Monetization Playbook #62 — How to derive a product or service offering using psychology + mathematics

How to derive a product or service offering using psychology + mathematics

I grew up working only in enterprise companies. Talking about pricing was impolite, uncouth, just not cricket! Pricing wasn't something you discussed out in the open.

The post-crisis SaaS boom busted that myth. Initially, a B2C play that didn't worry the enterprise folks, SaaS morphed into B2B player and blew the pricing door wide open.

The new kids of the block openly displayed pricing on their website–it was as if Gypsy Rose Lee had just walked into a cotillion, all out there and ready to party! 

So why did this radical transparency work? Well, it got rid of time wasters, for one. Clients almost qualified themselves before the sales closer even arrived. 

Set in motion, this is now one of the many new go-to-market strategies employed by disruptive startups. So how do they derive their initial product or service pricing?

Given that a new business will have a tiny market data pool of genuine customer feedback, the initial price derives from two core disciplines' intersection: psychology and mathematics.  

The psychology of anchoring and the mathematics of power-law provide a perfect combination for pricing tables.

Psychology provides the range of pricing choices––overwhelmingly observed in the market at three or four max.

Behavioural science prescribes that many people struggle to erase an initial interaction from their minds. 

As such, once a price is viewed–it forms the basis of all relative judgments. Allied with the limited number of pricing choices [3 or 4 from above], the user can avoid analysis paralysis and easily compare which options best suit.

The end price provides the anchor element. Either shown as the first or last price in the table, the customer is drawn to this 'premium' price to evaluate the value of the more affordable offerings. 

Think Tesla model X––before settling for a model 3!

Power-law pricing provides the actual price points. Let's assume a 3-tier pricing structure.

In simple terms, this implies that one number varies as a power of another.

The 80:20 rule, venture capital investment, or the Pareto rule are the best-known power-law versions in everyday use. 

The rule indicates that a minimal number–say, 20% in the Pareto example, will provide more than 80% of the outcomes.

In VC investing, often less than 10% of the portfolio delivers 99% of the returns.

Therefore pricing tables are constructed as [X, 2X, 4X] or [X,3X, 6X] or for very established, high feature companies [X,4X,16X].

Any combination of this power relationship is possible depending on your market circumstances.

For some real examples we can see Salesforce follow [X,3X,6X,12X] – [$20,$60,$120,$240] monthly model perfectly.

Hubspot uses the very steeped [X,17X,69X] model [$38,$655,$2,654] in their monthly pricing.

In conclusion, whether you're a new entrant or a well-established unicorn, pricing your offering using anchoring + power law is an excellent way to get started.