We all must have heard of the 4P’s of Marketing and would know that Pricing is one of the them. Thus, it is important to get the pricing right for any market offering. In case of digital products it becomes even more essential due to the nature of the business and the marginal costs involved.
Economics of Digital Products
These products are developed with a lot of investment into Research and Development, the development cycles may differ greatly from a few months to over a few years. Therefore, the price of the offering should be such that it is not only able to recoup the huge development costs but also maximize profits. Also noteworthy is that for digital products, the marginal cost of producing an additional unit of the product is negligible. For e.g. If today Microsoft develops a new operating system for Windows PC’s , the cost of development might be very high, however the cost of production or replication is almost negligible.
Price is always a Trade off against Value
Now, Price is usually the tradeoff consumers make against the value they seek in a Product. Different products offer differing value based on tangible and intangible factors. This would mean that different customers differ in their willingness to pay based on the value they derive from a product. Now, this is where versioning comes into the picture. Since the marginal cost is so low, there is great flexibility in creating multiple versions of the same product for different audiences based on the value people ascribe to a particular version of the product.
What is Versioning ?
Versioning is the creation and management of multiples releases of a particular product which has the same general function but are improved, upgraded or customized.
Customers are never one homogenous group, they can be divided into segments. These segments will value the product and offering differently based on the level of features or customization. Therefore, it becomes very essential to be a able to offer multiple versions of the products which all perform the same general function but are differentiated by the degree of features and customization at multiple price points.
Thus, you can have a Basic Version of the product at a low price point, then a middle version with certain additional features at a higher price point and finally a premium version with all the best features and at a high price point. This has been the playbook for many tech companies offering digital solutions
We see versioning all around us and it has existed from the very beginning. Convenience and access had led to one form of versioning which saw the emergence of freemium model. Where the free version provided the basic features, but to get more access one would have to upgrade to the paid version. Most of the Apps on our phone would be following this model. For e.g. I recently saw a company which runs a website and YouTube channel dedicated to the stock market and stock analysis. They share knowledge about the market and latest trends for free, and then have a subscription model by which, a monthly payment gives access to a chat room where in depth analysis of stocks and stock recommendations are provided.
Likewise, versioning can be based on many more factors like speed, community, comprehensiveness etc.
How many versions of the product do we sell ?
Well, we have the Goldilocks principle of offering 3 versions. As offering a single version is never optimal as it doesn’t capture the complete market and leaves money on the table. Having said that, offering 10 versions if also not optimal as it confuses the customer and can negatively impact sales.
However, going in for 3 versions has psychological reasons due to “extremeness aversion” . This is basically the tendency among people to avoid extreme choices. People don’t want to pay too much by opting for a high end product and fear they are getting too little by buying the cheapest product as well. This phenomena of extremeness aversion is aptly exploited by most firms selling digital products where they craft their offerings in such a way that consumers are nudged into buying the product which is placed in the middle.
One can find the below screenshot from the Hostinger website which sells web hosting solutions. They have gone with 3 offerings which are Single Web Hosting, Premium Web Hosting and Business Web Hosting.
As one can see, Hostinger has crafted the middle option in such a way that it stands out among the 3 and reaffirms extremeness aversion, all these have been done to nudge the customer into picking the middle option. Now, one can price the middle option accordingly.
A similar pricing strategy has also been employed by G-Suite which offer domain solutions for users.(Screenshot below).
How does it impact revenue ?
Lets consider the above example of G-Suite, in the 1st Case lets consider that only Business Standard version of the product is available. It is sold at Rs 672, assuming that there are 1000 subscribers for the product. The company would then earn a revenue of Rs 6,72,000.
The area shaded yellow is the Consumer Surplus. It is the difference between the amount the consumer pays and the consumer willingness to pay. Therefore, as a seller or producer it is imperative to reduce the consumer surplus as much as possible.
In the 2nd case, we now have 3 versions of the product available with us, a business starter , business standard and business plus. Even assuming that the entire subscriber base remains constant at 1000 users ( very conservative assumption) , we can split the subscribers among the 3 versions as 100 users ,800 users & 100 users respectively. We can calculate the cumulative revenue for the firm from all 3 versions as Rs 6,76,100.
Which is an increment of Rs 4,100 from Case 1. Also to note is that, since these are digital products , the marginal cost of producing the multiple versions is almost negligible. Thus profitability also improves as a result.
This can even be seen graphically as in the 2nd case, the consumer surplus is shrinking and thus the available surplus is being captured by the producers on account of offering newer versions which would not have happened in case 1.
Therefore, versioning is an important tool which can be used by producers in order to capture maximum value and also as it provides greater flexibility to consumers to choose the best offering suited for their requirements.
Thanks for reading!
Classroom learnings from the course Hitech & Innovation Marketing during my time at B-School