What You Can Learn From Microsoft And Starbucks

Pricing our products, services and time can be a tricky business. I’ve spent many hours scratching my head and wondering what a “fair price” would be for my latest products. In reality, there is no such thing as a fair price.

It’s impossible to set a price point that satisfies the maximum amount each of your customers would be willing to pay. You are always going to have customers who scoff at the price. And you are always going to lose money by failing to ask enough of those who have personal valuations higher than yours.

Most of us try to find a middle ground.

We have to balance the advantages of securing many low value sales against making fewer sales at a much healthier margin. The conventional persuasion suggests that more sales is better business. So we lower the prices. This may produce the increased sales, but how many of those customers would have paid much more had we simply asked them to do so?

If the answer is “too many”, it’s time to start taking price targeting seriously. Price targeting is the art of setting different prices for different markets to maximise profits and increase sales in one efficient swoop.

Sounds Pretty Cool, But Who Else Is Price Targeting?

One of my favourite examples comes courtesy of The Undercover Economist, an excellent must-have book that really sheds some light on the relationship between consumers and their purchases.

The book dissects price-targeting by using the example of a cup of coffee.

How much is a cup of coffee worth? Some people will pay $2, others will happily hand over $3. The difficult decision is how to price the coffee in such a way that it’s cheap enough to attract maximum sales at a profitable margin, but expensive enough to milk maximum profit from those who are less money-conscious about their caffeine fix.

Price the coffee too high and you’ll lose sales. Price it too low and you’re leaving money on the table. To find the middle ground, they would have to establish a price that balances the best of both worlds. But there’s actually a much better way of doing business.

So what does the coffee house do?

Take a look at the drinks menu and you’ll see exactly what they do. They use a staggered pricing model.

An ordinary no thrills latte can be picked up for a couple of dollars. This satisfies the customers who would go elsewhere if the coffee became too expensive. And then you have the shit that my girlfriend orders. The premium chilled white mochawhatever blend at over $3. These drinks appeal to the luxury seekers. Those who can justify spending more because they place a higher value on good coffee, and will pay the premium to get their fix.

Many of us assume that because the lavish coffee at the bottom of the menu costs twice as much as a regular latte, it must be twice as expensive to produce. This is actually a textbook demonstration of price targeting.

Realistically, it only costs a few extra cents to produce the luxury drink. But the mark up value could have you believe that the shop is sourcing ingredients from a distant organic paradise. This is rarely ever the case.

The lavish coffee shows how much the shop WANTS to charge, and the budget coffee is what it can AFFORD to charge. The shop has the means to sell the luxury coffee at a few cents more than the ordinary latte and still make the same margin of profit. But to do so would be to set a uniform price for all coffee lovers, when some are quite happy to pay the premium.

How Price Targeting Can Work For You

How can we spin the coffee example in to something that an online entrepreneur would be familiar with? Well how about we start with the notorious “full support” upgrade that comes with many online services?

How many times have you compared prices for a digital product only to find that the biggest price hiker is 24/7 support?

Your web server might only cost $50/month with the regular plan. This is a price point that is designed to attract the budget brigade. But your hosting provider knows full well that not every professional is budget conscious when it comes to his web hosting. For those who are prepared to pay more, why leave the money on the table?

If throwing in unlimited 24/7 support allows the provider to charge $75/month instead of $50, they have found a way of appealing to both those who are happy to pay more (extra value, peace of mind), and those who can only justify the budget option.

But then you have to ask yourself; What is the true cost of providing 24/7 customer support? Most of the companies who offer this upsell ALREADY provide 24/7 support for their budget customers. But it doesn’t make sense to campaign on this information. You can’t expect your premium customers to pay the extra $25/month if the budget customers are enjoying the same quality of service for less money.

Many companies will actually make a conscious effort to devalue their “starter packages”, knowing full well that they can’t allow the difference in service to become so marginal that a high paying customer would realise there is little to gain in paying more.

Is there really a need for so many different versions of Windows? We have Home, Professional and Ultimate. Microsoft could quite easily bundle all the capabilities of Ultimate in to EVERY installation. But if my Home edition were as powerful as the Ultimate edition, how could Microsoft possibly charge corporate companies through the nose for the same product? So, of course, Microsoft takes it’s carefully designed software and sabotages it.

They remove enough features to create three very different markets that price themselves accordingly. Crazily enough, the cost of rolling out the weaker product is often greater than the premium version. The additional effort of stripping away functionality can incur extra costs. But it’s worth it for Microsoft because the cream of the crop will be handing over an extra $100 per installation.

When you board an airplane in economy class, do you really think your legs are cramped because the massive profit spinning airline couldn’t afford to specify a few extra cms of room when designing the aircraft? The experience is designed to be marginally uncomfortable so that these companies can still milk money from the picky flyers who are willing to pay extra for first class.

Examples of effective price targeting are all around you. From the trains you board, to the groceries you buy, to the clothes you wear. We make decisions everyday on the value of these items. You should give your own customers every opportunity to find a deal they agree with.

Price Targeting Is Just Plain Smart

When you look at your own products and services, ask yourself what could you be doing differently to effectively price target your customers. Developing a fantastic solution gives you enormous control. You may be selling your product at $150 and attracting sales from both the budget spenders and the corporate ties and suits.

Think about what could be added to the product that would allow you to charge $250. And what could be removed that would allow you to capture more customers at $100?

Structured price targeting gives you the ability to place the ball in the customer’s court and ask: “How much are you willing to pay?” If you never ask this question, you will never realise your maximum sales OR your maximum profit margins.

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About the author

Finch
Finch

A 29 year old high school dropout (slash academic failure) who sold his soul to make money from the Internet. This blog follows the successes, fuck-ups and ball gags of my career in affiliate marketing.

2 Comments

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  • Fantastic article,I tried something similar in two different local markets. After deciding to up the price in one of them I then began to realize that customers give a product or service more value just because the cost is higher ( no additional features just a fancy new brochure)

  • Knowing which is the right price you can market your good or service is definitely not an easy endeavour. Quality and added valueare certainly components you must put communicate on unless you want to be competiting with the mainstream version of your product/services (in that case, prices are similar with competitors).
    In Europe, local pricing comes out through the delivery costs which will be different depending on where the e-retailer and the customer are, otherwise, the price is usually the same (if sold through the same website, having different retail sites and targeted marketing could permit local pricing).
    Thanks for this great post.

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