Hello everyone
Have you ever thought about how much something should cost?
Most people have an idea that a product in the shops should be priced to reflect the cost of the raw materials plus the cost of manufacture plus the cost of distribution plus a reasonable amount of profit.
However, this is not how pricing usually works. Let me explain by introducing you to pricing strategy. I’m going to start by talking about products and manufacturers, but these principles can be equally applied to services.
Before you jump in, I should warn you that there’s lots of business strategy here. But it’s worth knowing—it’s good to understand how businesses try to maximize what we spend.
Pricing Strategy
For any company selling a product, when it comes to pricing that product, there are two competing considerations:
- If a product is priced below the level a customer would pay for that product, then the company is “leaving money on the table” (in other words, not gaining the income that would come from charging the higher amount).
- However, if a product is priced too highly, then the company will lose the sale and lose the money that could have come from that sale.
You will note that neither of these considerations has anything to do with the cost of raw materials, manufacturing, or distribution. Customers don’t care about these issues.
So what’s a company to do when it’s worried about pricing a product too high and at the same time worried about pricing it too low, especially when “too high” and “too low” depend on the individual customer? This is where pricing strategy comes in…
The essential idea of pricing strategy is that a product should be priced at the maximum amount someone will pay. Not what they think they would pay…not what they want to pay…but at the maximum they will pay.
How Does Pricing Strategy Work?
The key to pricing a product at the maximum amount someone will pay, is not to have a single product, but to have a range of products so customers can select the product that is priced at the maximum amount they can pay.
You will have noticed the apparent flaw here…the manufacturer will be offering cheaper products, so won’t everyone choose the cheapest product? This is where the design for the range of products comes in… Each product in the range needs to be materially better as the price rises. Or looked at another way, the lower priced products must be materially worse than the more expensive products (although they must be desirable in their own right…just not as desirable).
Whether a product is better or worse may be a matter of labelling (for instance, if there is a “pro” product in a line, then the non-pro product may be deemed inappropriate for use in the workplace).
However, it is better if there is a feature or function, rather than a label, to drive consumers up the price range. If you’ve ever looked at a product and thought: this would be perfect IF… and looked at a higher priced product in the range which had the feature that’s missing from the lower priced product, then you’ve seen pricing strategy in action.
Pricing Strategies in Practice
One company which really knows how to use pricing strategy is Apple. Let’s have a look at their iPad lineup and see how their pricing strategy works in practice.
If you head to the Apple website, you will find five iPads in the range (under the heading Which iPad is right for you? at apple.com/uk/ipad). And for non-UK people, I’m pointing at the UK website and UK prices—you will find the same principles apply around the world, although some of the pricing steps may be slightly different. I should also note that I’m writing in November 2022—prices and models are likely be different after this date.
These five models range in price from £369 to £899.
Starting at the bottom of the range, there is the £369 model. This is the 9th generation, last year’s model—it was fine last year, but now it’s being positioned as the old model. In its place as the starting model is the 10th generation iPad which costs £499 (£130 more than last year’s model).
The newer model encourages the purchaser to spend that extra by offering:
- a new design (the old model now looks old)
- more color options
- a bigger/better screen
- a better processor
The changes might be subtle, but they all give the potential purchaser a nudge to spend more. Some purchasers will simply not have the money and will go for the cheaper model, but many will be encouraged to take the next step. They will rationalize their decisions with arguments such as: “I want the better screen” or “the more powerful processor will give the device greater longevity”. Whether the justification is correct, they will purchase.
Moving Further Up the Price Scale
Beyond the incentives to move from the ninth generation to the tenth generation, there are further enticements to keep moving up the price scale.
For instance, if you want an even better processor, and an even better screen (this time with a special coating), then you might consider the iPad Air for £669 (another £170 on top of the tenth generation or £300 more than the ninth generation model). By having the tenth generation model in the range, the gap between the bottom model (the ninth generation) and the Air is, in effect, halved.
But the Air serves another purpose—it is a step down from the Pro for those who can’t afford that higher priced model.
The Pro models start from £899 and offer a better/bigger screen, a more powerful processor, and a more fancy camera. Beyond the extra features, the “pro” label is there to drive people up the price scale. Anyone who wants to consider themselves a professional at what they do, and requires an iPad in connection with that profession, requires a Pro model. If you don’t use the Pro, then you’re telegraphing to everyone around you that you are most definitely not a pro.
However, £899 is £230 more than the Air and for people who are buying their own iPad, the law of diminishing returns may be coming into play when comparing features. When compared against the Pro, the Air is nearly as good, and when compared against the tenth generation beyond the screen/processor, there are material benefits (the Air is thinner, lighter, and works with the second generation Apple pencil).
In other words, the Air is a compromise. While it may be a compromise for the purchaser, it is not a compromise for Apple. By having this model, Apple is able to get more money out of the purchaser who can’t quite afford/justify the Pro, than they would if there were no intermediate step between the tenth generation and the Pro.
Anyone who can afford it will go with the Pro—it is materially better, and for those who covet Apple products, more covetable—but anyone who can’t afford the more expensive model has a fallback position.
Once someone has decided to buy the Pro (or more likely, has asked their employer to buy the Pro or can set the cost of an iPad Pro against tax), then Apple offer another step up on the price scale: the 12.9 inch iPad Pro which offers a bigger screen, and that screen is higher quality. These extra features are all available from £1,249.
And just for completeness, if you don’t want the tenth generation, then don’t forget the iPad Mini which has a smaller screen (giving a smaller form factor that you may like), but comes with a more powerful processor (albeit, not quite as powerful as that in the Air). The Mini is priced at £569, so only £70 more than the tenth generation, which may make it feel like a bargain if you want the extra power and smaller screen.
Squeezing Even More
We can see how companies (in this case, Apple) drive their consumers to spend as much money as they are able, even if they don’t want to.
But there’s more that Apple can do to squeeze money out of people. With the entire iPad range, there are inherent limitations with every product at each price point…and Apple will happily remove those limitations if you pay them some more money.
The main limitation for every iPad is the lack of storage. For £180 (for the ninth generation) up to £1,250 (for the 12.9 inch Pro if you choose the maximum storage), Apple will remedy that situation. And for £180 Apple will also offer cellular connectivity.
Then there are the add-ons…the Apple Pencil and various keyboard options designed to work perfectly with your specific iPad model.
So while the base iPad costs £369, if you want to get the 12.9 inch Pro with the maximum storage, an Apple Pencil, and a Magic Keyboard, that will set you back £3,197, in other words, nearly ten times as much as the cheapest iPad.
Manufacturing Cost
As you can see with Apple, there are improvements as you move up the price scale, but those additional features bear little or no relation to the additional manufacturing cost. Sure, a slightly better processor may have a more expensive manufacturing process, but those additional costs are marginal, and the distribution costs are the same.
This isn’t to knock Apple. Quite the contrary: this is an example of good business. And this good business is why Apple makes huge profits and is the most valuable company in the world.
There are many other companies that use a similar pricing strategy. Look at the car companies as one example. Equally, look at the airlines who charge wildly different prices for exactly the same seat on a plane depending on the circumstances when the ticket is bought and the customer.
Relevance to Novels
So why is a novelist writing about business strategy?
First, because this is how the world works and it’s good for me to understand these things. But I’m also mentioning this practice here because it also happens in publishing.
Now, of course, publishers don’t offer you extra storage, but they do offer books in different formats and have different ways to encourage you to spend more money.
Hardbacks
One of the first ways publishers encourage us to spend more money is with hardbacks.
When many books are first published, they are published only in hardback format. While it costs more to produce (and distribute) a hardback than it does to produce a paperback, it doesn’t cost that much more. A hardback will often cost £10 or so more than a paperback—that is extra income for the publishing industry for exactly the same text that comes in a paperback.
To encourage you buy the hardback rather than the paperback, there will be a period when the book is only available in hardback. In other words, you have the choice: pay the extra or wait until the paperback comes out.
There are other formats—such as audio—where a publisher can create a differentiated product which can have its price set at another level.
Variable Pricing
Another approach publishers use is variable pricing—this strategy is particularly easy to implement with ebooks.
Looking at Amazon today, I can find a best selling author whose most recent hardback costs £22. The (Kindle) ebook version of the same book costs £10.99. If we look at the same author’s book which came out last year and is now available in paperback, the Kindle version is priced at £4.99 (having been priced higher when the book was only available in hardback).
This pattern of dropping the ebook price when the paperback is available is used throughout the publishing industry.
Another pricing strategy many publishers use is to drop the ebook price to a very low level (often 99p) for a very limited time (maybe a few days). This pricing appeals to very price sensitive readers.
Until December
The key to remember with all this pricing strategy is that it’s a technique to encourage us consumers to spend money…and to spend more money than we want to spend.
The way to fight against these tricks is to remember that what we pay is a choice—the product differentiations that lead to pricing variations are often very minor, and almost always are not enough to justify the higher prices.
I’ll be back in December. Until then.
All the best
Simon