Episode #0097 - SAAS Pricing and Tiered Pricing options for Online Businesses

Pricing College Podcast

In today's episode, we're looking at SAAS pricing and tiered pricing - the good-better-best option.

What is the impact of tiered pricing on market segmentation and consumer behaviour?

In today's episode, we are surfing the web. We are joining the information superhighway. We're looking at, I suppose the very common method that pricing is shown on many software as a service, SaaS style businesses. I think we're all used to seeing them by now. Three options: When some on a month to month you're shown very often a cheap option; Which doesn't have all the bells and whistles. Something like a beginner or an intro or something like that; Then you often have the one in the middle. That very often seems to be highlighted and pointed out. That tends to be most of the benefits kit seems to cater to the vast majority of people. Then you tend to have a third option. A bigger option with even more benefits that maybe doesn't suit everyone and that can be the enterprise value. So I think we'll just talk around this today.

In terms of pricing, you may be aware that this concept is often referred to in terms of the Good-Better-Best Pricing, or Tiered pricing. Can even be explained in technical terms as Differentiated pricing. So you can differentiate pricing based on product attributes, features of the products. Some people look at the features and benefits of the products to differentiate into a good-better-best system. Other companies alternatively look a little bit further and they think, “how do our customers view these products? How do they use these products?”.Looking at an example there would be like a mobile phone company. Looking at good-better-best in terms of data usage. How much data a customer would use? Then would cut off those pricing tiers based on data usage. Obviously, if we look at the evolution of the mobile phones' tiered pricing, we can see now that got a little bit more sophisticated with their tearing. One reason for that was because customers didn't really like the fact that they were tearing the pricing, capping pricing and limiting their data. So what they did actually is increased and made most of their data unlimited. And used other things to other features and benefits to entice customers to buy different phone options. So obviously here now I've even touched upon that word entice. What is tiering all about? Well, underlying all of that is that is a deep-rooted sort of psychological pool using pricing to draw people's attention to different options.

I think there's there are two topics that are Joanna's discussed and I think they're both very relevant. The first one is clearly segmentation. You're not using a sales team. You're not using the customer's service team, maybe making phone calls. But you're selling predominately through a website, online, low human interaction in many instances. So the classic knowing your customer, understanding their value drivers that aspect is harder to do. And so, the segmentation strategy, the tiering is segmenting that market. So that you can charge different amounts for fundamentally the same thing with slight nuances obviously. But you're trying to tier it by stripping away certain aspects to cater to certain customers. Clearly, with that, I think we'll get to this a bit later. That means you really need to know what the value drivers are and that involves understanding why your customers use your product. Understanding who they are. Trying to categorise them in a way that's optimal. Because you can't charge you kind of infinite numbers of variations on this online format. It has to be reasonably simple and I suppose that is the classic three. That's positive, that aspect. The other thing Joanna touch on there, obviously, the other stuff, the psychological aspect of stuff. I think we've covered this in previous episodes stuff like Cialdini I think his name is who did stuff like influence and they're pushing you towards the centre. Something like menu pricing they're often pushing you towards the central one. That potentially could be pushing you to request more services than you may be needed. I think the example Joanna give off of the telephone thing. I think we've read in the past or discussed in the past that people often choose phone plans that give them way more data than they'll ever use and pay more. So there is there's a psychological aspect where sometimes you can be pushed into a category that maybe you don't need. And once you get used to that, you may not downgrade to a lower quality plan. But it's yeah, there's those two aspects. There's the first one which is a rational segmentation strategy and then the second is also psychological. How does the human brain work? And you tend to go for the one in the middle often. You think maybe the lower quality, the cheaper one maybe isn't suitable for you. Do people even buy the higher price one? I don't really know. Or, is it just purely there to make the middle one more enticing? Those are questions also that from a psychological perspective that is interesting.

The distance between the pricing between those price tiers is called something called price relativity analysis. And it looks at, what the optimal price is at each of those tiers? Moving aside from that though, if you think about price relativity on its own in isolation of how customers buy. Then it doesn't matter how much analytics you do. You'll never really find the optimum price because you've got to see, you've got to base that price on customer usage. It can be now you can look at sales per sales data. How did the customers use that data now we've got much more data disposal than ever before. But it takes some time to come through that you can look at past sales history. What options do they buy more of? But the question is, it does not answer the question of, why did they buy it? So that requires more customer base research, more external research. Then your internal benchmarks of customer usage. So I think often when I see pricing teams that work on tiered pricing. They're overly concerned with the what because it's something that they can control. It's easy, it's data that's at their disposal, they can just go okay, and often they make assumptions based on that. Now that's okay if you do it in a formalised way and you use hypothesis testing to then test those assumptions. But often I would say that those hypotheses aren't followed through and tracked and monitored well. So what the actual is really the business ends up with price points that are sort of out of sync with the market. And often they go back to default cost-plus to get a margin target. Because understanding the nuances and changes in customer preferences can be difficult. If you haven't got your price architecture and customer research set up correctly to inform your price architecture. In terms of the psychological aspects of tiered pricing, they work very well. But it does depend on what I've just said. You've got to have that research, documented and you've got to track because people change, we all change. Now looking at the mobile phone example that was an interesting one. Because they used to actually limit your customer data and put limitations on that to build the price options. And in so doing it created some kind of risk aversion. Because people would run out of data, and people would then sort of fear running out of data and sort of each month “gosh, where am I at with my data?” And there'd be a backlash against that as I've already mentioned. So then as Aidan mention there, what they did just go well, obviously, data usage is something that's of big concern. It's highly valued by our customers, but we're ending up negatively impacting our customers and they're switching because of it. So why don't we just give them an infinite amount of data? Because to a customer, nobody really knows how much a gigabyte really is in terms of real-time usage. So we're sort of as Aiden said, it's nudging us to buy more because of what we experienced before with the phone plan. So that's an ironic sort of use of they're actually benefiting from past failures in their mobile phone plan, usage and tiered pricing strategy. The mobile phone company has learned from it and is now enticing people to get more data that they don't need at probably higher price points. And the customer doesn't mind because they don't really understand the data. The amount of data that they're using, and they just feel oh, well, at least I'm not going to run out which is the biggest risk driver to them. So I suppose an example how of how you can build psychological drivers like risk usage into your tiered pricing to really optimise your revenue.

I saw when we started this conversation, I thought this was a reasonably simple topic, but clearly, there's a huge amount to it. I think, again it's the old classic of strategy versus tactics. Obviously, without an actual pricing strategy, what is your product or service, whether it's online, whether it's SAAS, whether it's a classic traditional business. You need to understand those value drivers and that's your strategy. The tactics clearly, with data, as Joanna mentioned. The huge amount of data it’s sometimes it's the old wood for the trees thing. People can be blinded by the amount of data that there is. But without a strategy, that makes sense, logically that can’t be explained to a human, no aspect of data is really gonna change that. With data, you can run AB tests on these pages, even very simple methods like Google Analytics will help any website do that. There are obviously a lot of companies now in this space, people like price intelligently and a huge number of new entrants are coming in Silicon Valley, focused based on optimising pricing. With websites, you can run A B tests or you can run infinite numbers, given a certain volume of traffic. Semrush will help with that as well other websites. You can optimise colours, click through rates, everything to optimise your pricing. It's a 49.99 and your middle option on a month by month versus 60 bucks, whatever that optimal price ranges. And you can optimise those things around the edges. But I suppose fundamentally you need to set it up in a sensible manner. You need to set that up with an actual proper pricing strategy. I often wonder about the enterprise versions that are on these things that the third option, the highest option. I wonder how many people even choose the enterprise option. If you're IBM or if you're a major corporation, do really just book online? I'd highly doubt it. I imagine you'd be going in and getting specific services and pricing. So I often wonder, even showing that online to some extent, I think it's just a psychological approach to drag you up. The low one in many cases, say this like I even use the example of sem rush. We used that on Taylor Wells for website optimisation. Originally, I think we went with a middle option which was the classic, you're always defaulted into. Later I realised we didn't need that and downgrade it to the cheaper option. So in many cases, there are rules that are there to be broken to some extent. But I think it's the old classic workout, the pricing strategy first and that's your strategy. Then it's down to implementation and tactics. I suppose I would put this SAAS on implementation and on tactics and there's always an overlap between pricing and marketing. And I think definitely when we get into this area of online, showing things you're getting into, certainly, with websites, you're very much into the marketing pricing overlap. And that's when really your pricing departments should be integrated with your marketing team, with your website team and it shouldn't be sitting siloed. Because clearly, in this instance, we know here the colour schemes, the highlighting of words, the word usage, all those things factor into how people convert. It's not just pricing. Pricing is fundamentally the commercial approach of your company. So it's not just the numbers is what I'm trying to say. It's the overall menu really. It’s the overall approach.

Interestingly, for uninformed customers that don't know about the product, use that same sem rush example when you're sort of new to a particular product, especially a technology product. People kind of know that they need it, but they don't know why or how they're going to use it. So what do they do? They go, Well, I know I need it. That's not an option. This one supposedly is good. So how they came about knowing about Sem Rush is an important factor. So that's a marketing poll driver. And then the ultimate decision, it's still ambiguous. So what do people do with it? We've got three options good-better-best. Is the cheapest one gonna be right for me? I hedge my bet so go for the middle. That's why people often go to the middle and then upgrade as they become more informed about the product and about more informed about their needs. Because as a customer, you go actually the middle option for sem rush, it's just not enough. I need to I need more capability. I need to look at more search terms. I need more analytics. I need to know what the competition is I need to know what the saturation is in the market. I need to then decide on what the selection of secondary keywords is. Those are things that you learned over time, but with that learning and using the actual tool, then you're educating yourself. Then the company gets their premiums over time and before you know it then you're using the best version. And then as your business builds, then you go into the enterprise version. Now, this is actually quite interesting about the enterprise version. So they put it as an option on online,good-better-best is the better one. But then they go through often through a very old fashioned fixed pricing negotiation, discussion with clients at the enterprise level. Then we go all the way back to what we've discussed before how they set prices usually cost plus. So on the facade, it's using decoy pricing and tiered pricing. But eventually, the end product is often the same fixed pricing based on cost-plus. So there's still a lot of work for technology companies that are using SAAS and tiered pricing models.