
Ten Years' Worth of Learning About Pricing - gk1
http://tomtunguz.com/pricing-summary/
======
matrix
While the article provides a basic definition of various types of pricing
tactics/strategies, it doesn't address important questions such as which
pricing strategies work best for which types of markets and products, and what
kind of marketing/sales is required to support the choosen strategy.

The best book I'm aware of on the topic is Nagle, but it's getting dated and
is focused on older B2B business models. If anyone had recommendations for a
more recent book on the topic, I'd love to hear it.

~~~
caro_douglos
pricing w confidence is a book worth checking out

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CoVar
There's lecture notes available from an MIT open course just on pricing that I
found helpful. Below are all of the lecture notes [1], and the summary lecture
note [2].

[1] [https://ocw.mit.edu/courses/sloan-school-of-
management/15-81...](https://ocw.mit.edu/courses/sloan-school-of-
management/15-818-pricing-spring-2010/lecture-notes/)

[2] [https://ocw.mit.edu/courses/sloan-school-of-
management/15-81...](https://ocw.mit.edu/courses/sloan-school-of-
management/15-818-pricing-spring-2010/lecture-notes/MIT15_818S10_lec08.pdf)

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paulsutter
All Tom Tunguz posts are good, this one is even better. One question though,
three part tariff is proven to be best, for what cases? Given how awkward it
would be if everything were priced this way, there should be a clear division.

> the 3 part tariff is proven to be best. It provides many different ways for
> the sales team to negotiate on price and captures the most valu

~~~
zwaps
This is actually a argument based on the economic theory of pricing. To be
quite fair, the statement that 3part is best is not entirely correct.

The idea is he following: In a old-school normal market, where you sell one
good to a whole bunch of guys each etc, and everyone wants just one good, you
may just post one price. You will not do better, no matter what you know or do
not know.

But in most cases, posting a single price will not be optimal for you. This is
because you sell multiple units to multiple customers, each possibly very
different. And, you do not know what they would be willing to give you. You
have asymmetric information. If you KNEW everything, you could tailor a
contract for each customer. But you don't.

In economics, we can tackle this problem using Mechanism Design. Using game
theory and nonlinear pricing (the non-linear is important here), you may be
able to set a menu of possible contracts in a way that the customer self-
identifies by choosing the best option for him.

The intuition of the problem is the following: Choose a menu of contracts that
allows you, the company, to maximize profit, while also making the customer
choose truthfully and thereby "tell you" what he is willing to pay. This is
what the three part price may do for you.

Now why is this not entirely correct? There is a (rather theoretical question)
as to basically how far a two-part or three-part price is "nonlinear enough"
for your set of customers. This is called implementation theory.

An excellent book to get behind this mystery is Tilman Borgers book on
mechanism design [http://www-personal.umich.edu/~tborgers/](http://www-
personal.umich.edu/~tborgers/) This was a free download for many years, so you
can probably find the pdf.

~~~
paulsutter
Ok, but for most things you really don't want a three part tariff: rides on
uber (SaaS!), gasoline, houses, employee salaries, health insurance, hotel
rooms, container shipping. The customer would just be annoyed and go deal with
someone else.

So what is the magic slice of products for which 3part is a good idea? All
enterprise software? Some enterprise software? Only enterprise software?

The most impressive pricing I've seen is Salesforce.com. The pricing is simple
but genius. Per seat pricing, where the cost per seat goes up with
functionality. I was boiled like a frog: the cost went from $300 per year to
$300K per year, and there was nothing I could do about it. How would a 3-part
tariff help them?

~~~
zwaps
If you can not differentiate your product at all, it will be pretty hard to
price non-linearly. You are right there: Customers will run away.

It has happened on the internet (targeting), but people get very angry. Uber
extracts from two sides of the platform, which is a more complicated matter.

For the other examples, you are not exactly correct. Health insurance is
clearly a two-part price, indeed it is a classical example. You pick your
tariff and coverage. Whenever you pick, it's a nonlinear pricing scheme.

Salaries are another thing. A base and a bonus are very, very common. That's
two part. Also comissions and somesuch.

Hotel rooms? Rate and extras? Minibar?

Cars? Extras and bundling...

All of that is non-linear pricing.

So your point is basically correct. If the customer notices you get to extract
all surplus, he might get annoyed. But a two part tariff most often seems
beneficial to the consumer, because he gets to choose!

~~~
paulsutter
Uber’s complexity and lack of transparency around paying drivers is a really
bad idea for the company, and only an MBA could think it’s good. Someday Uber
will discover that they were just a missing feature in Google Maps, and this
is why all the drivers will switch.

Your examples have convinced me that a 3 part tariff is generally bad and an
indication of extractive desperation on the part of the vendor, and
fundamentally based on deception. If you wonder why people hate their banks,
pricing is the reason.

~~~
zwaps
The pricing scheme is derived as an optimality solution for the company.
Obviously, it always (mathematically speaking, weakly) benefits the firm.

An all-knowing monopolist will extract 100-epsilon% consumer surplus. That's
why economists are big about regulation and taxation.

Is it deception? Not necessarily. A pricing scheme is a menu of deals from
which you pick the most beneficial for you. You then optimize as well - just
that the company gets to set up the menu.

If a company were to decide to leave a minimum surplus to you, the
optimization problem would be almost identical. We just assume that companies
set this minimum value small. Perhaps, however, this may not be the best long
term strategy? Not all companies may try to extract everything.

But what is a good and fair amount?

~~~
paulsutter
Business is about more than extracting the most you can. Most Wells Fargo
customers are unhappy, but they stay because the competitors are just as bad.
Unhappy customers is bad for business. Startups are often about giving
customers a better experience than the incumbents.

Toms writing is targeted to entrepreneurs who need to consider all aspects of
the business, unlike product managers at Faceless BigCo, who “win” solely by
the shitty little optimizations that you so love.

~~~
zwaps
Ignoring your needlessly hostile tone, it is Tom who proposes nonlinear
pricing schemes. If there were no interest in controlling the surplus left for
consumers, neither him nor anyone else would have need to employ such schemes.

Entrepreneurs probably employ such pricing methods more often than BigCo as
well, simply because they sell less uniform products to less anonymous
customers.

Your point?

~~~
paulsutter
Yes my point is that the term "optimal" could be misleading. People reading
the document are likely to interpret "optimal" to mean that it's the best
business decision. But in many cases it's not the best decision.

So my question (not point) is, when/for what is a 3 part tariff the best
choice, when you consider all the other issues (like, what would annoy
customers, etc).

In the case of Salesforce, the day I signed up, if there were a significant
base cost over-and-above the per-seat price, there's a good chance I would
have avoided Salesforce, and Salesforce would never have gotten that
(eventual) $300K a year from me. So it seems that their pricing is better than
a 3 part tariff.

~~~
zwaps
First, your point about optimality is "not even wrong". Like I said, the
surplus value you want to give your customers is really up to you and the
optimality starts from this point. Yes, people may misunderstand this in the
article. But I think that's the reason why the article does not offer any
concrete recommendations.

Non-optimality just means you are leaving surplus on the table, out of your
control. It certainly doesn't mean you will be better off in the long run. If
you are comfortable with that decision, go ahead and choose a flat tariff.
Since a business is also driven by cost, I would bet you will consider that
decision sooner or later.

Non-linear pricing is "the best" when you are doing a theoretical argument,
since you just can't do worse with more instruments than less - if you employ
them wisely. That's what is written in the article, and that's what I
elaborated on. It may just mean it gives you most control in deciding about
consumer surplus, whatever that strategic decision may be.

Second, with regards to salesforce: A x-part price does allow you to set fixed
components to zero, if that corresponds to the customer base. The "best"
mentioned in the article is a theoretical construct in the sense that
nonlinear pricing is simply more general. You are not the only customer, and
in the end it depends on the whole demand base as to what is optimal. A
product delivering high value per seat may just simply be best off with a low-
to-zero fixed component. Again, it all depends on who you are targeting.

You spend 300k a year? So what if I offer you a contract with 200k a year plus
a fixed 50k? Will you not take it? What if you do, and I tell you we both win
in this deal?

My point is that there is a general thing to understand about pricing, and
there is a reason why this article refers to something as best, while being
sparse on actual implementation.

The best business decision, as you put it, depends entirely on your assessment
of what customers want. This much will never change. But this article wants to
point out that you can deal with information asymmetries with a nonlinear
pricing scheme, something everyone should study deeply before pricing one's
product.

As a consumer, you are faced with price menus in almost every purchasing
decision you take outside a supermarket. That's for a reason. If you are an
entrepreneur, and you do not understand why or when one may employ a nonlinear
pricing scheme, then you are lacking knowledge.

~~~
paulsutter
Salesforce.com pricing is genius in its simplicity. I’m happy to discuss or
explain, it’s really easy to reach me so please feel free to do so. I promise
you can learn something unexpected about pricing. Because you really haven’t
read what I’ve written.

Meanwhile, I don’t think anyone but us are reading this thread.

------
jkuria
Good short post. Here's a Joel classic from 2004 that is still relevant. It is
a little long though:

[https://www.joelonsoftware.com/2004/12/15/camels-and-
rubber-...](https://www.joelonsoftware.com/2004/12/15/camels-and-rubber-
duckies/)

------
braindongle
"Maximization is charging the most you can extract in each sale"

Wouldn't that be the price that gets you one, or very few, sales? Isn't demand
elasticity still a thing?

~~~
zwaps
He is assuming you set individual prices per customer or basically that each
customer has his or her own demand elasticity.

What you are thinking of is a market demand, which is a useful approximation
when the market is large and anonymous. Instead, he gets at the idea that each
customer has an individual reservation price, upon which he will still buy
your service or good. If you manage to ask exactly this price, you can extract
the maximum profit from each customer.

Edit: I could do a write-up of the details. I don't have a blog or something
like that tho.

~~~
perl4ever
Isn't it common for people to have a gut reaction that price discrimination is
wrong or unfair? People are generally unhappy, for instance, if they find out
another person paid 1/3 the price for an airline seat. If I find out that I'm
being charged multiples of what another customer is, I'm going to have an
intense desire to punish and/or boycott that vendor. Failing that, I'm going
to look for a way to be anonymous, such as paying cash to a middleman.

Besides the risk of spreading ill-will, it also seems to me that price
discrimination can be risky because there is no way to firewall it against a
correlation with some legally protected class.

Edit: Also something that occurred to me just now - price discrimination seems
to me to lead to a reductio ad absurdam - suppose that it was absolutely
perfect and captured all the consumer surplus; then doesn't that destroy the
rationale for the transaction in the first place and make it purely
exploitative? If it is not desirable to get to that place, then maybe
splitting the surplus at least evenly between producer and consumer is the way
free markets should work?

~~~
amateurpolymath
Whether people are upset by price discrimination or not depends on how it is
perceived. For example, no one seems upset at discounts for seniors, students,
or military, despite this being a form of price discrimination.

To your second point, customers often do try to fool vendors into thinking
they are in the consumer group that is offered lower prices. As an example,
non-students use their old student IDs all the time.

Re: correlation with a legally protected class, this can be solved with
marketing. Price discrimination based directly on gender would be illegal. But
if you put one product in a blue box in the "men's" section and one in a pink
box in the "women's" section, consumers will self-select. This is very common
with razors, soap, and other such products.

Lastly regarding your edit, if a consumer pays his or her reservation price
they are left with zero surplus. But that doesn't mean the transaction was
pointless. The consumer gets the consumption value of the product. I'm willing
to pay at most $2 for a bottle of Coke. That's my reservation price. If I'm
offered a Coke for $2, and no vendor offering a lower price is available, I
will pay that price and enjoy the Coke.

~~~
perl4ever
In order to make a trade, what you are getting must be more valuable to you
than what you pay - isn't that axiomatic? If you are willing to trade $2 for a
Coke, then the Coke must be worth more to you, and therefore it follows $2 is
not your maximum price. Your maximum price is at least $2 + epsilon.

Since it is impossible to make a completely one-sided trade, one may ask how
one-sided is acceptable, and if perhaps the optimal situation is where it is
balanced in favor of the consumer...

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thenaturalist
One of the more detailed free resources available on this topic I know of is
this one: [http://www.priceintelligently.com/hubfs/Price-
Intelligently-...](http://www.priceintelligently.com/hubfs/Price-
Intelligently-SaaS-Pricing-Strategy.pdf)

Note: I am in no way affiliated with Price Intelligently and do not in any way
intend to promote their service. Just wanted to share this free PDF.

------
Lightbody
While this post has some useful tidbits and definitions wrapped up an easy-to-
read format, it is far from complete and I hope nobody views it that way.

For example, you can't have a complete discussion about pricing without
talking about packaging and fencing. So if you're interested in pricing as a
topic, make sure you find another sources that go deeper in those areas.

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biocomputation
This book totally changed my life:

[https://www.amazon.com/Strategy-Tactics-Pricing-New-
Internat...](https://www.amazon.com/Strategy-Tactics-Pricing-New-
International/dp/1292023236)

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bladewolf47
"If you’re targeting 50% margins, just double your cost and there you are."
Don't want to nitpick but wouldn't that be 100% margin?

~~~
Steve44
As /u/lukevdp said the article is correct. Part of my job involves pricing our
products and working out rebates when we use 3rd party agents for example.
It's surprising how many people struggle with understanding this isn't as
simple as they think.

For example if an agent wants a 10% rebate we need to calculate the markup
from our standard selling price to accommodate this. If we sell a product for
£100 then we'd need to invoice it for £111.11 because 10% of that brings our
real selling price back to £100.

If we mark it up by 10% we'd invoice out at £110, the 10% rebate to the agent
would be £11 and we'd have sold for only £99.

Comprehending that you don't use the same percentage up and back down is too
much for most people here. They eventually get to understand that they can't
do it that way, but actually doing it correctly is a dark art.

~~~
roel_v
I had a colleague once who bought a pack of cookies that said '10% free' or
something like that. I turned out though that only 10% of the initial volume
had been added (hope that explanation makes sense - it's a variation on the
issue Steve44 is describing). Anyway so he wrote a letter to the company
pointing that out, they send him back an apology letter and a box of free
biscuits.

Moral of the story: pay attention in math class kids. If you don't, one day
you might have to hand out free cookies.

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siruncledrew
The 3 part tariff sounds like a familiar pricing model to car leases

