Last week, Netflix announced a $1-$2 monthly price increase for its standard and premium plans. Investors applauded the move, with shares lifting 5.4% on October 6th, adding over $4B to Netflix’ market cap. How many other executives are now evaluating their pricing decisions in search of incremental revenue? Should you?
Economists might answer that question by examining the price elasticity of the demand curve - a price increase drives revenue if the demand curve is inelastic (e.g. gasoline, for your daily commute) and decreases revenue if demand is elastic (e.g. tomatoes, because peppers can be substituted). This principle is often observed in the B2C world, where transaction volume is high and pricing is relatively transparent. If you understand your elasticity, pricing decisions are easy.
The problem with elasticity analysis in the B2B environment is that sellers often experience derived demand from their buyers that limits changes in purchase quantities. For example, when Delta orders a 777, Boeing only needs two engines from GE, one for each wing – no amount of discounting will put three engines on that plane. The short-term outcome from a GE discount is less profit for them and more for Boeing, and in the long-term it will be difficult for GE to raise prices after training its customer that discounts are available.
So how should you evaluate your prices and avoid the discounting trap?
- Know your customers. If you truly understand your customer’s business model, you can evaluate how their sales will be impacted (or not, more likely) by your pricing. If you provide a discount, will they sell more? Remember the case of Boeing and their derived demand for GE engines.
- Relentlessly discover your value. Talk to your customers, or have a 3rd party talk to them. Validate why they buy your products, and uncover new reasons why they like you. The key is to learn what incremental financial benefit your product gives to customers relative to your competitors. Value drives profit to their bottom lines, and you can share in that mutual benefit through pricing.
- Tier your offering. Customer needs vary across segments. Versioning your products steers Value Buyers and Poker Players towards your flagship product, while Price Buyers will settle for a flanking offering that maintains price-value alignment. By removing the most valuable features from the flagship version, these Give-Gets™ create powerful negotiating tools that help you get your price after you set your price.
Netflix believed that its higher-tier customers would continue to value its streaming services beyond higher price levels, and now investors believe this, too. What is the most important factor to consider before your next price change? Understand your value.