We have written many times before in our blogs and newsletters that customers are not all equal. They have different needs, they value product attributes differently, and they have varying levels of price sensitivity. In order to address these multiple customer segments, it is common to have multiple variations of a product or service offering – a Good, Better, Best product lineup. Beyond just creating multiple offerings, your pricing strategy needs to include getting the relative positioning right. Your profitability depends on it.
There is no perfect number of alternatives or options to offer customers, but how many you will offer is an important question to answer. If you do not offer enough options, you run the risk of missing some customer segments by not specifically addressing them. Conversely, if you offer too many options, it is easy for customers to be overwhelmed with the complexity and not make any choice. To determine your best number of offers in your product lineup, consider the ease with which customers can assess the differences, the number of competitive offerings that exist, the range of values perceived by customers, and your capability in managing the range of products or services.
In addition to determining how many products to offer within a lineup, it is also important to determine how the price of each product or service will relate to the others. Multiple studies have shown that when faced with three or more options, customers tend to choose the middle option more frequently than the highest or lowest priced offer. Customers often avoid picking the least expensive offer because they don’t want to feel like a cheapskate. And they often avoid the most expensive option, because they really aren’t extravagant and do not need whatever additional benefits the highest options offer. So they go with the middle.
Thinking about this behavioral tendency can help you execute a stronger pricing strategy. If your goal is to maximize your profitability over time, you will need price points that attract customers at multiple levels of value. But what if you find that your results are skewed in that a large percentage of customers are picking either the most expensive or least expensive option? In that case, the prices of your product offerings are probably not aligned with their relative levels of value.
Try to plot the relative values that customers attribute to each of your products compared to the prices of the products. The result is a Value Equivalence Line (VEL). If your products appear similar to the unbalanced graph to the left, your less expensive product A is probably gaining a higher share than is appropriate. That is because it is value advantaged. That means customers who might want more features find greater relative value in product A and choose that instead of a higher priced product.
To correct this, you want to ensure that your offerings are relatively balanced on the VEL, similar to the second graph on the right. In this case the prices of the products line up with the values customers place on them. If VEL is currently unbalanced, start to correct it by adjusting prices. In this case, you would consider raising the price of product A and lowering the price of product D.
When making these adjustments, evaluate your overall profitability, not just sales. Lowering the price of the higher priced product D will likely increase the number of buyers of product D, but it will also reduce the price to existing buyers. Conversely raising the price of product A will also likely cause a few existing buyers to stop buying, but that customer reduction should be offset by the higher margin from those who continue to buy and those who migrate up to product B. It is important to model the potential scenarios and understand the impact on profitability from each. It is not terribly complicated and will help you make more informed decisions.
You know customers come in all shapes and sizes. If you organized your efforts around developing offerings that create value for those customers, make sure you also do the work to capture that value for your shareholders by setting the appropriate prices.