Pricing for Outcomes

What you charge for can be more important than how much. The right price format can unlock value, add revenue and improve margins. It can even lead to a better product.

In the early 2000s Michelin transformed how they sold tires. A wave of cheap, low quality tires that had flooded the market. Michelin couldn't compete on price points due to higher quality. So they used a new price format to rewrite the rules.

Michelin's move to mileage based pricing was not a superficial change. A change limited to pricing pages and billing systems alone. It was grounded in years of product innovation. The new format accentuated Michelin's core product and simultaneously spoke to customers' true needs. Tires were a means to an end. What users really cared about was going places.

Price format innovation goes beyond usage-based-pricing. It's not as simple as running a taxi meter. But rather understanding what customers care about, enabling that outcome and charging precisely for it.

This is most evident in the evolution of digital advertising.

Digital advertising has always been usage based. But the "unit" of usage has evolved with technological advances. It started with charging advertisers for "showing ads" (CPM). But that's not what most advertisers cared about. What mattered was ad-performance not ad-volume. "How many people made a purchase?", "How much money did they spend?" And not "How many ads were being served?".

So digital advertising evolved from charging per click (CPC), to per customer acquired (CPA), to a customer's ROI (ROAS).

A strong price format will create competitive advantage, improve unit economics and add revenue. In this piece we'll show you how to reinvent what you charge for.

Your price format creates a competitive advantage. Use it to Differentiate and Position yourself

Flat rates encourage users to look at price-points as the only differentiator. It encourages them to price shop. More intelligent price-formats however, change the way users perceive your product and brand.

• Michelin implicitly positioned itself as a higher quality product by charging for mileage
• Zapier reinforces the value of their automation by charging for "tasks" and not seats
• Hubspot positions itself as a lead generator by charging for customer leads

New formats can attract new segments and open new markets

At Clutter, we did a complete pricing do-over for our core storage product. This went from charging monthly flat rates like a self-storage company. To charging separately for move-in labor (hourly) and monthly storage (flat-rate).

We observed a strong willingness-to-pay for labor and moving. This led us to start what would become a highly successful Moving business shortly after.

The right price format can transform your unit economics when COGs are high

For businesses with substantial cost of goods sold, strong price formats may be a necessity. This is particularly true if COGs fluctuate dramatically with usage patterns e.g. cloud computing.

Flat rates expose you to unrecovered costs. They can create a segment of unprofitable customers. Over time, this unprofitable segment itself can grow in size, as more users find out about the deal they're getting.

Snowflake structures pricing to mirror costs. It charges for storage and compute separately. Storage innovations have helped them deliver storage at a substantially low cost. Compute costs are higher, they scale with time aka usage and are passed on to the customer.

Snowflake's price structure creates the following advantages:

• Makes cost recovery easier: Storage and compute have different cost basis. Breaking them out makes cost recovery easier, while keeping sticker price low.
• Creates desirable (high margin) usage patterns: Users will proactively optimize their compute behavior as prices are higher and pay-as-you-go.
• Increases conversions: Lower storage costs are a key value prop and differentiator

You can improve conversion rates by reducing sticker shock

Studies on price psychology show that bigger numbers, even bigger font sizes negatively impact purchase decisions.

Twilio's Notify for example charges $0.00025 per delivery. This creates a low psychological barrier to entry. It's an easy foot in the door that almost converts it into a Freemium model.

But these changes can go wrong! .. when what you charge for isn't what users value

In 2009 Marks and Spencer added a ￡2 surcharge to bras with DD+ cup sizes. Citing higher manufacturing costs. The move was met with uproar. It forced the retailer to apologize and back down. This applies to all apparel pricing. Charging to cost basis does not resonate with customers.

Your costs will not always neatly align with user's perception of value. In these cases you'll have to invest in finding a "unit" that sits at the intersection of COGs and user value.

You can do this by understanding:

• What the users care about - is it value or costs?
• What units do they perceive value in? Is it time, people, dollars, queries per second, gigabits etc.
• User-test mocks of different price formats: Do users viscerally perceive value?

Invest in trust to reduce conversion risk

Pay-as-you-go and similar formats come with a trust risk. Customers need predictability. When you charge by the minute hour or API calls, its becomes hard for them to budget. This is even more acute for retail consumers with low touch sales relationships.

Lack of trust for pay-as-you-go comes from:

• Unpredictability: It's hard to anticipate usage. Particularly for a new user.

• Unfamiliarity: Pay as you go is fairly nascent, particularly outside of cloud infrastructure products. More creative units like Lugg's $2.02/labor min add to cognitive load.
• Lack of Comprehension: Asking users to pay-per-task, per active session, per customer event or per mile requires them to deeply understand your product or service. SAAS users will invest that kind of time, but the average retail customer won't.

Any mental math a user has to do to understand, interpret or rationalize your price means there is more work you can do on format, positioning or value communication.

Some ways to build trust

• Add estimations and calculators: Help the user predict spend. Logistics companies do pre-job walkthroughs and provide range estimates e.g. $500-$800.
• Contextualize value by showing comparisons: Toptal is a platform for freelancers. It uses a calculator to compare and contrast the cost of hiring a consultant versus an employee.?

• Demonstrate value prop: Everlane uses cost breakdowns to communicate value prop and build trust.?

• Social Proof: You can create legitimacy and urgency by showing other users using the service - e.g. Priceline shows you "Someone just booked the same hotel for $389"

• Education: Educate the customer on how your service works, particularly if it's new and offbeat. Animations, videos, learning and modals embedded into your checkout funnel are all tools. Zapier uses animations and flowcharts to showcase how automation simplifies real use cases

A pricing format that's is aligned with the trifecta of user's value perception, company brand and value proposition is the ultimate trust-building tool.

Use format combinations to create certainty for the user

You can add predictability to usage-only pricing, by breaking it up into parts - flat and usage based.

Tomasz Tunguz talks about three part tariffs in the context of an analytics provider:

1. Linear Pricing (LP): $.1 per analytics event
2. 2-Part Tariff (2TP): Base platform fee of $10,000 and each event costs $.1 more
3. 3 Part Tariff (3TP): A base platform fee of $25,000, which includes the first 150k events for free. Each marginal event costs $.15

Research indicates the third option 3PT was most successful.

One place to start developing your initial prices is your cost basis. Use flat rates to cover fixed costs such as marketing costs, platform etc. and usage based rates for costs that vary with usage.

Tap into tiering and bundling for deeper customizations

Datadog's log management service has usage and consumption that varies along a few different dimensions.

• Log treatment: Ingestion, Retention, Rehydration (backing up from archives)
• Log volume: Number of events logged per month
• Days of retention: How far back do you want your logs to go? 3-day, 15-day, 30 day etc.

Datadog deftly uses a combination of tiers, usage based pricing and tier-hierarchy to customize pricing along all three dimensions.

Tiers and usage based pricing:

Tiers within Tiers

The Retain tier has further price discrimination based on time period.

Datadog is a shinning example of intuitive pricing. As complex as the product is, the pricing page simplifies it.

Their formats and tiers have been crafted to communicate both user value and feature functionality. It takes a only few seconds to learn and understand.

In summary, here are some factors you can use to compare and contrast different price formats

We'll dive deeper and illustrate these with examples in a future post.?

Lastly

Price formats can powerfully unlock more value. But even the most innovative pricing derives power from the underlying product.

Is your product delivering outcomes users care about? If not, use insights from price development to refine and build a stronger product offering.