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The BLUF (Bottom Line Up Front)

1. Price structure is how your price relates to time and volume. Don’t confuse it with metric!

2. The goal of price structure is to accommodate customers’ different willingness-to-pay and different billing preferences for consistency, flexibility, frequency, and predictability.

3. Don’t make structure overly complicated! Simpler is better.

The Theory of Price Structure

After our long series on Price Metric, I figured it was high time we covered the second element of Monetization, Price Structure. If price metric is what are you charging for (for users, for gigabytes, for actions, etc.), price structure is how that metric relates to time and volume. Everything below would fall under the purview of price structure.

• Do you have volume tiers? How many? How wide?

• Are the tiers flat or graduated?

• Do you have a minimum? A cap?

• How much volume discount do you give?

• Do you have a time-based structure, like monthly and annual plans?

The best graph I can use to summarize the difference between price metric, structure, and level is below: if metric is the name of the x (quantity) axis, and level is the y (price) axis, then structure is the shape of the curve.

Let’s dive in.

The Goal of Price Structure

Why have price structure at all? Why not just charge per x? If I’m selling users it’s $10 a user, to infinity? Well, the purpose of price structure is 3-fold:

1. Inject volume discounts to account for customers’ decreasing marginal willingness-to-pay¹

2. Account for customer preferences for billing consistency, predictability, flexibility, and frequency

3. Do both of the things above as simply as possible

Issue #1: Volume Discounts

It is a well-known phenomenon that people’s willingness-to-pay decreases as they “get more stuff”. So if you’re dying of thirst in the desert, you have an immense willingness-to-pay for a gallon of water. As I continue to give you more water, your willingness-to-pay decreases, up to the point where you have a swimming pool of Dasani² . Willingness-to-pay can even go negative: if you’re stranded in the middle of Lake Michigan, you would probably pay to have someone take water away!

The degree to which this phenomenon happens differs for every product and every segment. To illustrate this, it is often mentioned that diamonds have no decreasing marginal willingness-to-pay, although even that probably isn’t true. I’m sure you can buy diamonds in bulk out there somewhere³ .

How do you know if you have decreasing marginal willingness-to-pay? Measure it. The best way is via a quant study, but you can do it in an enterprise context if your customers heavily negotiate their bills.⁴

Below is a good example. The x-axis is the metric, the y-axis is the price. If we switched to the dotted lines, we would severely overcharge the folks on the right side of the graph. We need the volume tiers to bring down the price at higher volumes.

Issue #2: Customers Don’t Like Your Billing

Imagine being charged for services in the most frustrating way possible. I’d imagine it looks something like this…

1. Every time you use our services (down to the minute), you will get an invoice. (annoyingly frequent)

2. The invoiced amount will vary day by day, depending on how much service you use. (inconsistent)

3. There is no way to predict how much you will pay at the end of each day. (unpredictable)

4. You have no control over how much you spend. (inflexible)

If that price structure looks familiar, it’s because it’s the one that most lawyers, accountants, and general contractors use - essentially hourly billing. I might be going out on a limb here, but I think literally everyone hates how their lawyer charges. Let’s change it up and make a more advantageous structure:

1. Billed at the end of each month. (reasonable frequency)

2. Fixed fee that doesn’t vary month to month. (consistent)

3. Predictable bills, since they don’t vary month to month. (predictable)

4. I choose how many hours I want to buy. (flexible)

Obviously everyone would want the 2nd structure. Here’s the problem:

You see, that 2nd structure costs the lawyers / accountants / contractors money. They have to accurately price their projects. They might have clients that over use them or they might have a tax return / case that is super complicated and takes all their time. They also might have worse cash flow because of the timing of the bills.

The Bank Doesn’t Care

What kind of mortgage do you have, fixed rate or variable rate? Most Americans are on a fixed rate mortgage, but it’s cheaper to get the variable rate. That means…

What about those Amazon subscriptions where you can subscribe to monthly laundry detergent shipments and save. I personally hate those because I always end up accumulating detergent⁵ . In my case, I’m prioritizing flexibility (matching my usage) over consistency, predictability, and cost.

What’s important in both of these examples is that the bank (or Amazon) doesn’t care. They are equally profitable whether you take the fixed mortgage or the variable one, or the subscription or a la carte. In fact the two options are priced exactly at the point where the company is indifferent.

A Tale of Two Price Structures⁶

Let’s look at these two different price structures. Both account for diminishing marginal willingness-to-pay equally - that’s a fancy way of saying that they both have the same volume discount. They are both charging by the same metric, so what’s the difference?

Structure 1: Flat Tiers

Structure 2: Sawtooth Tiers

You need to graph these to see how they differ:

See how the total price is the same on average. So price level isn’t different, price metric isn’t different, it’s price structure that distinguishes these two models.

Flat tiers are more consistent while sawtooth tiers are more flexible (and inconsistent).

Issue #3: Keep it Simple Stupid!

Below is my absolute favorite price model of all time⁷

This is the most complicated set of volume tiers I have ever seen. Do you need all of those volume tiers? Probably not, but how would you know?

Answer: Math⁸

Spot the difference!

Do you see a difference between these two images?

Hint: it’s between 50 and 150 users. In the initial proposal, there were 6 volume tiers between those user levels. See how smooth the curve is in Image 1? Does it need to be that smooth? Not at all. We want the cleanest, simplest structure possible, while also accomplishing our 2 goals, 1) volume discounts and 2) billing preferences.

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  a.k.a. “more stuff should be cheaper”

2  Full body thirst quenching

3  Probably Costco

4  It’s assumed that in a negotiation, the final contract value approximates the customer’s true willingness-to-pay

5  Don’t worry, I do my laundry as much as any other pricing guru

6  Not as popular as Dickens’ other book

7  Which shows you how much I care about this stuff

8  Usually the answer