Pricing is a critical, yet often overwhelming, topic for Product Managers. It directly influences a product’s profitability and long-term success. As Product Managers, it’s essential to get ahead of pricing conversations. While we may not always have the final say on pricing decisions, we should aim to heavily influence them.
I often hear questions like, “Should we use Cost-Plus Pricing or Value-Based Pricing?” These are valid considerations, but they often reflect a surface-level understanding of pricing. Before jumping to these tactical decisions, it’s crucial to grasp the foundational principles and dependencies that shape pricing strategies.
Why Pricing Matters
Setting a price determines how much revenue your product will generate for the business. Price it too high, and potential customers may walk away. Price it too low, and you might struggle to cover costs, let alone make a profit. Despite its significance, pricing often gets shrouded in complexity, treated as a mystical art. It doesn’t have to be that way.
Pricing is a strategic lever. We can approach it with the right principles and frameworks with clarity and confidence. In this article, I’ll introduce a simple pricing model to help you think about pricing decisions more effectively.
A Simple Pricing Model
The Brainmates Pricing Model provides a clear framework to think about pricing from a customer and business perspective. Once you understand this basic structure, you can build upon it with more complex considerations.
1. Zero Line
This is the baseline from which all pricing discussions begin. Think of it as ground zero. Everything we consider about pricing is relative to this line.
2. Cost to Serve
The Cost to Serve represents the internal cost to the business to deliver the product to the customer. It includes all direct costs (e.g., materials, production) and an appropriate share of indirect costs (e.g., support services, operational overheads). This is the minimum price threshold. Pricing below this line results in a loss for the business.
3. Price
This is the amount the customer pays for the product. It’s what generates revenue for the business and sits between the Cost to Serve and the Willingness to Pay.
4. Willingness to Pay
This is the maximum amount a customer is happy to pay for your product. It represents their perceived value of the product and lives entirely in the customer’s mind.
The Hard Thing About Pricing
All of this seems quite simple.
We just have to set a price between above the Cost to Serve and below the Willingness to Pay. Easy.
The problem that we quickly run into is that clearly defining values for these levels can be hard and depend on a range of factors.
1. Cost to Serve
Determining the Cost to Serve is relatively straightforward. It requires calculating the following:
- Cost of Goods Sold (e.g., app hosting fees, content licensing)
- Share of service costs (e.g., customer support)
- Share of operating costs (e.g., marketing, infrastructure)
With some effort, a Product Manager can develop a reasonably accurate estimate for the Cost to Serve.
2. Willingness to Pay
Understanding Willingness to Pay is far more challenging. It’s not a fixed number but a range that varies across customers.
Factors influencing Willingness to Pay include:
- Urgency: If the customer has an immediate need, their willingness to pay increases
- Impact of the Problem: A severe or costly problem elevates the perceived value of the solution
- Frequency: A solution for recurring problems will justify a higher price
- Competitor Pricing: Availability of alternatives at a lower price puts downward pressure on Willingness to Pay
- Customer Type: Innovators and early adopters may pay more, while late adopters tend to be more price-sensitive
- Lifecycle Stage: Products in the growth stage may command higher prices than those in maturity.
Segmentation is Key
Customer segmentation helps identify groups with similar behaviours and preferences. For example:
- A premium segment might value exclusive features and pay more.
- A budget-conscious segment might prefer a basic version at a lower price.
The Real Pricing Conversation
The most important discussions around pricing should focus on understanding the customer’s Willingness to Pay. By exploring their needs, challenges, and perceived value of the product, Product Managers can influence pricing decisions effectively.
Conclusion
Getting pricing right requires balancing two critical perspectives: the customer’s and the business’s. For customers, pricing reflects the product’s perceived value and their willingness to pay. For the business, it’s about ensuring the price covers the cost to serve while delivering sustainable profitability. These considerations are not just an afterthought—they’re foundational to a product’s success. Missteps in pricing can undermine even the most innovative solutions, causing a product to fail despite addressing customer needs. Take the time to align value and cost before launching, because getting this wrong can mean the difference between thriving and failing in the market.
