If you look at every single SAAS, enterprise, and consumer facing company's website; you will notice that they all have a set of prices and features. This idea is not new and has been a ubiquitous practice. What is often not discussed is why these practices exist from a scientific perspective and how effectively develop the tier pricing model. Most companies either look around the web and copy more established players or develop their own tier offering with much less thought that they should.
Since we know that the price your product is as important as your product itself, being conscious about this practice can significantly improve your revenues.
The first thing to note is that people like choices. I am going to repeat this again: PEOPLE LIKE CHOICES. So given this statement, the worst thing that a company can do is not to give the customer a choice. If the customer does not see a choice in your offering, they will subconsciously create a choice in their head. In this case they will decide between pay for your product or not. If on the other hand, you have a nice set of offerings, the customer's attention will be focus on choosing between which of the offerings that best suits their needs. As you can see here, including choices in your offering changes the type of decision that the customer is thinking about. In the first case, they are focusing on the choice of whether to buy or not. In the later case, they are focusing on which offering to buy. This makes a big difference on your revenue and so you always want the customer in the second state of mind.
When creating a tier pricing model, you can also run into the problem of giving too much choices. Typically beyond 5 alternatives, clients have a difficult time of assessing which one is the best for them. This may lead to frustration and given the difficulty of making this decision, the client might not choose any of the alternatives. This is a classical case of paralysis by analysis. When making a decision, people want to be assured that they are making the right decision. If your pricing strategy can give a sense of assurance, your conversion rate will also be higher. Likewise people also want to walk away from the process feeling happy about their choice. Remember that whenever we make a purchase, we want to feel good about it afterwards. Bonus points if you make them feel so good that they will tell their friends about you.
So in order to create a fine balance between too few options and too many options, the good rule of thumb is to create between 3 to 4 choices for the customers with different features and price points. The exact method for how to create this price discrimination and feature discrimination will be discussed in greater detail in a later post. I will cover some basics here.
Within each of these tiers, the feature set needs to suit a particular customer demographic. For example, offering 1 is best for the small business owner. Offering 2 is best for a medium enterprise with 100 to 500 employees, etc. By deliberately alining the offering with a particular customer, you can more likely induce the affect of having a customer know that the choice that they pick is the right one for them.
There is also a number of tricks that you can use to enhance your pricing strategy. One of the most predominate trick is creating the "dummy or decoy" offering. The "dummy or decoy" offering is an offering that you know very few people would go for but the existence of the offering creates an anchoring effect to the other alternatives and frames the decision in a positive way. For example, expensive restaurants always list a few very expensive dishes and wine knowing that few people would purchase them. These alternatives create a psychological frame so that clients would feel happy when they order a slightly less expensive dish because they get to think that they are getting a great value. The "dummy or decoy" alternative is quite interesting because you often create this alternative to generate a comparison between our product and a more expensive competitor. You know that most people will not choose it but its existence can help the client's internal team justify your solution over the competitors. The reason that this trick works so well is that in decision-making, people generally think in terms of relative differences rather than absolute differences.
Another trick that you can play around with is the psychological perception of different numbers. For example the difference between $69, $70, and $74.99 are quite different even though they are not that far apart numerically. In this is an area where the best way to test is through experimentation but as with the other tricks this can make a big difference in the conversion rate.
A third trick that you can use is called anchoring. I learned this from a street performer in Europe. Whenever he performed, instead of asking people for a specific amount of money, he would say: "If you enjoyed the performance please support us with a small donation. I think that our performance is worth the sam price as 1 or 2 cups of coffee". In this situation, he anchors his services to a price of a cup of coffee which is familiar to the audience. In doing so he is able to get a reasonably good amount of money from everyone. You can apply the same trick to enterprise software as well for certain pricing situations.
So overall this post talks about the paradox of choice and how to use it for creating a tier offering for SAAS products. Every organization, every software, and every industry is unique and these are just some guidelines. One thing to take away from this post is that pricing strategies are a lot more complex than what most people think. Within this complexity is opportunity to fine tune your offering to increase revenues.
If you have any further questions about this post please email at: doanh [at] paramountdecisions [dot] com.
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