The Price Is Right

Your Guide to Product Pricing Models

Pricing is a lever to capture demand and maximize margin.

Too high and you lose sales. Too low and you leave money on the table.

Strategic pricing decisions influence revenue growth, sales volume, and margins. But more than just setting a number, strategic pricing involves the choice of a monetization model  — such as subscriptions or one-time fees — as a key lever to influence go-to-market, demand capture, cash flow stability, and customer lifetime value (CLV). 

In simple terms, think of pricing in two parts. First, each product has a rate, or the dollars per unit. Second, and more importantly, the pricing considers the monetization model to position the product in the market.

A 10,000-foot view of pricing models can help you review the basics. Consider this your cheat sheet to help your clients evaluate pricing models. 

Let’s begin with setting the rate.

1. Cost-Based Pricing

This traditional pricing method involves calculating the production cost of a product and then adding a profit margin. It’s straightforward and often used in competitive markets, where prices need to match those of similar products.

Considerations:

• (+) Easy to manage

• (+) Predictable margin

• (-) Limited earnings since most customers won’t pay for added value or differentiation 

Best For: Commoditized markets

Example Use Case:

• Gasoline, where the price is based on the commodity cost, production cost, taxes, and retailer margin

2. Value-Based Pricing

This method sets the price based on the value delivered to customers. It’s focused on what the customer is willing to pay for the solution or benefit the product offers.

Considerations:

• (+) Stronger customer loyalty

• (+) Potential to charge a higher margin

• (-) Challenge to communicate a clear value story and differentiate in the market

Best For: Premium goods

Example Use Case:

• Luxury cars, where people pay for the brand and experience

After laying the groundwork, the next step is to choose a monetization model that best-fits the customer experience, marketplace, and business strategy.

Here’s a quick overview:

1. Subscription Pricing

Products with subscription pricing charge customers a recurring fee, usually paid monthly or yearly, for continuous access. This provides them with continuous value over time, rather than a one-time purchase.

Considerations:

• (+) Regular, predictable revenue for the producer

• (+) Lower barrier to entry, lower CAC 

• (+) Better cash flow management for customers

• (+) Stronger customer retention and higher CLV

• (-) Need to invest more in retention efforts and product improvements to keep customers engaged

Best For: Platforms, software, memberships, and digital services

Example Use Cases:

• Netflix, Spotify, and Disney+ that offer ongoing content

• Gyms and clubs that offer ongoing services for a monthly fee

• Meal kits and beauty boxes where customers receive goods on a schedule

2. “Percent of” Pricing

An attached product’s price is determined as a percentage of another product’s price. This monetization model is often paired with "graduated pricing”. As a customer spends more on the main product, the percentage-based fee for the add-on product declines.

Considerations:

• (+) Shifts value perception from an individual product to a holistic solution

• (+) Enables investment in the attached product

• (-) Can be complex to transact and communicate with customers

Best For: Products sold as ‘solutions’

Example Use Cases:

• Software support is sold as a percent of the software subscription fee or consumption

• Paypal reduces transaction fees for higher-volume users

3. Pay As You Go

With this model, customers are charged for their actual usage of a product or service. Instead of paying a fixed fee, customers pay only for what they use.

Considerations:

• (+) Low upfront costs for customers

• (+) Best for customers who don’t like subscriptions

• (+) Useful for markets where customer credit is a requirement

• (-) Unpredictable revenue because customers can easily stop the service without a long-term contract, higher CAC

Best For: Utilities and usage-based services

Example Use Case:

• Prepaid phone plans where customers pay for minutes, texts, or data they use

4. Subsidized Pricing

This pricing model lowers the upfront cost of a product, with the expectation that the company will recoup through long-term contracts or additional services.

Considerations:

• (+) Lowers barrier to entry, attracting more buyers

• (+) Potential for long-term revenue and lock-in

• (-) Initial hit on margin and cash flow

• (-) High reliance on future revenue to recoup profit

Best For: Hardware paired with service contracts

Example Use Cases:

• Discounted smartphones offered by mobile carriers

• Low-priced printers with ongoing ink cartridge purchases

5. Dynamic Pricing

The rate of a product changes in real-time as market conditions adjust. Rates drop as demand increases or supply is limited. As demand rises and supply becomes constrained, the price increases to reflect scarcity.

Considerations:

• (+) Maximizes revenue and margin

• (+) Manages limited supply

• (-) Customers might see the price increase as exploitative or unfair, leading to negative reactions

• (-) Upfront platform investment and algorithm monitoring 

Best For: Limited products that can be managed digitally

Example Use Cases:

• Uber changes rate based on the traffic, demand, and driver availability

• Third-party concert ticket sales increase in price as fewer seats are available

• Airlines raise prices for the last remaining seats

6. Marginal Pricing

Price changes are made as more units are sold. High initial prices cover production costs, but as supply increases and demand grows, prices drop to capture demand. Alternatively, if the supply becomes limited, prices increase to reflect scarcity.

Considerations:

• (+) High initial price covers development and production costs

• (+) Initial scarcity and premium price drive pent-up demand

• (-) Decretive margin over time 

• (-) Poor customer experience for initial adopters

Best For: Manufacturing a high-demand product with short-term production barriers

Example Use Cases:

• Automobile models are expensive when they’re new, but prices drop as newer versions are released

• Video games launch at a premium price, but lower as sales increase and development costs are covered

7. Minimum Advertised Price (MAP)

In this pricing model, suppliers and retailers enter an agreement where they negotiate the lowest price a retailer can advertise for a product as part of a larger retail agreement.

Considerations:

• (+) Avoids “race to the bottom” price cuts for suppliers and retailers

• (+) Protects supplier brand value

• (+) Protects retailer marketing investments

• (-) Requires trust and stability to enforce across retailers

Best For: Branded products

Example Use Cases:

• Consumer electronics (Apple, Samsung, etc.) with consistent pricing across multiple retailers

• High-end brands use MAP to protect their premium image

8. Licensing

Companies sell the rights to use their intellectual property (IP), like a logo, brand, or technology, to another company in exchange for a fee or royalty on sales.

Considerations:

• (+) Steady passive income 

• (+) Low-risk, low-investment venture for the IP owner

• (-) Reliance on the reseller’s success

• (-) Reduction in control over brand experience

Best For: IP owners seeking additional revenue streams (technology, patents, logos)

Example Use Cases:

• Sports leagues license their logo to apparel companies

• Scale technology IP across use cases

Framework Focus: The Mix and Mekko Charts

Let me introduce two frameworks to the mix.

Both the Simple Mix and the Mekko Chart enable comparison between groups.

The Simple Mix is useful for quickly showing composition differences, like changes over time or growth. It is commonly used and easy to understand.

The Mekko Chart is a powerful tool that can illustrate the composition of a whole with a single visualization. My advice? Use this sparingly. It requires an audience to interpret the chart before insights become clear. It works well when the intent is to show a fragmented landscape.

The Simple Mix Framework

When I ran consumer merchandising at Dell, I used the simple mix chart frequently in executive reviews. It was a simple visualization to illustrate the retail landscape and share Dell’s place in it.

For example, my team compared the types of PCs sold by different retailers. Using a Simple Mix Chart, we found that Walmart primarily sells lower-end computers with Intel i3 processors, while specialized retailers like Newegg focus more on higher-end models with Intel i7 processors.

This kind of comparison helps us understand each retailer’s product focus more clearly. We used these insights to inform our product development, promotion strategies, and sales pitches to retailers. 

The Mekko Chart

Mekko charts are useful for comparing different groups and variables, like product lines or retailers selling the same items. They also let you show another factor by changing the width of the columns—wider columns represent larger percentages, while narrower ones represent smaller percentages.

Let’s go back to the example, looking at chipsets sold by different retailers.

If I were to use a Mekko chart in the same presentation, I would include the top five retailers alongside Walmart and Newegg for a clearer picture of the market.

The mix chart would show the proportion of unit volume sold by each retailer along the x-axis. The top three retailers would have the widest bars, indicating the highest sales volume. Looking at the y-axis would illustrate which specific chipset drove those sales.

In this scenario, the illustration would reveal that i3 PCs sold by the largest two retailers drove the majority of the market volume and thus revenue. It would also show pockets of i5 and i7 volume with specific retailers. These spaces become target opportunities for margin growth since advanced machines typically had higher margin.

One other drawback of Mekkos? They’re difficult to create. 

Feel free to download the template here.

Remember, the path to success is paved with continuous learning and embracing fresh perspectives.

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Stay curious, friends.

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