Losing Money With Your Volume Pricing Model?

February 2nd, 2011 by Craig Vodnik

If you’ve ever gone to a grocery store (I hope you have…), you’ve clearly seen the effect of volume pricing on your purchasing motivation. There are often drastic discounts offered to buy a larger package of ground beef, a case of soda or a larger tube of toothpaste. Why? Because the manufacturer is willing to take a lower per-unit price in order to move more quantity.

In the digital goods world, this business tactic is made all the more compelling because the cost of selling one additional unit is very low compared to physical goods. Producing and selling another license key for a piece of software or another virtual gift in an online community results in very little additional cost when compared to producing another package of beef, can of soda or tube of toothpaste. Because of this high profit margin, digital goods companies frequently offer their products in volume.

However, did you know that there are different methods for calculating volume discount prices — and they each have different financial effects? We’ve identified three different volume pricing models for digital goods to help you evaluate your current strategy and make sure it is working for you.

1. All-units

The first pricing model we’re going to talk about is the very common “all units” model. In this model, the price of each unit is equal to the unit price for the cheapest volume tier reached. The following table illustrates a typical all units volume pricing model:

Table - All Units Pricing

This graphic demonstrates what the per-unit cost is as the customer selects a higher volume:

All-Units Volume Discount - Per Unit Price

As you can see from the graphic, the price per unit depends on the number of units the customer chooses to buy. If the customer selects two, each unit costs $80. If the customer selects 8, each unit costs $70. On first blush, the pricing model seems logical. The more that the customer buys, the cheaper the per-unit price become. However, there are a few quirks that become apparent when looking at the total cost compared to the number of units:

All-Units Volume Pricing - Total Price by Volume

As you can see, the total cost drops between buying nine and 10 units as well as between 19 and 20. You may decide that enticing the customer to buy 10 instead of nine is exactly the behavior that you want, but it actually results in you making less money. Who really wants that? One solution to this problem (if you want to stick with the simplicity of the all-units pricing model) is to narrow the discount gap between units. By instituting a smaller difference between the per-unit price levels, this step down will narrow and can even reverse to have no drop at a higher number of units.

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Need Help With Your International Pricing Strategy?

November 16th, 2010 by Craig Vodnik

Pricing your product is one of the most important steps in a product’s life-cycle. Price your product too high and you send potential customers to your competitors – price too low and you may be overrun with customers AND operational problems. The right pricing strategy is important, not only for your product, but also for your company.

The ability to sell globally is generally viewed as one of the most attractive things about digital products. However, pricing in the digital product space gets even more challenging because you are not only competing in your home market, but also around the world with companies that have different cost structures.

As discussed in a previous blog post, pricing your products in local currencies and marketing-friendly prices helps lower barriers to purchasing. Recently, a top anti-virus manufacturer from Europe displayed a 29.34€ pop-up advertisement from their free product. As someone that lives in global e-commerce, I wasn’t shocked, but the average American would definitely raise their guard upon seeing such a price.

If you sell a product competitively for £50 in the UK, converting that product to U.S. dollars results in a product that costs about $80 in the U.S.A. However, competitors in the U.S. might price their product at $50, so even though you are pricing in the local currency, you are not price competitive and price conscious shoppers will abandon your site for a competitor’s. The need to lower pricing is often a hard pill to swallow for companies that roll up transactions to their home currency but it is a necessary exercise to compete locally.

Product Prices in Other Currencies

Hopefully, the cost of producing one more digital product is nominal so that you have flexibility in modifying your prices to compete in local markets.

Let’s assume that in each country, 50 is the magic number for a competitive cost (for Japan, we chose something approximate to illustrate our point). Someone in the U.S. considers $50 as the fair market price of their product while someone in Germany considers 50€ the same. The bold prices in the chart below are the base price and other prices in the column are converted based approximately upon today’s exchange rates.

We infer from this chart that someone manufacturing the same product in the U.S., using today’s exchange rates, could price their product at 35€ and still receive the equivalent of $50 for their product. This 35€ price would undercut the European manufacturer of a similar product.

Likewise, the British manufacturer is competitive in Britain at £50, but is overpriced everywhere else if they simply use the current currency conversion rate. This all seems to make sense based upon what we all know with manufacturing heading to cheaper places like Eastern Europe, Southeast Asia and China.

To further illustrate the point that you need to consider not just what the exchange rate is, but also how competitive your price is in other countries, let’s look at prices for the same products produced in these four countries in 2002 (i.e. based upon currency conversion rates at that time):

At that time, the U.S. manufacturer was at a disadvantage in other markets and the European and Japanese manufacturers were in a much more favorable position.

Take Away

What can I do about this?

You can not simply use the current currency exchange rate as a basis for pricing your products in other markets! If you live in a country with a strong currency, like the EU countries or Great Britain, you are at a competitive disadvantage in other markets.  If you are in a country with a weak currency, like the U.S., you can certainly use the exchange rate, but there is also an opportunity to increase your prices to still be competitive with the local market and make a little more money, but watch out for losing sales as an outsider.

Watch monthly for currency changes!

Keystone: When pricing your product in foreign currencies, be sure to look at the local competition or you can price yourself right out of a market.

What tips do you have for pricing your product in other markets?  Is this an absolute rule or are there exceptions?

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Set Customer Friendly Prices in Local Currencies

September 28th, 2010 by Craig Vodnik

Psychological pricing research suggests that product prices should be rounded to odd numbers (9, 5 or 0) in order to decrease e-commerce friction. A Marketing Bulletin study from 1997 found that 97 percent of all product prices ended in one of those three numbers. Considering the global reach of digital product e-commerce, pricing your product in local currencies is also important to prevent lost sales.

Most people go about their day-to-day lives carrying around one currency in their pocket. They are familiar with how much things cost or are able to make a value judgment at a store as to whether they can afford (or are willing to pay) the advertised price marked on a product.

In the online world, it’s very likely that people will shop outside their region without even knowing, because there are few borders for international selling. With this in mind, what does someone, who is used to seeing one currency, do when confronted with an unfamiliar currency? Most users at least pause, if not abandon, because a product’s price is not shown in their familiar currency.

The vast majority of U.S. customers are unfamiliar with spending money in any currency other than the U.S. Dollar. Seeing a Canadian Dollar, Euro or British Pound price will surely cause at least the 72 percent of Americans without passports to struggle to calculate what the cost is in U.S. Dollars, facilitating cart abandonment.

Similarly, the 75 percent of Japanese who don’t own a passport would also pause when presented with a U.S. Dollar, Euro or British Pound product price. Furthermore, the German population with 71 percent not owning a passport will probably be pretty unhappy about paying in British Pound, U.S. Dollar or Japanese Yen.

On the other hand, 76 percent of the UK population didn’t have passports in 1984 compared to just 20 percent not holding a passport today. So, are British citizens less sensitive to prices set in currencies other than the British Pound?

Passport Penetration by Country

During the first wave of e-commerce, selling globally in a single currency was accepted. Companies required customers pay in the currency from where the company was based. The obvious drawback is customers’ unfamiliarity with the real cost of the “foreign currency.”

The second wave of e-commerce resulted in many companies using a floating exchange rate to automatically calculate the price of a product based upon that day’s exchange rate. This practice addressed the issue of customers knowing how much a product costs but results in unfriendly “crooked” prices (see image below). Depending on how you manage product marketing pages, this practice becomes a management challenge because the prices may or may not be pulled from the same place in your system, resulting in duplicate work.

Smith Micro Cart with "Crooked" Prices (click image to enlarge)

Your customers should see product prices in clean, rounded numbers to further simplify the purchase decision-making process. If you show a European Union customer a product priced at €23,81  rather than a more customer friendly price of €25,00, you are increasing e-commerce friction unnecessarily and making them aware of the fact that your company is obviously not located in their home country.

VMWare Cart with "Crooked" Australian Dollar Prices (click image to enlarge)

Once you decide to price your products in clean, round numbers, the next thing to consider is pricing your product not only based upon the exchange rate of that local currency, but also based upon what the local market will bear for your product.

Keystone: Decrease e-commerce friction and cart abandonment by setting prices in clean, round numbers in every local currency, and don’t forget to price your products appropriately for the market.

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