Price: Why Lower Isn't Always Better

I want to tackle the issue of forecasting and projections next in the MBA Mondays series but I don't yet have an outline in my head of how I am going to approach this critical subject. So I am taking a breather this week and instead will tell a story I heard from a marketing professor in business school.

This professor did a lot of consulting on the side. He was known as a highly analytic marketing expert. He was asked to take on a french producer of champagne as a client. This champagne producer was trying to enter the US market but was not selling very much of their product in the US.

The professor did an analysis of the "five Ps"; product, price, people, promotion, and place. He determined that the champagne was of very high quality, it was being distributed in the right places, and that the marketing investment behind it was substantial. And yet it wasn't selling very well. 

He did an analysis of comparable quality champagnes and determined that this particular producer was pricing his product at the very low end of the range of comparable product.

So the professor's recommendation was to increase the wholesale price such that the retail price would double. The client was very nervous about the professor's recommendation but in the end did it. And the champagne started selling like crazy. They couldn't keep it in stock.

The morale of this story is that price is often used as a proxy for quality by customers, particularly when the product is a luxury item. By pricing the champagne at the very low end of the range of comparable product, the producer was signaling that its product was of lower quality than the competition. And by raising the price, they signaled it was of higher quality.

So when you are selling something, be it advertising, software, or something else, think carefully about how you are signaling the market with your pricing. Having the lowest price among your competition might be the right strategy but it might also be the wrong one.

#MBA Mondays

Comments (Archived):

  1. Julien

    I think there is a notion of “perceived price”, which would be what people think a fair price is. It’s obviously more of a range, than an actual value, but being out of it (either upper or lower) is a bad place to be!

    1. Orrin Xu

      Well said, for example even if the product is of the highest quality, if it was made in china people instantly think it isn’t well made. Likewise, european cars = quality. This perceived value is immeasurable but if harnessed properly can make a huge difference

  2. Pascal-Emmanuel Gobry

    You always hear a story like this in business school. And they’re absolutely right.Funny enough, it also came from my marketing professor, who was also very active on the side (serial entrepreneur (we almost started a company together and he started another with a friend I knew from his class), business angel, and previously had led or had high level positions in pretty big companies). The story involved a French beauty products company and not champagne, and Japan instead of the US, but the problem and the solution were the same. ๐Ÿ™‚

  3. Dan Ramsden

    I struggle with the issue of forecasting and projections also, especially in digital media, and this champagne pricing discussion is a perfect illustration why.When champagne will always be champagne, you can adjust pricing strategy and financial planning falls into place easily enough: numbers of units sold, profit margins, etc., now and in the future.But what if champagne stops being champagne by year 2? And what if it is impossible to determine what champagne will become? Units sold and pricing on champagne per se is then a senseless forecast. And champagne pricing strategy even in the present could be an empty exercise.Digital media is so full of champagne products today that will be something not champagne tomorrow. Which is not to say better or worse than champagne, but just different. And different in a way that is still TBD.

  4. Philip J. Cortes

    I couldn’t agree more – Maureen Chiquet (Global CEO of Chanel) recently commented on how Chanel sometimes chooses to reduce or halt production of a very popular item in order to render it scarcer. This might seem counterintuitive at first, as Chanel is a profit maximizing firm, but her argument is that Chanel’s greatest strengths are its brand (positioned as a luxury good) and creativity. There are times where it makes more sense for the long term, strategic longevity of the brand to render popular items scarcer. I too agree that price can have this same strategic implication, but only if it lines up properly with your product. Not all products and services can be positioned as a luxury good – and teasing that line sometimes is the hardest part.

    1. Tereza

      Scarcity is an excellent tactic to highlight the value of your product.It also can be employed artfully in game-like marketing strategies, to great effect.You must create and maintain the perception of superior value in order to exact a premium.I mentioned Beverages as a prime industry to look at, but cosmetics are another. Cheap to manufacture, all about the positioning and perception.

      1. Scott Carleton

        Speaking of scarcity in a market. If you watch energy at all, look at how Exxon and some others are starting to store up their Natural Gas while they tell their wells and pumps to stop operating. As in the past they are waiting for prices to sky rocket and with their heft they can corner the market. Different approach to highlighting the value of your product. I guess champagne doesn’t have inexhaustible demand though ๐Ÿ™‚

        1. Tereza

          Don’t get me started on the Exxons of the world. What a racket.It bears saying that too much cheap champagne = a really big headache.My mom used to say, don’t eat bad chocolate. Save your money and calories and splurge on a single piece of the good stuff.

          1. Scott Carleton

            Oh if only the world’s infrastructure followed your mom’s advice. Woe is me.

          2. Tereza

            I really do wonder if that’s shifting, Scott.I’ve witnessed some low-cost service firms get abruptly fired in the last few months from some big enterprise jobs. Their price tags looked fabulous up-front, but a few weeks on the job and the lack of quality quickly became a big problem.Find clients who’ve been burned by low-cost providers.

          3. Scott Carleton

            Well this is certainly occurring in the renewable/alternative energy field. Problems seem to happen when the feed-in tariffs/subsidies don’t return a profit even when they were designed to pay off when no power is produced. Shoddy maintenance, poor quality work etc compound the issue. On such large, capital intensive projects, investors seem to want to take cheap up front investments that can turn around in less then a decade. They would be better off listening to your chocolate advice and save up for a large upfront capital cost with low operating fees that provides steady returns for decades.

          4. Tereza

            I often find chocolate is the solution to big problems.:-)

          5. Matt A. Myers

            I was problem solving tonight…

          6. Fernando Gutierrez

            I’m afraid that too much expensive champagne also gets you a big headache inmediatly! And a second one when you recover and realize how much that first headache costed you!

          7. Dave Pinsen

            Exxon is a racket? Exxon is a great company. It’s prudently run, with an eye toward the long term; it provides needed products; employs tens of thousands of workers, from roughnecks to scientists and engineers, at good wages; pays plenty in taxes; and has rewarded shareholders with high long-term returns for decades (it would reward them more if it scrapped its share buybacks for increased dividends, but that’s a minor bone to pick). We could use more companies like Exxon, and fewer like Goldman Sachs.

          8. Tereza

            It really got my craw when they jacked prices up in 2008. Cost almost $100 to fill my car. And the franchise in my town had to switch to Sunoco, because he was getting squeezed so hard.And yet they and their brethren recorded record profits.As a consumer, I will not forget this.

  5. RichardF

    Pricing higher can also create a barrier to entry to time wasting customers, as long as you can justify why your price is higher than a competitor and it’s not priced so high that it puts off the customers that you want.

    1. Carl Rahn Griffith

      Indeed. I’ve spent so long, and so often, discussing this with many ISVs, over the years. One can easily ‘invest’ as much in pre-sales chasing after a relatively small deal (or one that will inevitably require huge discounting to ‘win’) as one would spend on high-value opportunities. Thus, it is often best to focus on the customer profiles even though they may appear more daunting to a smaller ISV. Hence they frequently too often focus on chasing small-value price-led deals. Controlling the cost of pre-sales is something that is rarely – intelligently – factored in to the price of the end product/’value’.

      1. greggdourgarian

        Carl, that “small-value” software deal may really be a $200k yearly marketing, financing and accounting services deal.Lack of intimacy and failure to create a whole solution can masquerade as a sales expense problem.

  6. Carl Rahn Griffith

    It’s a particularly interesting – and challenging – topic when in the context of software.

    1. fredwilson

      i agree carl. software is not scarce and is increasingly becoming ubiquitous

  7. Dave Pinsen

    This is true. Before more than doubling the membership price of one of my sites, I ran the idea by a family friend who owns a highly profitable surgical equipment business. He mentioned that he had difficulty selling one particular piece of equipment once, and was going to get rid of it, but before he did, he doubled the price of it. And sales of it promptly took off, so he kept it.Another, related, point is that when starting out, you can underestimate the cost of acquiring a new customer. I made that mistake. That has to be factored into the price as well.

    1. awaldstein

      Raising the price to find and hold the customers that have more value over time. I’ve done that spreadsheet and while difficult to roll out, there are times when it is the correct one to do.

  8. Sean Black

    This is a bit over simplified Mr. Fred. There are some laws of economics going on behind the scenes. What you are really talking about here is price elasticity, which measures the change in demand for goods as the price changes. Price elasticities are almost always negative, meaning as price goes up demand goes down – basic supply and demand. There are two types of good for which peoples’ purchase goes up as the price goes up, violating the law of demand: Giffen goods and Veblen goods. With a Giffen good, consumers keep buying as the prices goes up because there really isn’t a good substitute and these goods are a basic necessity. The common example is staple foods like rice. With Veblen goods on the other hand, greater price means greater status. Veblen goods usually include luxury goods like wine, luxury cars, and designer goods. The more expensive it is, the fewer people who can own it, the more it makes a statement for those that can. Thanks for the 6:30am economics refresher:-)

    1. fredwilson

      wow, that is a great comment Sean. thanks for sharing that. as always MBA Mondays gets even better when you wade into the comments

      1. Morgan Warstler

        This is exactly textbook right. See also Cialdini on the behavioral side.My question is, can you think of a situation where this has happened online?Murdoch’s crowd plus the folks who can’t afford Freemium any more (Ning) would be trying to argue Veblen. I don’t think technology allows for Giffen past Apple. Altho Apple has been feeling the price heat too. Certainly, Rahul Sood’s Voodoo was such a company.But Voodoo kind of proved the opposite as well, since technology evolves – people only really pay to live on the bleeding edge. If you must have the 30″ UHD LCD, or the pure fiber lan, or digital back on medium format camera…. it’s only a luxury for at most 18 months.I can’t think of any.

        1. Ed Freyfogle

          Morgan, a good digital example would be virtual objects to decorate your avatar in virtual worlds. A huge business in various Asian markets. The scarcity of the object is completely artificial (marginal cost of producing next one is nil), but then again that’s also the case with many real world luxury goods.

          1. ShanaC

            But that doesn’t make it a Veblen good per say- the price can’t be driven up, people will fall away from digital goods because there is some sort of awareness of the artificial scarcity.

        2. Sean Black

          Love, love, love Robert Cialdini’s Influence on understanding how people buy!

        3. Matt A. Myers

          Any good links to info on Robert Cialdini to share? Thanks in advance

          1. Matt A. Myers

            Thank you Morgan

          2. Jed Cohen

            For a quick overview of Cialdini’s work on persuasion, you can read “Harnessing the Science of Persuasion.” Here’s a PDF of the article – http://www.itu.dk/~kristian

    2. Tereza

      You can create disruptions though, which convert a good from Veblen to Giffen.I worked for a gentleman years ago who introduced Perrier to the United States. He coined “The Earth’s First Soft Drink”. (Anyone here remember the line-drawn animation with the guy sticking a straw in the ground and sipping to satisfaction?)At the time the business venture sounded completely crazy because no one believed one could SELL water to Americans.They went premium and created a market.Incidentally, Beverage as a sector is generally a fabulous place to look for these lessons. They’re all about price and perception, and low unit cost (kinda like software). Many of these concepts were honed in Bev…for years these co’s have commissioned bespoke analytics tools around their marketing vectors.

    3. tedryan

      Sean. Slight correction. Price elasticity is only partially related to demand. Elasticity is the RESPONSE of sales to a change in price. It is not a measure of demand, more a measure of demand slope.

      1. Sean Black

        You are totally right! Thanks for clarifying. It’s been a while since business school and the only reason I even remember this stuff is that I had a kick-ass professor who traveled around the world consulting on the science of pricing for large companies.

        1. ShanaC

          At some point though won’t the price still go meet demand as people find replacements (other grains, different luxury item?)

          1. Carl Rahn Griffith

            That reminds me, Shana, re: a micro MBA workshop I did a few years ago – the example was Parker Pens (apologies if this story is old news to anyone).Anyway, they – Parker Pens – wanted to better understand who their primary competitor was and we all broke into groups to come up with our own SWOT/theories (having not encountered this story before).None of us got the answer right.Their primary competitor back then turned out to be Ronson (of shavers fame). Most mid/higher price Parker Pens were bought as a gift and most purchasers of the gift saw the Ronson shaver of the time to be the most likely alternative gift purchase.Your competitor can be who you least expect. Pretty worthwhile remembering this in today’s topsy-turvy world …

    4. S. Pandya

      I think you might have the two backwards (at least according to Wikipedia):http://en.wikipedia.org/wik… – Giffen goods are the ones that are like staple foods (i.e rice)http://en.wikipedia.org/wik… – Veblen goods are the ones that are like luxury cars

  9. reece

    Here’s a similar simplified example that I like about pricing on menus using Balthazar as an example, especially as it relates to having multiple products/offerings.”The main role of that $115 platterโ€”the only three-digit thing on the menuโ€”is to make everything else near it look like a relative bargain.”http://nymag.com/restaurant…

    1. Fernando Gutierrez

      I have a couple of friends who own restaurants and they say that most of them do the same.With wine they say that most people will never order the cheapest one nor the most expensive ones, so they play with the prices of the wines in both extremes to guide you to the wine they want to sell, which usually is the one with the higher margin for them.

      1. Tereza

        Yes. My husband has a restaurant background. This is a standard menu pricing tactic. It works!

      2. Scott Carleton

        I’ve heard that the second cheapest bottle on the menu is the best wine for the buck, but my girlfriend who happened to work in the fine dining industry has told me that it’s much more complicated then that. Makes sense given that in true fine dining, the ingredients are so expensive that wine is their best chance at even getting close to profitability

    2. awaldstein

      Keith McNally…the genius of the restaurant and menu scene. Balthazar, Pastis, Lucky Strike, Odeon!

    3. fredwilson

      or showing off

  10. Fernando Gutierrez

    This price/perception relation is really important in products in which the average buyer is not an expert (lets face it, most of us are unable to distinguish between champagnes unless they have really different qualities… specially after a few drinks) or have limited access to the product (I’ve tried, but they never let me open champagne in the shop to test if I like it).However, when none of these premises happen, trying to increase price doesn’t always work (if some app does similar to another one but you price it higher you’re not gonna sell a lot… I can think now of that $50 WolframAlpha iPhone app when you could just go to their website for free).

    1. Orrin Xu

      I think like Sean Black stated, this trend is targeted towards high end goods like wines, cars and fashion. For low end goods/mass produced goods, the only way is dead since it is a highly competitive space

      1. Fernando Gutierrez

        You are right, I was thinking only on high end. I don’t know a lot about rice and I have a limited amount of information, but most times I’ll just buy the cheapest one.

        1. Orrin Xu

          Well it depends, In some cases i would buy high end rice but that would be for a party but since it’s just rice, the so called “status” of it isn’t that important. I guess in general if it’s on “show” then you can put a high price tag for it.

    2. Tereza

      If you have a superior product, you deserve to charge more.But it’s hard to demand a higher price vis-a-vis competitors if you are a new, unproven product.And at the same time it’s perceptually impossible to move of the food chain price-wise. You can go down, but you cannot go up.That’s why Freemium works. You take yourself out of the price equation for a period of time to get established among your customer set, prove your value, and then set it at the right position vis-a-vis competitors.Consumers WILL pay a premium if it’s worth it, and not just in the luxury segment.

      1. awaldstein

        Good point TerezaIn an anti-intuitive way, launching ‘cadillac’-priced models at retail offered the same advantage as Freemium does today for software and services and price elasticity.You set the value of the segment with the cadillac, then build discounted versions at set retail price points ($99,$199 and so on) and find the feature/volume points. Still being done from computers to TVs at retail.

        1. Tereza

          Yes. And don’t forget scarcity. When something runs out, people suddenly really want it.

        2. Dave Pinsen

          Geoffrey Moore made a similar point in Inside the Tornado, if memory serves.

          1. awaldstein

            Maybe Dave…I was a big fan of his during the time I was doing a lot of this type of channel work.Still a fan actually as he was a real thought leader back then and some of it still sticks.

          2. Dave Pinsen

            He still seems to be quite influential. I noticed an allusion to his work in a press release by a Canadian tech company last year, and footnoted that on my old blog at the time.I’d be interested in reading a book about the lessons you’ve learned in your tech career, if you get around to writing one.

          3. awaldstein

            I do find myself using ‘chasm crossing’ references from time to time. It’s a market making truth that is part of our vernacular now.I’ve thought about a book a bit…maybe after a while. Thanks for the encouragement.

  11. Christian Brucculeri

    This can be especially tricky for new technologies, when there is very little information on the marketplace to price something new. Sometimes a great way to price a new product is to ask people what they’d be willing to pay for it, keeping in mind that “willingness to pay” and actually shelling out money are two very different things. Still, it helps you find a starting place.The cost plus method is probably the worst idea. It’s a good place to get your reservation price, but beyond that it’s almost irrelevant for pricing.

  12. William Mougayar

    Your point is well taken, but I might argue that this trick works to an un-educated consumer base. If I’m a Champagne connoisseur who has spotted this Champagne knowing it offered great value for the price, I would be disappointed. But I realize that the bigger market opportunity lies in fooling the greater consumer base, and I’m the exception.Regarding pricing strategy in a start-up business, it depends if you are entering the market or if it’s later during a more mature stage. I might use a lower price to lower the barrier to entry and cost of selling. If my features/benefits are better than the competition, and I’m giving the client a much bigger bang for the buck, how else am I going to grab market share, unless I hire an army of Sales Reps which I can’t afford to do initially. Look at SF.com- they started at the very low price point to dislodge existing players. Now, they want a full-year’s license upfront, minimum number of users & have become arrogant to deal with if you’re too small for them. Aside from SugarCRM, you can’t compete in the CRM market unless you virtually give the product away, and with at least the same features as the bigger boys.I agree with your point above for more mature stages, but perhaps not always initially.

  13. r_y_feig

    I agree that the cost plus method is a very bad idea for pricing. However, I don’t agree with asking people what they’d be willing to pay for it. I think the company needs to ask, “what is our product worth to the customer?” and “how can we better communicate that value, thus justifying the price?”When you ask people what they’d be willing to pay, you run the risk of them not knowing how to use the product, or fully understanding what the benefits are. That, and there’s also the risk that people will naturally state a lower price, hoping to get a better deal.

  14. kidmercury

    while i agree with the premise of this blog post (def lots of suckers who buy status goods), on a long enough timeline, prices fall due to competition, thus allowing consumption to increase (at least, that is the natural pull — monetary and fiscal policy can prop prices up). bottom up disruption is where it’s at, though it is more of a function of lower operating costs than lower operating margins.

  15. andyswan

    One thing I’ve found is that pricing doesn’t just effect the customer’s behavior.It can have a significant positive impact on the members of your team as well. There is an inherent responsibility to produce a superior product, give amazing support, and take the sales process seriously when your product is priced above the competition.I like “Price high and EARN it.”

    1. Dave Pinsen

      Price high and justify.

  16. robertavila

    All prices are relative. Consumers expect the market to work. However, they will discover if the relative price and relative quality are out of whack. I did work for a large branded food company, which had been purchased in a leveraged buyout. The subsequent reasoning had gone like this: The LBO had priced the value of the Brand at X, an asset valued X should produce a return of Y, to produce a return of Y the price of X must be raised to Z. I demonstrated to them that there was a long term learning curve on the part of the buyers who routinely purchased banded products, i.e. the recalibration of the price quality trade off in the minds of consumers takes time, but it happens. They raised the price to Z any way and made a bundle of money for a number of quarters, but then sales volumes began to steadily decline. I was called back in. I told them that, unfortunately, the learning took just as long going the other way and that in the mean time loyalties to other brands may have been developed. Getting prices right is a bitch.

    1. fredwilson

      it sure is

      1. PhilipSugar

        This is a classic on trading on a brand’s equity.I have no idea of how to account for this…..it really is an issue…but accountants can never measure….As I always say accountants love counting the beans, but if you can’t make somebody give you beans it doesn’t amount to a hill of beans.Two examples: Sears and Home Depot.Both were taken over by financiers….Lambert and Nardelli.Both literally shat on their employees.Short term……Profits galore!! People take a while to switch, but once they do…….watch out.GM and Chrysler are two good examples….I’ve been in meetings with both where exec’s cry about the fact that they spend $2k more per car in marketing…..if they spent $500 in better plastic and materials….they wouldn’t have to.

  17. jeffyablon

    While this was way too simple and read like a manifesto, it reminds me of the legendary story that began the validity phase of PC software.Lotus 1-2-3, the title that “made” the software business, was originally priced at $199. It wasn’t selling, and management didn’t understand why. So they hired then-hotter-than-hot business consultancy McKinsey and Company to help them make their spectacular product take the market.McKinsey put a very young MBA student named Jim Manzi on the account, who (horrors!) had Lotus raise the price of 1-2-3 from $199 to $495. At this point, the thing Fred is talking about took hold; perception of the software as “wow it must be great” took hold.The software industry and success of personal computers sprung from this event.And Manzi became CEO of Lotus and got very, very rich, even though pretty much every move he ever made after that one was wrong.Hmm . . . backed up Fred’s point, and made a sad ending all at once. Wasn’t my intent . . .Jeff YablonPresident & CEOAnswer Guy and Virtual VIP Business Change Coaching and Virtual Assistant ServicesAnswer Guy and Virtual VIP on Twitter

    1. fredwilson

      great story

  18. andyswan

    I was in a golf scramble last summer with a friend and two of his clients. One of his clients, John, was a salesman….some type of paper or printing equipment. The other player was John’s boss.I’ll never forget standing on the 6th tee. My friend asked how business was. John’s boss said “not bad, considering…….it’d be REALLY good if John would stop making sales below our f*cking bottom-line price.”John didn’t blink. “Ehhhhh f*ck off. I’m out there getting new customers…they’re telling us what the products are worth….it’s YOUR f*cking job to either make that profitable or make the shit worth more.”It was hilarious, and so true. I love salesmen. Especially the ones that are great enough that the boss won’t go to a golf scramble without them.

    1. Tereza

      Love that story!

    2. Donna Brewington White

      I’m of the opinion that we can all learn from those in the sales trenches. It’s where the rubber hits the road. Would love to have that guy in my “rolodex.”

  19. Harry DeMott

    Understanding your market is absolutely key here.Can you get away with selling Cristal Champagne? If so – by all means raise the price.But if you are selling a subscription to Club Penguin – I’m not so sure you are going to be successful at a 4X higher price point as Webkinz.As one commenter mentioned – you almost have to give away CRM software. There’s lots of competition – so if you are in that business – you better have something massively differentiated – or be the low cost provider with reasonable service.How many start-ups or web based services are in the champagne business – and how many are not? I’m betting the vast vast majority are not – thus the relentless drive to use the internet to reduce friction in the system and drive costs and pricing down.

  20. Satish Mummareddy

    Off Topic But this thought has stuck in my mind for a few days and I wanted to know your opinion:If we all enjoy the comments section of this blog so much and we treat it as coming to a bar at the end of a day and having random discussions with different people showing up each day (fred’s quote a long time ago. ๐Ÿ™‚ ), should Fred post his blog in the evening at say 6PM every day and we show up and enjoy the comments section for a couple of hours? Right now i like to read the comments section and reply but i feel guilty doing it in the middle of the day during work. ๐Ÿ™‚

    1. fredwilson

      i’m a morning personif you were to look at the time of my comments, very few happen between 6pm and 5am

      1. Satish Mummareddy

        Fair enough. :)Usually, once you post, it takes an hour or two for the great threads to develop in the comments section. The quality of almost all comments is great here but someone posts an amazingly thoughtful response to your post and conversation builds around that comment.No real analysis done but I’m speculating that for most posts there are probably 3 or 4 really great comments around which the conversations build up and maybe another 10 smaller discussions. And by the time these start to happen it is 10 ish. ๐Ÿ™‚ And I kinda usually miss out on the conversations as I get all consumed with work. ๐Ÿ™‚ And I was trying to see if there was another way around. :PBut I can understand your point about being a morning person. I am a morning person too and my most productive hours usually are 6am – 10am for individual contribution work and 10am – 4pm for team based work.

    2. ShanaC

      It’s been a problem for me for the past few days, I’ve been busy.

  21. Junk Bond

    When in doubt, price higher

    1. ShanaC

      No, be aware of what your product is- it actually might be be better to own a wide swath of a little than not enough of tiny at a high margin. Cialdini has a wide variety of techniques to push something to market- some will work when you have to own those wide marks.

  22. Tereza

    You start too low in an established field and you’re setting up a race to the bottom.The beauty of Freemium is it buys you time and flexibility to get to know your market and go higher on price when it’s proven.Generally, is perceptually impossibly to start with a low price and then move up the food chain. This has only succeeded in extreme circumstances and I would not stake a business on that strategy.

    1. Nick Giglia

      Great comment. Some of the best market opportunities come in industries where competitors are on a mad dash to the bottom, because it leaves a ton of room at the top. It’s very important to gauge your market and determine proper pricing, and in most cases the only real way to do that is to get it in front of clients and let the market speak to you.

    2. fredwilson

      yupthat’s one reason i like freemiumthe most elegant freemium models allow you to offer a range of prices and a range of valueand there is no race to the bottom because there is always a free option

      1. Fernando Gutierrez

        39 Signals is one of the best examples I can think of. They always have a very limited free version of their software, but they also offer a full featured free trial. Like you start with the full product you are more likely to remain there and pay, but if you don’t want you can always get the free one. And I love their products!

    3. ShanaC

      It’s possible to move up in price- it’s just not possible without moving in tandem without everyone else moving too…It’s a commodity good- you make money on the spread. Largely, you hope for price fluctuation and you can cause/hope for real/articial scarcity.

      1. Tereza

        Agree, but if the tide has risen, that doesn’t help you much. The value to the consumer is relative to their own needs and the competitive set.We position toward premium value in order to reduce substitutability. You don’t want to be a commodity.

        1. ShanaC

          If you are the largest commodity by a lot- yes you do. I don’t like the food industry, but look at Monsanto when it comes to grain in the US. It’s Monsanto vs everyone else. And corn is a total commodity product…

          1. Tereza

            Sure, but aren’t we here on AVC talking about startups??

          2. ShanaC

            It’s MBA mondays. Besides, it would be so interesting to see a commodity startup, the product you need (remember, after food, the first cost to come in is cell phones in the third world)

  23. im2b_dl

    Fred I have heard this before. I think it is about exclusivity. Not that a product needs to be exclusive but if you team any version of exclusivity with lowest price (say in time/expectation or release awareness/buzz) …creates an appearance of exclusivity This obviously needs to be teamed with work to make the product the best in satiation… ..it becomes a no brainer. Price is about ease of real time entrance. ..and I say this model (with lowest price) kills all the others. It’s why my teams don’t release any of our shows into the wild until they are at “that point” but also because we are giving it away for free (the tv model) …and hiding while we work on it…keeps expectation and exclusivity of the “find” higher. ..and working to get it as close to perfect….(a model I have heard so many say is wrong “get out to an audience” -ugh) is the smartest business model on destination products. The free…or fight for the lowest price makes entrance easy… the delay in gratification and expectation makes it worthy. I agree in small examples where people didn’t do the right long term work… higher price creates a false sense of exclusivity…but rarely does that last long.

  24. awaldstein

    Price, no matter what your intent (margin to volume), defines value to the customer and bang, defines your brand to the market.One of the largest decisions and an art to evolve and change.

  25. Mark Essel

    Marketing is much like pattern matching products to customer expectations. If the product falls into a category that customers associate with tastes (high quality, premium price) it is well received.But for me it’s the products that don’t fall into any categories which are most interesting. It has been one of the barriers to Tablet computing, as they weren’t as useful as a laptop but too big for our pockets. Back in a 2005 interview of Steve Jobs and Bill Gates, Bill mentioned the ideal product may roll up the screen into our pockets. But it’s hard for us to know what a good price point for such a device would be.Web services are a great category because the default expectation is free for personal use. When you can show users enough value that they convert to paying customers (bingo) you overcome the natural inclination to reject cost. Tools that create or make a product (content) are generally easier to sell than tools that save something or decrease loss.Premium products generally have a higher profit margin, and make running the businesses much different culturally and full of possibilities. There’s only so cheap you can offer product/services, but the variations in quality offerings is endless. The perceived value of premium in the feautures that count can be many times a price floor.We also have to be aware of subsidized business moves. Google subsidized their free GPS before chopping out the legs of that market. There cost has made a huge impact on existing business structures.Today I got premium weather ;). Cold earlier but warm and sunny now!

  26. Pete

    This example is instructive. However, the market dynamics of Champagne differ from many other markets. For many/most offerings in the US, your initial pricing is the highwater mark for that offering. To increase price you must add something to the offering. This makes pricing in newish markets tough. Ad CPMs online were first set by their print equivilents (if they existed.) Online only companies tended to price much more aggressively. The entire online ad market grew up post-bubble. Many companies would sell their inventory at any price just to keep the doors open. Try raising CPMs now. It better be with value added or it must be something with such popularity/demand that you can create a pricing frenzy around the product. Since that is really rare, most people do one thing – work to create more inventory! When it doesn’t sell, they price it to move by making it cheaper… This is not unique top the online ad space but it is the one I know best.

  27. Nick Giglia

    They always love to say how perception is reality, and it’s no different here. People have no problem paying a premium, but to me there are 2 big factors:1. Perception of your brand: This applies whether you’re a startup with an unproven product, a company entering a new market, or a company with an established rep expanding its product line. Sometimes the perception is too much to overcome, and while there have been successes (Hyundai’s Genesis outsold similar cars from Audi last year), there are also failures and actions that alienate large sections of a market (i.e. Anheuser-Busch suddenly trying to move into more “craft” beers).2. Underlying Quality: You can’t get away with selling a subpar product at a higher price forever; you’ll need to back it up.Overall it’s a fascinating case study….I wonder, especially, what this means for startups that may offer integrated solutions and are competing against companies in silos.

  28. Scott Carleton

    I have found that this paradox of raising the price leading to higher sales is particularly exemplified in luxury retail such as champagne or cigars. I had a friend working for a cigar store in midtown Manhattan. I found it intriguing how much price and brand management were the key to sales, much more so then the quality of the actual cigars. It can become a question of perception when the consumer is buying to look the part. The price of these goods is not a signal of their quality as much as a brand taking advantage of its namesake.

  29. PhilipSugar

    I think the advice of “could you charge more?” is always something good to look at.Most entrepreneurs overestimate unit volume and underestimate how much people are willing to pay.My belief is that if you don’t have a certain percentage (lets say 5%) that dismiss you out of hand because of price its too low.That being said, I like Andy’s golf story. Its easy as hell to sit in an ivory tower and say “double the price” when you’re not the one out in the trenches having your competition trying to cut your head off.That’s why this is something that only you can know in your heart of hearts is right.

  30. PhilipSugar

    I will also say this in and it only pertains to technology as a service…..It is possible to go from low price up (takes time), It is almost impossible to go from high price down (and understand you will have competition, guaranteed, so understand that)So when Siebel tried to go to on-demand after Salesforce started to eat their lunch by coming upmarket they couldn’t.I will also say when you look at technology as a product, it almost always goes the other way…..i.e. early adopters pay to be first, and prices go down as the product goes mass-market.

    1. fredwilson

      that is very insightful and true in my opinion Phil

      1. David Haber

        This is what I think will eventually happen to guys like Factset, CapIQ, Bloomberg, and ThomsonOne. Ridiculously expensive products which look like they’re from 1998. Can’t wait for someone to disrupt this massively inefficient industry.

    2. zackmansfield

      phil – i agree with your SF.com/Siebel example. But one important caveat – in this example, Siebel had an established brand and legacy product. The signaling/customer expectations to price had been established and worked for a long time. Then SF.com comes in with a radically different product/price mix and, as you stated, it’s hard and nearly impossible for Siebel to switch gears and price down.However, I will say it’s not always easy for a new market entrant to work from low price up. In fact, for truly nascent technologies or offerings, it’s even more challenging. You’re entering the mix with a new offering and trying to match customer expectations with value. If you go in with a price that ultimately proves to be too low, it’s a tough sell to all of a sudden ramp up pricing (you really need to have added discernible features or have a darn good story for why). Unless your product truly is “must have”, the result can be that you are not able to raise the price effectively. All the more reason to perhaps price higher up front (a la the gist of this post).And perhaps the most important point is that price is only 1 of many, many factors which could be determining consumer appetite. Especially with a new product it’s important to not place 100% focus on price – because there’s always the possibility that (gasp!) the market doesn’t really have an appetite for the product/service at any price…something entrepreneurs may not figure out until it’s too late.

      1. PhilipSugar

        I agree that if you price too low….below a point where you can make good money…i.e. lose money on every sale and make it up on volume…I agree.I’m not smart enough to figure out how eyeballs, ????? (i.e. no price or little price) = profit….I mean that with no disrespect.I do know if you are the super high price producer….in technology not in luxury goods..somebody will come in and eat your lunch, and the problem is that you as the super high price producer can’t lower your price because you will kill your high end market, and the high priced team that is servicing the market.

  31. Tereza

    Let’s remember here that the critical opposite side of the coin for premium pricing is *scarcity*.It doesn’t have to be “luxury”. But you necessarily need to have a perception out there that there is a limited number of what you’re offering, to provide teeth to the higher price.Many have failed when they price higher but don’t have the cojones to enforce a scarcity mechanism.Here’s a story about scarcity.We were getting ready to launch the first commercial TV network in E Europe. I was one of 5 ad sales and we were on commission (I was 23). We had come up with a pricing structure triangulated from various data in other markets, but at core, was totally made up. We were selling air.Our business model had 25% the # employees of the “competitor”, the state-run station. The press was full of stories that we were not going to launch on time, were going to lose our broadcast license, etc. There was really no fact-based indication on price.Instead of “value pricing”, we went premium, and then premium-plus. One of my colleagues packaged a “Launch Night” sponsorship which was based on our rate card, plus 10%. He had few lookers but no one was closing.I had the worst agency list, as the youngest and least experienced of the team. But I discovered a guy who was very status-conscious, was the chief of staff for some big local rock star that owned a media agency. I told him I could offer him, for the window of that afternoon, exclusive right to buy the sponsorship package…at rate card plus 40%. The deal was signed by COB that day and re-set pricing in the market.Launch night had the highest audience ever in the country — around 85%-90% of households. His client, an until-then fairly obscure voucher fund, killed. They had placement at the start and finish of every ad pod for the historic night (about 12 spots), and massive viewer recall. To call it a win-win is an understatement.If you want to perform at parity, price modestly along with the market. If you want to kill, go high and craft very real ways that the value equation works for all involved.

  32. smartone2

    I actually had a friend who had a TV Production company that did this very thing.He have many loyal clients but his pricing was much lower than prevailing rate but he barely made any profit.In addition it seemed like the clients were always looking over his shoulder during his productions. Like they didn’t really trust his skills because he was so inexpensive.His solution is he created a “fake merger” with another production company. He changed the name of of production company and instituted rate increases across the board that were in line with industry standards When his clients asked about his new pricing , he blamed his new partner (who didn’t exist) for the new pricing.What he found is that none of his clients jumped because of the cost and they no longer looked over his shoulder because they were paying him so much more they felt he had to deliver.

    1. Tereza

      What a fabulous example.In my consulting work, I’ve always found that clients who pay me more treat me better and respect the advice I give.And the worst? The pro bono.Thing is, they’re operating under the assumption that “you get what you pay for”. So if you underpriced, they don’t respect you.But a limited-time offer of something free in the context of your “regular” much higher price? An entirely different message.

      1. PhilipSugar

        I agree with pro-bono or free for professional services. We tried giving away installation for free. We sell on a subscription basis, and you really want to remove any barriers to trying the service. Our retention rate is ridiculous (over 99%) so you’re willing to lose money to get a new client.We had to go back to charging because people wouldn’t implement, since it wasn’t costing them anything, everything else was a higher priority.

        1. Tereza

          Free is powerful but especially in a services environment you have to be surgical in how you offer it and position it. You can’t “make it up in volume”!If it’s a product and your marginal cost is zero, and your goal is user adoption, for example, that’s another story. Sow your seed however you want!However I would still argue that a little bit of scarcity can’t hurt…

      2. fredwilson

        providing services for free is generally a very bad idea

      3. JLM

        “no skin in the game” — pro bono — ugh!

        1. Tereza

          Yes. Fugly.

  33. akharris

    The market is clearly seeing a huge amount of value in models that are promoting scarcity, luxury, and access at the same time right now: see Gilt Groupe. They’ve made scarce, luxury goods accessible to a much wider audience while maintaining brand integrity.Incidentally, my mother always taught me to examine clothes before buying them, no matter what the price or label. I look at the stitching, the feel of the fabric, etc. I am still surprised at what people focused exclusively on brand recognition are often willing to pay for a premium product, regardless of the relative quality.

    1. Tereza

      People pay premiums for:–scarcity–quality–customizationI am continually surprised that more people don’t focus on Customization.Buyers are very loyal and proud of something they perceive was made just for them. It makes them feel special and paid attention to.That’s my “Back to Bespoke” meme.We will see more of it.

      1. akharris

        Couldn’t agree more (and I have the bespoke shirts to prove it). What I find really interesting is that people pay far higher premiums for lower quality, but “labeled” goods, than they would for custom.The number of custom tailors marketing in NYC right now is incredible. Even within that market though, there is a wide disparity in quality, but, as with champagne, most people don’t know it when they see it.Before too long, I imagine we’ll all be wearing custom fit clothing, from whatever brand we like. The technology to make that both practical and affordable does not seem to be that far off, but there are still plenty of hurdles in the way.

        1. Tereza

          Funny about custom-made shirts, or using a personal fashion stylist.________________________Disqus didn’t post this properly. I’m re-pasting what I wrote:________________________Funny about custom-made shirts, or using a personal fashion stylist.Once you’ve done it once, and have experienced something that fits you and suits you perfectly, it’s almost impossible to go back. You don’t understand how much better it is until you experience it.It’s the ultra-brand: so premium that the person you’re talking to doesn’t know what it is! Very, very ‘insider’.Technology is beginning to make this experience price-accessible. With just enough upward price-stretch that it feels special.At the end of the day, humans are aspirational beasts. What they really want is something that’s just a smidge beyond what they think they can afford.

        2. ShanaC

          It isn’t truly bespoke for a lot of these products- it’s piece custom off the shelf. You take this part, that parkt, and poof- custom product. And after a while, this too, as a service, because it is so automated, will also be a commodity. (If you can do it ad infitium….)

      2. Matt A. Myers

        Customization ability for web applications though?? I just can’t see very many possibilities that would make a business think something was made for them..Do you have any examples for what you mean by this?And thank you for all of your comments on this topic so far. ๐Ÿ™‚

        1. Tereza

          I see it as web apps that help people customize off-web decisions.That’s where the richness will happen.Customizing a web app in and of itself is passe. And it’s often too complicated.

  34. Cody Swann

    Good point, Fred.Price is one of the biggest signals of quality among consumers.Robert Cialdini points out the same thing with a jewelry shop. The owner goes on vacation and asks an employee to mark jewelry with a “1/2” off tag, but the employee marks them “x2” and the jewelry sells out.For people with limited knowledge of something, price is a surrogate for value.

  35. Rocky Agrawal

    And with a higher price, you’ve got more room to do promotions that make people feel like they’re getting a deal and encouraging impulse purchases. (Though with alcohol promotions tend to be more regulated.)My favorite story along these lines was a national wireless carrier determined that the “offer code” box on their checkout page was serving as a barrier to completion. People who didn’t have an offer code were frustrated that they weren’t getting as good a deal as someone else, so they refused to check out. Instead of doing what most companies would do — get rid of the offer code — they made it very easy to Google for modest offer codes. Even $5 off a major purchase like a mobile phone made people feel better about the purchase. (And they felt they were beating the system, too.)

  36. Rocky Agrawal

    My friend Adam used to accompany folks on piano for their recitals for free. He was good, but found that people didn’t appreciate his work. No thank you cards, no gifts, etc. He started charging and found that people still wanted him to accompany them. He got paid, but he also got the thank you cards, gifts, etc. that he wasn’t getting before. He’s got a great blog post on the experience: http://bit.ly/a6E0PZ

    1. Tereza

      If someone’s going to give their TIME away for free, it should be viewed as a “marketing expense” and tracked against a conversion rate to paid business. You’ll find it rarely converts because — guess what? — they think they can get it for free!It can be OK if it’s a gig that gets you exposure to a whole new audience you’d otherwise not have access to. Such as a free speaking gig.But even then, if you can get them to pay you a little something so there is a transaction, it makes a difference. Or see if you can get something in return, such as a premium ad in their program, referrals to high-potential clients, an online testimonial for your website, etc.When it’s your time, make sure you get something in return that has value to you.

  37. Michael Beckner

    It’s interesting to read so much about pricing from the product or the (general) market viewpoint, but very little in the way of — first and foremost — understanding the customer/end-user. Perhaps it’s implicit in the commentary, but I would think the natural first step would be to deep-dive on customers to develop a market strategy way before proceeding to pricing.I wonder if we’ll see a post on value word equations in the near future… ; )

  38. Marc Bush

    Hi Fred -This post reminds me of a strategy a good friend of mine has when selling items on Craigslist.My friend will look through the site to see the range of prices for items in the same class (say, a TV of a certain size), and then will price his item at a 20% premium above the most expensive listing. His TV (or whatever item) may or may not be in any better condition than the other items for sale, but the cost of information for buyers is high and the higher price price is perceived by buyers as a signal of quality. His items usually sell quickly, at the listed price.

    1. fredwilson

      well there you go

    2. PhilipSugar

      I don’t agree with this…..I used to collect old cars (pre-kids)….I found people wouldn’t even bother looking if you were 20% over….the only reason they looking at Craig’s List or any other site like Ebay is they are looking for a “deal”….why bother if you are not a bargain hunter??I agree with Mark Suster’s post on why he doesn’t bother with deals that are overpriced….people don’t want to pay for “brain damage”Price it at 20% under and have to fend off buyers, and get a premium….20% over….not a single call.

      1. Tereza

        Phil — I agree with you wholeheartedly for when you’re talking about a unique product where you can by definition have only one buyer. A house works like this too.In this type of sale, the key to getting the highest price is to maximize the # of bidders. You have to price fairly and let the market do its work.I had to sell my parents’ house in estate. I priced it super-fairly, got a 9% premium above my fair market estimate, and was done in a week.If you overprice, it goes stale. The smart buyer’s first question is always, “how long has this been on the market?” If it’s been on for a year, that’s never a good answer. They won’t get involved if they walk in with the vibe that you want to rip them off.Set up the market mechanics and trust the market.

  39. paramendra

    Looks like the iPad is underpriced. But, oh wait, they do have a 899 version.

    1. Scott Carleton

      In fact, I believe that even the bottom line iPad’s are severely overpriced. At least in comparison to the iPhone line. Take a look at the eBOM and what it really takes for them to bring it to the market and they’re making a killing.This may of course be (in the context of this post) an intent to make the iPad appear to be that much more then an iPhone and take advantage of perceived scarcity, quality etc. But we know the iPad isn’t scarce… or at least won’t be for very long. So what we have here is Apple trying to communicate how especially cool tablet PCs are by pricing them so highly. And apparently it’s working… so far.

      1. Scott Carleton

        To follow up on my comment:Before the iPad’s pricing was released, I thought Apple was going to sell it intentionally at a loss to try to get even more adopters, especially in schools (Steve Jobs has a strong focus on education from what I hear). I can remember my middle school days when Apple gave huge education discounts to schools. My generation used Macs in school which may have led to many cases of early fanboy-dom. Think of it like Lucky Strikes during World War II. Early adopters are key.

      2. Tereza

        I agree with you, Scott.

      3. paramendra

        Scott. Of course I think the iPad is overpriced at 499. I was, of course, kidding, playing along.

  40. Eric Leebow

    Great post, and it’s good to have a break sometimes from the other kinds of posts. Low price selling works with commodities, and if you can uniquely differentiate your product or service, then you shouldn’t have to sell on price at all. The basic rule of thumb, never ever sell a product on price, as there will always be someone who can beat your price. You can market a service as “free” yet this is not a price, as anything that’s “free,” you’ll be eventually paying for it with your time and energy using, or really paying for it.I find it amazing how some bottled waters can charge so much for the water, and water is essentially a commodity. When it’s raining outside, and water seems to be everywhere at times, and then there are people buying water in a bottle. Makes you wonder at times, why people would pay for it. It’s because once it’s bottled, it’s not thought of as water, it’s bottled water. However, it’s interesting to think how bottled waters with added vitamins and flavors can sell for more. When it’s bottled with vitamins and flavors, it’s no longer even thoguht of as water. However, it always relates back to supply and demand as well. Price is based on location, too. If you don’t have any access to water, and you’re in the desert, an iced cold bottle water could be higher price. When selling a product, whatever the product may be, always relate it back to water, and then compare it to bottled water, I think you’ll have the right strategy there. In closing, the lowest price is not always the best price.

  41. Phanio

    Great post. I have similar story of a software company doubling its price and doubling its market share – it is all about perception. Additionally, if you can sell it โ€“ actual benefits or not โ€“ you can raise your prices โ€“ you just have to sell it to your customers.On the other hand, discounters do poorly when raising prices. I just read that Wal-Mart took over the number 1 spot on the Fortune 500 by lowering prices โ€“ these lower prices even helped it turn a great profit in 2009.All depend on perception of the business and product. One of the lessons I learned in my MBA studies โ€“ you can be a quality provider or a low cost provider โ€“ but never both.Great post!

  42. stevealfandre

    I also believe that a product generally has to be discernible in quality in order to warrant a higher price, though not always the case. If potential customers can clearly see that your product offers no additional value than that of a lower-priced competitor, a higher price is not a good strategy (Sony attaches higher prices on all of its products regardless of “advanced features”. It wins with this strategy in categories like TV’s but loses in other categories (e.g. Dictaphones) where other products are clearly just-as-good but at a lower cost.

  43. HowieG

    In Business School your taught to for the most part pick one of two models which is be the Value Added Supplier or the Lowest Cost Supplier. Being the first doesn’t always mean best quality, value etc if as Fred presents you can have people believing it is. And Value Added is a way to protect your margins. Lowest Cost Provider normally works hard to keep lowering your own costs to survive pricing pressures.Sean Black adds a great take beyond this simplified version. But if you have a choice of working for a Value Added Supplier or a Low Cost Supplier, your more likely to be an Asset on the Balance sheet and well rewarded at the Value Added Supplier, and more likely to be a cost of doing business on the Liability side of the balance sheet. Think of the floor workers of Nordstroms v Walmart.

  44. Michael F. Martin

    This seems to be one of Warren Buffett’s tricks also.

  45. Albert Sun

    This probably works better for products where (lay) people can’t actually tell if there is a difference in quality between the expensive and inexpensive. For software, people are likely to have strong opinions about the product regardless of the price.

  46. Michael Shafrir

    We went through this exercise at TheLadders a few years ago. We had some traction with our FREE recruiter product. But we had figured recruiters would flock to use our free resume database and free job postings and that just wasn’t happening in the numbers we wanted; outside of a fervent core of power users, we had trouble gaining mass adoption. We realized we had to get rid of the free product (slowly), and charge premium rates, to get people to pay attention to us and to value the product enough to make it part of their day-to-day recruiting activity.HBS did a case study about our transition from free to paid: http://hbr.org/product/thel

  47. jpmarcum

    This is why Fred is so valued by entrepreneurs: first he uses AVC to preview the changes in Twitter’s developer relationships and now he’s using it to advise Yahoo! on their Foursquare acquisition pricing…

    1. fredwilson

      LOLthat’s very funny

      1. jpmarcum

        glad you enjoyed…

  48. hildavis

    I think pricing exists on a much more dimensional scale, which includes what are you trying to build (brand or throughput), what is potential market size and how can price impact that up or down, packaging and branding and perceived value, and profit dollars based on pricing based on inventory turns. Trying to build a product in a category that Wal Mart sales can be very difficult, as that is a price sensitive customer and brand is less relevant. Target leaves an opportunity, as Method proved, because that is a more affluent customer who will put some premium on brand, IF the brand delivers against expectations. The Neiman’s customer is brand sensitive and external/social perceived brand value is the price driver. So the question is more of who your customer is, what their need is (savings versus features/benefits vs social standing), what is the premium they will pay for benefits/features/social branding, and how can you maximize turns and $ profit on understanding the above. In the world of high luxury, pricing is very relative as it creates social status and separation among their peers. As you move downstream, pricing becomes more relevant on benefits/features and also use/frequency (so a person may pay up for a Westin on vacation but not business trips where a Holiday Inn Express delivers their price/need strike price), and as you move even further down the stream, true pricing value is extremely important.Keep in mind the further downstream you go the larger the market so more households, but this can become a commodity game quickly. At the high end, it is rare air and the market is small so you need to maximize brand and $ profit because turns will be slower. In the middle, lies the nectar but it is fickle and demanding, so if you can deliver the right mix of price to benefits/features to social status (this can be small) then you have landed in a very lucrative position

  49. Nathan Leehman

    The perception of value is what is truly being addressed here, and can be used to create a vastly superior point of entry for products across a broad spectrum – once consumers are engaged, the actuality of value must be proven.Take this example: I have an acquaintance who literally introduced premium tequila to the world market (you know the brand) and decided that there was additional room in the ultra premium space. He intentionally priced the product at the top of the market. This did two things: increased margin and created the impression of superior quality.Eventually, his premium positioning gave him the opportunity to sell to Grey Goose, who at the time defined the premium vodka category. Guess what they did? They lowered the price (somewhat), and sold even more. Why? Because the Grey Goose name and positioning with consumers and distributors gave the product the credibility it needed in the market โ€“ credibility that was previously established through premium pricing when it was an independent brand.For ongoing sales, the primary differentiator is the quality of the product, and we revert to traditional supply/demand curves. Once the product has established its premium positioning, new users can be drawn in using placement and marketing efforts, while past aficionados are excited that they can secure the product at a lower price.This is why the freemium model is so exciting โ€“ it allows the user to immediately find their own value in the product, and self-select into the purchase funnel. At that point, the service can price as they see fit โ€“ high prices for a premium product that appeal to the โ€œstatus drivenโ€ consumer (with available price decreases in the future tied to user commitment and market demands) and low prices to bring people into the fold and increase value for โ€œvalue drivenโ€ consumers. Truly the best of both worlds.

    1. Donna Brewington White

      Nathan, love your illustration and how it elucidates the beauty of the freemium model.

  50. JimHirshfield

    Funny,I’m reading a book called Priceless right now on this topic. Good read so far.

  51. Donna Brewington White

    I wonder if at some point this leveled off. Unless the product was truly superior wouldn’t the consumer eventually catch on? I can understand initial perception, but it seems that at some point a branding effort would be needed to sustain the perception…or at least promote consumer loyalty. Otherwise, it seems that eventually someone would say — “Hey, this isn’t really any better than Brand X at half or a third of the price.” Although I guess you’d need a lot of someones saying this.BTW, do you have to go to biz school to get the 5th P? We only had 4 in undergrad marketing. I like 5 better… see this really IS MBA Monday — I just learned something.

    1. Tereza

      I agree Donna. Back in the day, in b-school, they only taught us 4 P’s. Somewhere along the way, Fred picked up “People”. There you go, proof that indeed he is empathetic.In the Wharton Follies we did a riff on the 4 P’s, called the 4 P’s of Dating. They were: Personality, Pecs, Paycheck, and… Package.Since then, I always have to pause to remember the original.

      1. Donna Brewington White

        Hilarious!I don’t feel so bad now that I know that Wharton only included 4 Ps as well. Thought maybe I’d missed out. Anyway, now we’ve got Wilson University.

        1. fredwilson

          we strive to give you 25% more here at AVC

          1. Donna Brewington White

            in any event, we always get our money’s worth here…just don’t raise the price!

      2. fredwilson

        oh man, not the empathy thing againi can’t understand why you care about that!

    2. Nathan Leehman

      Exactly the point Donna (see my post just above): this is a market access and market positioning price strategy, and at some point the true differentiator becomes value to the user. This can be buoyed by increased marketing/advertising – even through the medium term – but eventually the market clearing price point will identify itself. The most well positioned and leveraged products will find ways to place themselves along a continuum at various points, capitalizing on the perceived value and service level of a differentiated customer base (thus the power of the freemium model and Lotus 1-2-3โ€™s initial strategy from another post). This is much more difficult for hard goods on a store shelf, but a very reasonable solution for service or net based products.

      1. Donna Brewington White

        Well, if I’d first read your comment above, I may not have felt the need to comment. You said it well. Also, it helps to have the clarification (from your reply to my comment) that the strategy described in Fred’s illustration is for market access and positioning, rather than as a long-term pricing strategy.

  52. ShanaC

    You know, I just read through all the comments and the post, and I still don’t know how to set a price. I just realized this is again, an art and not a science because you can lean too hard in each direction depending on the target market and depending on your costs….

    1. fredwilson

      do a focus group and find the price elasticity and then pick the spot whereprice x quantity is the biggest

      1. ShanaC

        Thank you

      2. nikhiljagga

        I don’t think a focus group would be a good idea. Focus groups are good for qualitative information but to determine pricing using elasticity you will need a lot more data. Doing multiple focus groups will be expensive without the benefit.I can suggest looking at competitors or similar products/services as a reference point. If the product is non-differentiated you have to ultimately take the competition into account. if it is differentiated then you can set it above the competitor and measure the response.

      3. Michael Shafrir

        is focus group really the most effective? don’t people often say what they think the moderator wants to hear?isn’t it more effective to get out there and start selling something at what you think it is the right price and adjust from there (first customers as focus group)? perhaps don’t go gangbuster on printing fancy rate cards and price lists and what not so you don’t flood the market with soon-to-be-out-of-date info?

  53. Prabhakar Gopalan

    Pricing significantly below competition has actually been one of the most effective strategies for successful open source software vendors. Even if it is abhorred by marketing gods ๐Ÿ™‚

  54. phoneranger

    I know I’m late to this but I learned that position (not people) was the other P. And if I read the story correctly trepositioning as a high end champagne was trick that did it. OTOH notice that this move didn’t add any consumer surplus. It simply fed the target market’s need for self-approbation. Nothing wrong with that in moderation but when it gets out of hand as it did when Americans went so deeply into debt in the ’00s, the cumulative drain on consumer surplus piles up quickly and disastrously.

  55. Dennis M.

    I caught this on Tuesday but wanted to add that price is one indicator of quality, the term I believe from marketing years ago was “surrogate indicator” which marketers used to distinguish the product from the masses. Some examples of surrogate indicators were price, material (100% cashmere), and country of origin (made in Italy) which consumers used if they were unfamiliar with the brand or the product.We as consumers use these surrogate indicators when shopping for products in categories that we’re unfamiliar with. Clothes is a perfect example and so is food, (organic, 100% USDA Prime, or free range) which are key attributes on labels that we unconsciously search for when validating a purchase of a product.Good post, thank you.

  56. eric_bingham

    even later to the comment stream here – at HBO in the early 90’s there was discussion about going from the premium tier to a new tier that gained near universal distribution at a lower price point. That discussion never gained too much traction as the price reduction, while having some short term financial appeal, would have come at the cost of the overall positioning as THE premium cable channel. Subsequent success and growth has proven that the long term should be considered in all pricing/positioning discussions.

  57. Michael B. Aronson

    Fred- which marketing prof at wharton said this?

    1. fredwilson

      that was 25 years ago Michaeli honestly can’t recall

      1. Michael B. Aronson

        I spend a lot of time with the wharton marketing profs for our Fund who show us deals and serve as board members and advisors to our companies. Sounds like this comment might have come from Jerry Wind who is still very active or Paul Green who retired a few years ago.http://marketing.wharton.up

  58. Vijay Basrur

    In my previous stint where we built a movie exhibition chain in India, we were at the crossroads of pricing our tickets when we launched our first multiplex. We had only 2 folks (one being our CEO) who were for the higher prices and the rest of us lobbied for competitive prices. We debated a lot, eventually agreed to price the ticket at a premium (we were also offering a much better ambiance & services to go with it). 9 years into the business we are the most profitable while competition is catching up on the profitability curve.I think underpricing products doesn’t work in the long run. But if you are to price it higher, then you MUST have it backed with higher quality. If not, consumers will thrash the product

  59. Geoff D.

    Reminds me of a story Kevin Ham, the Domainer, told at a VEF event. He was describing the early days of web advertising and his first pricing experience was identical to the champagne example.Unrelated, Kevin Ham currently owns god.com, heaven.com, and religion.com

  60. larrybitner

    Pricing is indeed one of the most sensitive and emotionally driven issues that a business owner faces. Studies show that price drives a consumer’s perception and price often makes a strong first impression. Whether it’s a 50 cent cup of coffee or a $6 haircut, people are smart enough to recognize that like it or not, you get what you pay for…

  61. greggdourgarian

    That’s a fun read Charlie but I’d take the crack over sleeping with a VC. Plus the way it’s worked out for me is that the $100k service contract spawns yet others like fish in the sea and soon you have all the revenue you need to nurture the mass model.

  62. William Mougayar

    You’re damn right Charlie. Services business can have a healthy profit margin, and is easier to ramp-up, but it’s dangerous to go that route if you’re a product company that wants to achieve economies of scale.

  63. Tereza

    That’s such a common issue among many of us, isn’t it? It is (or at least was, until a year ago) pretty much only possible to bootstrap if you were offering a service and doing your R&D on their dime.It’s not easy, that’s for sure.

  64. Tereza

    Agree — it’s really freaking hard.I’m trying to figure out how to make that conversion myself.

  65. Scott Carleton

    Cuban Cigars are a great example. Cigar companies across the U.S. and plantation owners in Honduras and the Dominican Republic are terrified about when the U.S. will lift the Cuban embargo. The problem is that Cuban tobacco has actually fallen in quality and the Honduran and DR tobacco have become quite good. So when the embargo gets lifted, the entire cigar market will be flooded with shoddy, overpriced cigars which will screw up everyone’s price points.