PRICING STRATEGY

Price elasticity is the change in demand for a product, given a change in the price of the product. Mapping out the changes in demand, given the changes in pricing, creates a demand curve.

Let’s use the example of a pizza maker, with a tiny little store in New York City. Let’s say it costs the pizza maker $5 in ingredients to make each pizza (really good ingredients!). If he charged a premium of $20 per pizza, he would sell 500 a month. If he charged $12.50 per pizza, he would sell 1500 a month. If he doubled his cost and charged $10 per pizza, which is called keystone pricing, he would sell 1800 a month. Let’s say he was opening up a new pizzeria, and to get as many people to try his pizza before the opening, he was going to charge $4 per pizza to sell 4000 per month. We can plot all of those prices and demand quantities on a graph to create a demand curve, and we can plot the variable cost ($5 per pizza) on the same graph.

The second graph plots the pizza maker’s gross profit (revenue minus variable costs) at different prices and demand quantities. At the premium price of $20, he’ll make $7500.  The $12.50 pizza is the profit-maximizing price, which generates $11,250 in profit. At the keystone price, he’ll make $9000. And, the $4 pizzas will translate to a loss of $4,000. On this second graph, you can also map the fixed costs (e.g., rent, electricity, overhead) to calculate total or net profit.

Ok, that was some seriously dense material. While many people think of demand curves as being theoretical, they are real and important. While it isn’t practical to try and figure out every single point necessary to create a smooth demand curve, it is relatively easy to do some pricing experimentation or surveys to plot a few points on the chart, which is typically all you need to figure out the price demand dynamics of a product. In pricing strategy, it is insightful to answer simple questions such as “What roughly happens to demand if the product is 10% cheaper, 25% cheaper, 10% more expensive, or 50% more expensive?” There could be a lot of money in those answers.

Over the past 20 years, subscription pricing models have emerged as an innovation across almost every industry. You can get almost anything with a monthly subscription, from massages to beers of the world.

From a business model perspective, if you can crack the code of subscription pricing, you can even out a predictable revenue and cash flow stream. The graphic goes over the typical subscription pricing strategy and the cumulative profit over a 12-month period.

Companies utilizing subscription pricing continually optimize the customer journey and economics by tweaking pricing, add-ons, benefits, and retention programs.