In an earlier post we stated that as a general rule, price segmentation works by charging the majority of the customers a standard price and then giving a discount to people who can somehow prove they are price sensitive. (Think students at the movie theater.)
Versioning is the exception. When we use versioning, we develop a lowest cost base model and price this model at margins that are as low as we can tolerate to capture our most price sensitive customers. Then we offer more-featured versions of the product at better prices and margins to profit from our less price sensitive customers.
Let’s run this through our rules for price segmentation. Step 1 – segment the market. This is a great method because we know there are people out there who are more sensitive and others who are less so. Even if we can’t identify which is which, using this method they will self-select into their own category.
Step 2 – develop a pricing mechanism to charge different prices to the different segments. In this case we build the bare-bones model for the really price sensitive customers, and a higher end product for those less price sensitive. It works great.
The lowest cost base model attracts our price sensitive customers, but we have to have the attitude that if we didn’t have this model, the customer wouldn’t buy from us. We want to make a little money on the sale. Besides, this customer may buy some accessories from us as well, and of course our accessories have better margins.
Two quick examples. On eBay you can buy a new brand-name large screen TV for a price that is less than the cost for most resellers. I talked with a director from eBay the other day about this and he described that these on-line stores were selling the TVs at their cost in the hopes of selling accessories, like stands or wall mounts. Sounds a lot like our price segmentation.
A bike store in the midwest only builds custom bicycles. They have a formula for how to price the frame, the parts, and the labor. Every bike uses the exact same formula. This is “fair” in their minds. They described to me how a customer walked into the shop the other day and ordered top of the line everything. I’m not sure they could build a more expensive bike. The customer didn’t ask about price until the end. Obviously this was not a price sensitive customer. How could this bike shop earn more money from these type customers? What about versioning a little more? What if they changed their formula (i.e. markup) so that the higher end parts have a little higher markup? My very rough calculation shows this small pricing move could put an additional $1,000 in their pockets. That’s a lot for a bike shop owner.
Action: What are you waiting for? Figure out how you can use versioning in your business.