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The BLUF (Bottom Line Up Front)

1. Most people wrongly assume that “silver” should be their most popular tier. It’s probably bronze, and we’ll show you why.

2. However, you can use data analysis to find out if you’re the rare case where “silver” actually should be your most popular tier.

3. There is no right answer with packaging, but there are many “wrong” answers. We show you a few.

Pricing vs. Packaging

Pricing and packaging are so commonly said in the same sentence that some people probably don’t know the difference. Some day, we will do an overview of the 7 Elements of Monetization, but until then, the difference between pricing and packaging can best be explained by…

Packaging is the intersection of Pricing and Product. If pricing (in a vacuum) explains how to calculate the dollars and cents¹ of what you’ll pay, packaging is how the product experience differs for different customers, and is as important as many elements of pricing.

When to use tiers (and what your other options are)

Tiers of features (like the picture above) are so ubiquitous in software packaging that one might think that is the only way to package. There are actually many more packaging options; but for the sake of brevity, I’m only going to talk about tiers today.

For what it’s worth, a company should use tiers of features if number of features desired by a customer is predictive of willingness-to-pay. Let me say that again, in larger font, to get that to sink in.

That pattern might not be true, although it is the most common pattern in markets. Other typical patterns include:

• Every customer wants the same features, so it doesn’t predict WTP - monolithic / buffet packaging

• Every customer wants completely different features, so it doesn’t predict WTP - a la carte / dim sum packaging

• Customer segment or use case is more predictive of WTP than features - modular packaging

• There are 3 more patterns but you’ll have to subscribe to learn about them next week.

What’s the right customer distribution across tiers?

I get this question all 👏 the 👏 time.

Let’s assume that you actually do have packaging tiers. Then there are 2.5 right answers to the question above. The first “correct” answer is that it should be a normal distribution - something that looks like the graph below.

The second “correct” answer is that it should be a power law distribution, or something like this.

If you couldn’t tell from the BLUF section, the correct answer for most companies is the 2nd pattern. Most companies should have a power law distribution across feature tiers.

Why?

Because willingness-to-pay is also power-law distributed. Most of your customers probably pay a low price, some pay a medium price, and very few pay a high price. It is HIGHLY UNLIKELY that most of your customers pay a medium price, and therefore should have a medium package. Let’s show this in data.

Assessing packaging distribution using data

Let’s start with the data that you’ll need:

• Customer Data: How much is each customer paying you annually? If you think something is terribly wrong with your current pricing, you may want to use a proxy for “paying you,” such as product engagement (active users, logins, orders, etc.)

• Feature Usage Data: Which customers are using which features, and how much are they using them? Time horizon doesn’t really matter, it can be a monthly average or annual. If you don’t have feature usage data, then you can get which customers purchased which features.

Step 1 - verify that customer willingness-to-pay is power law distributed.

• Line up your customers from least to most according to your proxy for willingness-to-pay. In an enterprise company, that is often their negotiated bill. In consumer companies, engagement (sessions, users, logins, buttons clicked) is a better proxy. The best proxy is survey data for what it’s worth.

• Does that line look like a hocky stick or a sideways S? Hocky stick? Congrats, you have power law distributed WTP. Sideways S? You’re weird but please tell me more about your business.

Here’s a real example from a client in the CRM space. Our proxy metric for willingness to pay was “orders,” but the graph looked the same if you used annual contract value.

Step 2 - examine feature usage distribution.

We’re going to do the same kind of analysis, but this time, your y-axis is going to be the number of features the customer uses / purchased.²  

• Line up your customers from least to most feature usage.

• Does that line look like a hocky stick or a sideways S? If it’s a hocky stick, you also have a power law distribution of feature demand.

Below is a real client example. The purple is their actual feature distribution; the gold dotted line would be what we would expect for a normal distribution.

For the customer above, we would expect most customers to be in the bronze / good pack, some customers to be in the silver / better pack, and few customers to be in the gold / best pack.

When should you expect most customers to be in the “middle” package?

There are really 2 answers to this question. One is common in software businesses and the other is common in services.

In software, a normal distribution happens when customers’ feature needs match their level of maturity, rather than their size, complexity, and willingness-to-pay. A highly topical example of this is today’s market for AI products.

If you see the pattern above, you should NOT have traditional tiers (good-better-best / bronze-silver-gold). You should instead have “Lite/Premium Packaging”.

Lite/Premium Packaging: A Primer

Lite/Premium Packaging is where you have a “standard” package which appeals to “most” customers (think 80% - 90%), but customers can purchase a Lite and/or a Premium package instead. This is most commonly seen in open source companies, but it applies to many other software and non-software companies too.

For example, WordPress, a popular, free website tool, offers an enterprise plan that has more security and extensibility. Below is an open source CRM tool called SuiteCRM that also has Lite/Premium packaging.

Fancy Food: Lite/Premium Packaging

If you’re curious what this looks like in the “real world”, look no further than restaurant wine pairings. San Francisco restaurant Atelier Crenn (with 3-Michelin Stars), offers diners a $395 tasting menu.

But…if you REALLY want something nice…you can order the $1,225 wine pairing that accompanies the meal.

I’m going to go out on a limb here and assume that the standard - premium distribution of diners at Atelier Crenn is nowhere close to 50/50.

And while Atelier Crenn doesn’t offer this, many restaurants offer a “Lite” version of their menu during lunch or at the bar. Eleven Madison Park, another 3-Star Michelin restaurant, offers their “standard” tasting menu for $365, and a “bar menu” for $195.

No, I do not only dine at 3-star Michelin restaurants…³

Professional Services: A hybrid approach

There is one other situation where most customers will choose the “middle” tier, and that is in professional services firms where each customer is presented with a custom quote.

If the firm is pricing well⁴ , they should present each new customer with 3 options, the standard option that they believe satisfies the customer’s needs, a “stretch” option that they might be able to upsell, and a “budget” option if the customer negotiates. In that situation, most customers will by definition choose the middle option, because it is the most likely outcome. The difference is that in professional services, what constitutes the “middle option” changes for each customer.

This is how almost all consultants, designers, bankers, contractors, body guards, and wedding planners package their services. It is how some lawyers and accountants price their services, but only if they’ve had the pleasure of working with me 😁 

The “wrong” answer

Is there a wrong distribution of customers across packages? Yes - provided you’re in one of the tiered packaging frameworks I’ve described, rather than something more flexible like platform packaging⁵ .

This is wrong.

That pattern almost never appears in markets and the silver tier is cannibalizing revenue from the other two.

This is also wrong. Again, it’s highly unlikely that there is that much differentiation in market needs.

Remember - packaging is a blend of art and science. Yes, there are some best practices, but you shouldn’t be afraid to get your hands dirty with some data.

Tune in next week where we’ll go deeper into other packaging options.

Get in touch

Crescendo works with medium-sized software companies to improve their pricing, packaging, and promotion strategies. If you’d like to book a quick consult, reach out at [email protected] or schedule time via the button below.

1  Or Euros and Yen

2  Usage is usually preferrable to purchases, but sometimes a feature can be valued highly, even if it shows zero usage, like data recovery.

3  On occasion, I will stoop all the way to 2-stars

4  If not, they should call me

5  More on what that is later