Price discrimination sounds like a bad thing, but its actually just economist-speak for selling the same thing to different buyers at different prices. And, it happens literally all the time. In this talk, Michael Klett, CTO of Chargify, will examine real-world examples of differential pricing and why they make sense. Then, you’ll learn price discrimination strategies to get your amazing product into the hands of more customers.
Michael Klett:
Hello out there. My name is Michael Klett and I am CTO and co-founder at Chargify. Chargify is a subscription and recurring revenue management business for SaaS, and today I'm coming to you from my home office in Cary, North Carolina with a topic that's at the intersection between something I learned in economics class way back in college and things that I've observed in 10 years of running a SaaS business and seeing lots of other SaaS businesses.
Michael Klett:
So let me share my screen now, and my topic has something to do with discrimination. So immediately negative feelings come up because this is a topic with negative connotation, and for good reason, because most discrimination in the world these days is bad, but this particular discrimination is price discrimination and it comes from economics and it's not necessarily bad.
Michael Klett:
So it was given its name by economists and the thing you need to know about them is that they just think a little bit differently than the rest of us. So for example, here is Gerard Debreu. He won the 1983 Nobel Prize in economics for his rigorous reformulation of the theory of general equilibrium.
Michael Klett:
So right off the bat, you can tell this guy just thinks on a different level than most of us do, and economists also have to believe that buyers are rational beings and we know that's not necessarily true because we can see the mansion that Kim and Kanye bought for $60 million. Here's a hallway in that mansion and it seems to have no rational qualities, as far as I can tell.
Michael Klett:
So out of this economist way of thinking come the term price discrimination, which is really just their way of talking about selling the same thing to different buyers at different prices. So for the rest of the talk, I'm going to relabel this price differentiation because discrimination seems bad. It seems like we're trying to punish somebody, but price differentiation, I hope that I'll show, can help your business and also help your customers.
Michael Klett:
So I think you'll find that it can even help if you're a product-led business. So the things that we're going to talk about are first degree, second degree, and third degree price differentiation, but I'm going to reorder them just a little bit. We're going to do first, then third, then second, because I think it'll make more sense this way.
Michael Klett:
So I'm going to jump right in with first degree price differentiation, and this differentiation that's based solely on each buyer's willingness to pay. And the economists jump back in with another definition called perfect price discrimination, which is selling to every buyer at the maximum amount they're willing to pay.
Michael Klett:
So in an economist sense, this makes sense because the goal is to maximize revenue and this does that because nothing is left on the table, but that's not really what I'm going to get at and talk about in this talk, because that really sounds kind of dirty, right? It really does sound discriminatory and it conjures up this idea of used car salesman.
Michael Klett:
But I think what you'll find is if you're doing it correctly, you will lower the price for customers with less willingness to pay and you'll raise the price for customers with more willingness to pay.
Michael Klett:
Now, I hear what some of you are saying. You're like, "Wait a minute. Some customers actually want to pay more?" And yeah, it does happen. It happens because some customers desire preferential treatment.
Michael Klett:
You see this in the valet lot when someone in a very nice car pulls up and they give the valet a $50 tip to park their car right up front and make sure they take care of their car. This is a customer with more willingness to pay and they want to make sure that they're taken care, right?
Michael Klett:
You also see it if your customers want you to hold their hand through the process. This is a customer who doesn't want to read the documentation, they don't want to go through the tutorials, they just want you to come alongside them and show them what it is that they need to do and they will pay more for that.
Michael Klett:
You'll see this when customers want faster service or better guarantees in the form of SLAs, or service level agreements, right? This customer may be buying the exact same product as one of your other customers, but they're willing to pay a higher price because they want that guarantee.
Michael Klett:
And lastly, you actually see it from buyers who don't want to be judged by their boss or management for going with the cheaper option. It sounds crazy, but it's true. Some people will pay you more just so that their choice appears more justified.
Michael Klett:
So when you're going to do this first degree price differentiation, where you're going to collect different prices for the same thing from different customers, it does help to have a dedicated sales role within your team.
Michael Klett:
Now, I know it's kind of out of place to discuss a sales team at a product-led summit, but I think that if it's done correctly a sales team can help really any business, and I want you to think of them more as guides who are there to help connect your product to customers at the amount that they're willing to pay, because it ends up getting your product into the hands of more customers.
Michael Klett:
And this is great because it allows you to sell to those smaller customers and larger customers, and this works perfectly when you have a product that has wide applicability. It really opens up your market and doesn't shoehorn you in or pigeonhole you into one market.
Michael Klett:
But there are some things to be aware of when you pursue this strategy, and the first is this kind of personalized service can get really expensive, right? Labor costs are high, it's expensive to hire a sales team, it's expensive to pay onboarding specialists to come alongside somebody rather than just having your customer read the documentation, so you have to be ready for that.
Michael Klett:
And also, you don't want to use having personalized onboarding to take the place of a good product experience and a good first use experience in your UI. You don't want it to make you lazy.
Michael Klett:
And then lastly, you really need to be ready for having an external opinion come into your decision-making. Some customers who are paying more expect more. They want to be a part of your roadmap decisions to decide what you build next and you have to decide if you're ready for that or if there's any ground rules you need to set up ahead of time.
Michael Klett:
So after first degree, we're going to talk about third degree, and it's actually just an extension of first degree. So instead of selling on a customer by customer basis, you're selling to customer segments. You put them into groups and you price according to those groups.
Michael Klett:
So we're all familiar with this already with educational pricing, or nonprofit pricing, or governmental pricing. You see it at the movie theater when student tickets and senior tickets are cheaper because the movie theater doesn't have the ability to price and charge each customer a different amount, but what they can do is go ahead and pre-select some segments with less willingness to pay and charge less for those tickets. It makes total sense.
Michael Klett:
So this is really the easiest form of price differentiation, I think, that you have available to you in SaaS. There's no sales team required. You just set your prices, your price books, for each of your segments, and then you either put your customers into those segments, or you could even let them self-select into them to get their prices that they're looking for.
Michael Klett:
But what you need to look out for is SKU proliferation. What you don't want to happen is to have your product catalog multiply out by every segment that you have, because what you really have is the same products and plans over and over with just different prices.
Michael Klett:
So Chargify can help you with this. Chargify has a feature called price points where the same thing has different prices defined, and then you take your customers and you assign them to those price definitions on that product rather than duplicating the products and plans over and over.
Michael Klett:
Okay. And then finally, we have second degree price differentiation. Now, this is the one that we're all really familiar with when it comes to SaaS. The economists call this menu-based pricing and it's pricing based on packages or feature upsells. So almost all SaaS you know already does this. I've given here an example of the Shopify pricing page and it has what you'd expect. It has basic, regular, and advanced with prices going up as you go across and getting more features.
Michael Klett:
So when you're going to think about packaging your products and charging for features, what you want to think about is the value of those features to the customer, not necessarily the cost to you. So what is the pain or the cost to the customers if they don't have it? And that's how you figure out what you can charge for it.
Michael Klett:
A fallacy, a common mistake, that can be made here is thinking about the amount that it took to build the feature, not the amount that it has value to the customer. So in the first example here, we have a high cost to build feature, but with low customer value. This is probably not one that you're going to be able to charge extra for, you should include it in your base plans.
Michael Klett:
And then, in the bottom example, we have something that didn't cost much to build, but it actually has high value and it's okay to charge extra for that. Now in the middle, you'll see the cost to deliver. I included that because it's pretty common these days with hosting, and platform as a service, and great SaaS tools, that your cost to deliver is probably pretty low and pretty constant whether it cost you a lot to build it or cost you a little bit to build it. So since that's your constant and the cost to build it as the sunk cost, focus just on the customer value.
Michael Klett:
So I'd like to jump into the Shopify example again, because I think they've done something nice here. This row here with unlimited products included in all plans. At first, that seems kind of strange, and I would wager to bet that, in the past, in some previous iteration of Shopify pricing, they probably included different amounts of products along with their different plans.
Michael Klett:
But what I think Shopify has realized here is that the number of products you have in a store doesn't really correlate with the value you're getting out of the service, because you are either a shop that doesn't have many products, where you sell five things and that's it, or you're a shop that just has lots of things. We sell thousands and thousands of things.
Michael Klett:
And so, that has more to do with just what your business is and what it sells rather than the value you get out of it, so they've just gone ahead and included unlimited products in all plans, even though that shop with lots of products is going to have more product pages, it's going to potentially put more load on the Shopify servers. They don't think about that. It's the value to the customer.
Michael Klett:
The next row down though shows a place where they have found value is given to the customer, it's in staff accounts. You only get two in this basic Shopify account. Now, it's probably true that most customers that are selecting this account only have a couple of customers, but I bet there's more than a few that have many, many team members on their team and they're using one of these staff accounts as a shared login, where several people are logging in with the same login.
Michael Klett:
And Shopify probably knows this and probably is okay with it because they know at some point it's going to become more and more important for that customer to know, all right, who was it that changed the price on that, and when? And if you have shared logins, you don't know who it actually was. So as the customer becomes more sophisticated, they get more value out of differentiating of staff accounts, they're going to move up the tiers.
Michael Klett:
Okay. So after you've thought about how to package your products and how to upsell your features and charge more for your features, you should think about how you're going to handle usage and consumption-based pricing. It's something that's very common today and AWS and Twilio have really shown the way on this.
Michael Klett:
And I think the day is coming where customers are going to start to demand to pay only for what it is that they use. Now, the argument against this from most SaaS companies is that it doesn't give them much predictability in their revenue. It's really nice to say, "Hey, I know that customer is going to pay me 299 a month, and they're going to pay me that every month until they churn and cancel." And that's nice for predictability, but you're missing out on a lot of benefit.
Michael Klett:
If you price based on usage and consumption, you're tying your success to the customer success, and I bet there's not a lot of successful companies out there that are using less and less AWS services over time, for example, right? They're using more and more and more. So if you're able to tie yourself to your customer's success, there's a mutual beneficial relationship there, and your customers won't ever feel like they're overpaying for anything.
Michael Klett:
Now, as they grow, they probably will want to renegotiate the prices, but there's never a case where they feel like they're paying for a lot of stuff that they're not getting like they might with your packages.
Michael Klett:
So I have some recommendations about the second degree price differentiation, and the first is, develop a common way to gate and upsell your features. I can speak from personal experience on this that Chargify had, at one time, three different ways to gate and upsell features, some were gated in code, some were tied to what customer service reps could turn on and off, and some were tied into the billing system. So once a customer decided that they wanted to pay $99 a month for feature X then we gave them access to feature X.
Michael Klett:
So we're in the process of consolidating that now and tying everything into the billing system because that gives us one place to control it, it lets us do development work once and upfront, and then puts the power in the hands of our product owners and business owners to package and price the way they want to and do experiments without having to involve the development team at every turn.
Michael Klett:
All right. Secondly, you should measure everything that your customers are doing in your app so you can find out where the value actually lies. You might think that your customers are getting value out of one thing, but when you look into it, they're actually getting value out of something entirely different.
Michael Klett:
So how would you do this? I can recommend Keen, keen.io. In full disclosure, they're a sister company of Chargify's, in the same investment portfolio, but they have tools that make it very easy to measure those events that are happening in your app, and then visualize and get insights on those so that you can find out, Hey, where is the value really at in my app?
Michael Klett:
And then finally, consider charging based on usage. Customers are going to start to expect it and any billing system worth its salt should be able to do metered and usage-based billing. Chargify, of course, does that, and in fact, this is one place that we're looking at making it even more powerful and more easy in the future since we see things moving in this direction, so look for some really new and powerful usage-based features out of Chargify in the next few months.
Michael Klett:
So that pretty much wraps it up. So in conclusion, I just want you to realize that it's okay, it's okay to differentiate on price. Not all of your customers have to pay the same thing. A lot of businesses go to great lengths to find that one true price that's the one that really works and that's fine to be intentional about your pricing, but you got to realize that not all of your customers are equal and it's okay to charge different amounts.
Michael Klett:
And then, treat your pricing the same way you might treat your conversion rate optimization. Hypothesize, experiment, and iterate, and find out what really works for you and your customers and where the value really lies in your system.
Michael Klett:
And then, know that great products aren't one size fits all. You're going to create different packages, you're going to do different things, you're going to treat your smaller customers differently than your bigger customers, and that's okay.
Michael Klett:
And then finally, use tools like your billing system to help out with your sanity on this. Don't build this yourself in a spreadsheet, don't try to build all of it yourself. There's tools out there to help you through this.
Michael Klett:
So that's the end. I am @moklett on Twitter. I'd love to hear what you thought about this. I hope you enjoyed watching it as much as I enjoyed putting it together. So thank you very much, and I wish you much success in 2020. Cheers.
