering Structure 1: Identify Customer Value Drivers & Design Offering 2: Estimate Economic Value Customer Value Drivers: Product or Service characteristics that creates value to customers there by providing an economic advantage (like lowering the total cost) Based on Customer Value Drivers, design Offering Structure: Bundle of products and services that are designed to cater to specific customer segment. Quantifiable estimation of the economic advantage gained by customers due to the value drivers. For e Source: “The Strategy and Tactics of Pricing”, 5th Edition, Thomas Nagle, John Hogan, Joseph Zale 12
  13. 13. 1: Identify Customer Value Drivers Four Key Areas – Customer, Product, Competitor and Organization – will help with Defining Value Drivers  Why do customers buy our products?  What are key segments?  What are the benefits derived by each segment?  What is impact on current revenue and cost structure?  Who are key competitors?  What is the value offered by competitor products?  What is the competitive differentiation?  What are the value drivers of competing products?  What are price points?  What are key product features?  What is our product differentiation?  What is the current usage pattern?  What additional value added services does our product provide?  What are the price points  What is our organization strategy to compete in the market?  How has our company historically able to price profitably in the market? Value Drivers & Offering • Customer interviews • Direct surveys • Advanced analytics like Conjoint Analysis Key Questions that can help with defining value drivers Inputs • Product data sheets • Historical transactional data • Market and Product requirements documents • Market and competitive analysis • Market requirement and product requirement documents • Organization strategic goals • Business unit objectives and targets Key to identifying value drivers Key to designing offering structure Inputs 13
  14. 14. 1: Define Offering Structure based on Value Drivers Category Freemium Trial Value Premium CoreOffering Value Driver # 1 Value Driver # 2 Value Driver # 3 Add-OnProductsSupportServices Basic Offering Premium Offering Bundle 2 Bundle 1 Bundle 3 Bundle 4 Core offering: Includes one or more value drivers Representative mapping of bundles to features/ products Sample Offering Structure Add-ons: Offers secondary benefits, in addition to key value drivers Support Service Offer all or majority components for a limited time Offer few components for unlimited time 14
  15. 15. 2: Estimate Economic Value Price Floor – based on products available in market that deliver low value compared to your product Reference Price Point Price Ceiling – based on products available in market that deliver lot more value that your product Sample Pricing Waterfall for Premium Bundle Price Offering Structure Components $200 +15% Additional Value Delivered due to Product Value Drivers -5% +10% Support Services Price Estimation for Premium Offer: $240 Can be obtained by competitive product price points or by estimating value of products/ features that are table-stakes Value Customer Expects, but Not Offered by your Product 15
  16. 16. Identifying Willingness to Pay 16
  17. 17. Methods to Identify Customers Price Sensitivity Direct Surveys Conjoint Analysis  Conduct survey to identify the willingness to pay  Questions have to be worded so WTP can be estimated based on customers response  Customers perception of value may not translate intro real purchasing behavior  Measuring individuals’ preference through variations of product attributes  WTP does not only depend on the composite product but also on alternative product offerings, so- called reference products 17
  18. 18. Steps to Applying Conjoint Analysis Overview of Conjoint Analysis (Page 1 of 4)  Conjoint Analysis is a technique used to determine how customers value different features/ products that make up a product/ bundle Lets design a survey to measure preferences for a snack box, with following options:  Drink – Coke or Fanta  Spread – Honey or Nutella  Salty Snack – Chips or Pretzels  Price – $4 vs. $5 Rate snack box combinations from 1 (strong dislike) to 3 (strong liking) Drink Spread Salty Snack Price 1 2 3 Coke Honey Chips $4 Fanta Nutella Chips $5 Coke Nutella Pretzels $4 Conjoint Analysis is best understood through an example 1. Select Attributes 2. Select Attribute Levels 3. Create Product Profiles 4. Collect Data 1. Attributes 2. Levels 3. Product Profile Sample Survey 18 Source: “Conjoint Analysis: A Do it Yourself Guide”, Harvard Business School, August 2014
  19. 19. Overview of Conjoint Analysis (Page 2 of 4) Steps to Applying Conjoint Analysis 1. Select Attributes 2. Select Attribute Levels 3. Create Product Profiles 4. Collect Data 5. Estimate Values 5. Conduct Regression Analysis: Mathematical process for estimating relationship among variables. There are two variables:  Dependent Variable – The main factors that we are trying to predict. For e.g, the score from customer surveys (1 through 3)  Independent Variable – The factors that have an impact on dependent variable. For e.g., the various combinations of product features that impact customers preference Rate snack box combinations from 1 (strong dislike) to 3 (strong liking) Drink Spread Salty Snack Price 1 2 3 Coke Honey Chips $4 Fanta Nutella Chips $5 Coke Nutella Pretzels $4 Independent Variables Dependent Variable  Conjoint Analysis is a technique used to determine how customers value different features/ products that make up a product/ bundle 19
  20. 20. Overview of Conjoint Analysis (Page 3 of 4) Steps to Applying Conjoint Analysis 1. Select Attributes 2. Select Attribute Levels 3. Create Product Profiles 4. Collect Data 5. Estimate Values b1 (Coke) + b2 (Fanta) Select a Drink Select a Spread Select a Snack Select a Price Weight for independent variable Output of Regression Analysis Drink Coke = 0.67 Fanta = 0.51 Sample Output Weight for independent variable  Conjoint Analysis is a technique used to determine how customers value different features/ products that make up a product/ bundle Spread Honey = 0.10 Nutella = 0.72 b4 (Honey) + b5 (Nutella) Snack Chips = 0.17 Pretzels = 0.50 b6 (Chips) + b7 (Pretzels) Price $4 = 1.04 $5 = 0.50 b8 ($4) + b9 ($5) 20
  21. 21. Overview of Conjoint Analysis (Page 4 of 4) Steps to Applying Conjoint Analysis 1. Select Attributes 2. Select Attribute Levels 3. Create Product Profiles 4. Collect Data 5. Estimate Values 6. Derive Insights Best Product Combination for our Snack Box Drink Coke = 0.67 Fanta = 0.51  Conjoint Analysis is a technique used to determine how customers value different features/ products that make up a product/ bundle Spread Honey = 0.1 Nutella = 0.72 Snack Chips = 0.17 Pretzels = 0.50 Price $4 = 1.04 $5 = 0.50 Customer Preference 0.67 + 0.72 + 0.5 + 1.04 2.93 The Maximum Score for a Product Combination is 3, with 2.93 the combination of Coke, Nutella, Pretzels at $4 is the best offering 21
  22. 22. Role of Product Management 22
  23. 23. Role of Products in Driving Pricing Evangelize product Define compelling value proposition Monitor Market/ Business Model Trends Orchestrate product development and delivery Envision product roadmap Identify and assess opportunities Product Manager Understand Customer Needs Operations - CPQ Product Marketing Sales $ PricingCorporate Collaborate to realize Strategic Pricing through data driven inside-out and outside-in view point

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