Unlocking Hidden Value: Price Fences for Smarter Pricing and Stronger Profits
Pricing Pointers, Issue #24
Offering a tiered pricing menu is an effective way to attract a broad range of customers and boost sales. But it comes with a major risk: the lower-priced options could cannibalize (or divert) sales from your premium offerings, severely harming your profits.
To succeed with tiered pricing, you need a safeguard: price fences. These are conditions that prevent buyers from qualifying for, or selecting, a lower price not intended for them.
But creating price fences presents a fundamental dilemma: balancing perceptions of fairness against the need to protect your revenue.
Fence Buyers Based on Who They Are
One way to create a price fence is to base it on an observable customer characteristic, such as age, student status, or group membership. For example, a senior citizen discount or a student rate on software are classic “who-based” fences. For another example, an accounting firm offers a lower fee to its nonprofit clients than to its for-profit clients.
These criteria are easy to verify and are highly effective at preventing cannibalization. Customers who don’t meet the criteria simply cannot access the lower price.
This method is excellent for protecting profits. However, it can be perceived as unfair by those who are excluded, as it’s based on an attribute of the buyer, something they cannot change.
Caveat: When you start offering, for example, a senior citizen discount, you are going to cannibalize some of your existing sales. This is because some of your current customers who were paying full price are senior citizens. The hope is you will gain enough new customers at the lower price to offset the revenue you lose from those who didn’t need the incentive to purchase.
Fence Buyers Based on What They Do
Another approach is to base the fence on a customer’s actions. For example, a lower price for purchasing a larger quantity, buying at an off-peak time, or opting for a version of the product with fewer features.
These types of fences are often seen as fairer because the discount is earned through a customer’s action.
However, a potential pitfall is cannibalization (or diversion): a customer who would have paid full price opts for the cheaper option instead. As a result, you lose out on revenue. Cannibalization occurs because the lower-priced option provides too much value for the price.
The safeguard against cannibalization is to create a trade-off between price and value that deters quality-sensitive buyers from downgrading their purchase.
The Fundamental Dilemma: Fairness vs. Diversion
This brings us to the core trade-off. Fences based on who the buyer is are a powerful tool for preventing diversion and protecting revenue. Their rigidity is an effective barrier. But that same rigidity can lead to perceptions of unfairness.
On the other hand, fences based on what the buyer does feel more equitable and promote a feeling of choice. Yet, because these fences require an action that anyone can take, diversion is a potential side-effect.
The most effective pricing strategies will strategically choose the right type of fence for their business, balancing the need for profit with the need to build customer trust.
Rethink Your Approach to Pricing
Stop thinking about your pricing as a single decision. Instead, see it as a flexible, multi-layered strategy.
Your goal is to design a price structure that provides a clear menu of options, each with a specific value proposition.
Consider how you can use different types of fences, from product features to timing, to segment your customers by how price sensitive they are.
By using effective price fences, you can serve more customers, capture more profit, and build a stronger, more resilient business.