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Is there a PERFECT pricing model?

The perfect pricing model—i.e., the question of what, when, and how a customer pays for a product or service—is one of the hottest and most controversial topics in the pricing community.

A few years ago, subscription models were seen as the measure of all things. The customer does not pay for a single transaction but pays a regular (typically monthly or annual) fee for the use of the service. The business models of the world’s largest companies by market capitalization (e.g., Apple, Microsoft, Amazon) are partly based on subscription models for good reason. They generate recurring revenue for the companies and provide customers with flexible access to services without the need for large one-time investments or payments. Startups also tend to be more attractive for investors if their business model is based on subscriptions.

Performance-based pricing models have been increasingly discussed recently. Instead of paying for use (pay per use), the customer pays for the benefit or result. Worth mentioning in the B2B area is Google Advertising (price per lead), for example. Customers benefit from the fact that the provider’s and customer’s goals coincide, which is perceived as particularly fair. The disadvantage for the provider is that revenues are less predictable than in the subscription model. However, customer-specific price acceptances can typically be better exploited.

From the perspective of classical value-based pricing, a pricing model is superior for the end customer if it costs the customer as little as possible for a given service, and optimal for the provider if the price is in line with the value delivered. In this sense, performance-based pricing would be the “best” pricing model.

5 price models - a familiar example

What this means in concrete terms can be illustrated using a familiar example: Having to get to the airport and the question “How do I get there?”.

Usually, you have several options to get to the airport:

#1: Public transportation

This is undoubtedly the most favorable solution in terms of the cost-benefit ratio. However, since a one-way trip is often costly compared to a monthly pass, customers without a monthly ticket tend to feel treated unfairly when choosing public transportation. Thus, resulting in a decision not to use this means of transport.

#2: The own car

Cars are sitting in their garages for weeks on end. Many people have not moved their cars due to the pandemic and the option for home office. And although it would be expensive (because additional parking fees are charged at the airport) to take the car, people still tend to choose this option so that the purchase is (still) worthwhile. A classic sunk cost effect: A high one-time payment is justified by later use, even if this use incurs additional costs. And especially when it comes to prestigious products like cars, it is the sheer ownership of a particular product that represents a value in itself (endowment effect), which is why people are willing to ignore the ongoing costs.

#3: Carsharing by Sharenow

This is actually a fair option since the customer only pays for the duration of use (pay per use). On top of that, there is a pretty considerable incentive for speed lovers: The faster you drive, the cheaper the trip. However, in case of a traffic jam, the ticking clock becomes very annoying because time is indeed money. It could hardly be clearer to the customer that he is paying for something of no use to him but is simply irritating. As if the traffic jam on the way to the airport with the worry of missing the plane wasn’t already stressful enough…

#4: Carsharing by Miles

Instead of being billed per minute, customers are billed per mile. It is a pure performance-based pricing model that avoids the pain point of Sharenow’s usage-based pricing model. The customer feels treated very fairly, but the provider has less control over how much revenue is generated in a given period.

#5: Taxi

Expensive but also very convenient. Interestingly, the answer to the question of whether a person wants to take a cab often depends not so much on whether the budget per trip has already been exhausted, but rather the other way around: So if the flight was very expensive, people are more likely to think: “It doesn’t matter at this point, I might as well treat me to a cab.”  This is not exactly a rational form of mental accounting.

The decisive factor is the (price) motivation

There is no such thing as the perfect pricing model for all situations and offers. The decisive factor is the customer’s (price) motivation for the selected pricing model, the mental accounts from which the costs are booked, and the behavior the provider wants to motivate with the pricing model (e.g., use at certain times through dynamic pricing – link to article). In this case, an objectively more expensive pricing model may well seem subjectively fairer to a customer.

According to “GRIPS” (link to article), the decision-making motives of the customer types also provide indications of an adequate pricing model. If, for example, customers who are willing to pay a certain price accept certain options, the pricing model should be sufficiently flexible to take advantage of this (e.g., by differentiating the prices of the pay-as-you-go options). Loss Aversives want to be treated fairly and not pay for services they do not use, so they tend to feel more comfortable with pay per performance.

We observe time and again that young companies (understandably) focus intensively on their product and do not consider the issue of the pricing model until very late in the process. However, since the pricing model is decisive for the business model’s success, we also recommend addressing the pricing model very early and intensely. 

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Vocatus AG Preisstrategie Behavioral Economics
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