Pricing a product is often a very difficult task: there are simply too many variables out there. Joel Spolsky of Fog Creek Software has written a great article on the subject.
Spolsky first illustrates how segmentation - separating your customers into different groups according to how much they are willing to pay - maximes profitability. Theoretically.
He then argues why segmentation does not prove to be such a good idea in the real world:
It pisses the heck off of people. People want to feel they're paying a fair price. They don't want to think they're paying extra just because they're not clever enough to find the magic coupon code. The airline industry got really, really good at segmenting and ended up charging literally a different price to every single person on the plane. As a result most people felt they weren't getting the best deal, and they didn't like the airlines. When a new alternative arose in the form of low cost carriers (Southwest, jetBlue, etc.) customers had no loyalty whatsover to the legacy airlines that had been trying to pick their pockets for all those years.
And God help you if an A-list blogger finds out that your premium printer is identical to the cheap printer, with the speed inhibitor turned off...
...Even assuming you're willing to deal with a long-term erosion of customer goodwill caused by blatant price discrimination, segmentation is just not that easy to pull off...If your customers talk amongst themselves, they're going to find out about the price you're offering the other people, and you'll find yourself forced to match the lowest prices for everyone. Especially the big corporate purchasers who theoretically should have the "maximum willingness to pay" since they represent rich customers. Corporations have full time purchasing departments staffed with people whose entire job is whittling down prices. These people go to conferences where they learn how to get the best price. They practice saying "no. cheaper." all day long in front of mirrors. Your sales guy doesn't stand a snowflake's chance in hell.
Arun Natarajan is the Editor of TSJ Media, which tracks venture capital activity in India and Indian-founded companies worldwide. View sample issues of TSJ Media's Venture Intelligence India newsletters and reports.
Spolsky first illustrates how segmentation - separating your customers into different groups according to how much they are willing to pay - maximes profitability. Theoretically.
He then argues why segmentation does not prove to be such a good idea in the real world:
It pisses the heck off of people. People want to feel they're paying a fair price. They don't want to think they're paying extra just because they're not clever enough to find the magic coupon code. The airline industry got really, really good at segmenting and ended up charging literally a different price to every single person on the plane. As a result most people felt they weren't getting the best deal, and they didn't like the airlines. When a new alternative arose in the form of low cost carriers (Southwest, jetBlue, etc.) customers had no loyalty whatsover to the legacy airlines that had been trying to pick their pockets for all those years.
And God help you if an A-list blogger finds out that your premium printer is identical to the cheap printer, with the speed inhibitor turned off...
...Even assuming you're willing to deal with a long-term erosion of customer goodwill caused by blatant price discrimination, segmentation is just not that easy to pull off...If your customers talk amongst themselves, they're going to find out about the price you're offering the other people, and you'll find yourself forced to match the lowest prices for everyone. Especially the big corporate purchasers who theoretically should have the "maximum willingness to pay" since they represent rich customers. Corporations have full time purchasing departments staffed with people whose entire job is whittling down prices. These people go to conferences where they learn how to get the best price. They practice saying "no. cheaper." all day long in front of mirrors. Your sales guy doesn't stand a snowflake's chance in hell.
Arun Natarajan is the Editor of TSJ Media, which tracks venture capital activity in India and Indian-founded companies worldwide. View sample issues of TSJ Media's Venture Intelligence India newsletters and reports.