Pricing Pitfalls: The Four Most Common Packaging Mistakes
15 Minute Read
The series “Pricing Pitfalls” examines the common errors that startups make when pricing their products. In this entry we’ll look at packaging, particularly the frequent failures we see with creating tiered offerings.
Several years ago, much of the guidance with packaging was just “make sure you create packages!” This sounds almost redundant, but it spoke to the fact that we frequently observed companies using the monolithic “one size fits all” approach. The implicit message to the customer is: This is our product. Take it or leave it.
Thankfully, we see this far less frequently today, particularly with SaaS companies. Most startups we encounter have adopted a “Good, Better, Best” (GBB) approach. This means creating several tiers of packages which vary in terms the price level and the amount or quality of items included (features, services, usage levels, etc.).
The Many Benefits of Good, Better, Best
Adopting the GBB approach has many benefits. Since customers typically dislike “take it or leave it” offers for anything other than very simple products, providing choices can make a customer more likely to buy. If nothing else, moving from a single offering to a GBB approach will likely increase velocity of sales.
However, GBB can also offer a highly-effective method of price differentiation. In swapping one price level for three (usually), you can accomplish two things. First, you make your product viable for customers at the lower end, who would not have purchased it previously (therefore adding sales volume). Second, you create a higher price point to monetize customers who would value a premium offering. All of this equates to more value capture at the initial sale. These packages can then even be used to grow your base business through upselling customers from basic to premium packages. It’s encouraging that we’re seeing more innovative GBB models in the startup community.
There are many other approaches to packaging. Use-case and buying center-based strategies can be effective for more mature companies selling to enterprises. But GBB is simple and readily accepted by customers. A GBB model – when well designed – is a highly-effective packaging strategy.
The Four Frequent Flaws in GBB Design
The key words in the above sentence are “when well designed.” The reality is that while many startups now realize the benefits of GBB, few have taken steps to create a robust approach. We commonly hear “we didn’t put a lot of thought into our packages.” We estimate that this oversight translates to a loss of 5-15% percentage points of revenue growth a year.
In order for a GBB system to work effectively for both price differentiation and sales velocity, GBB packages must be designed with well-defined customer segments. Each package should provide the target segment with a product it will be satisfied with, at a price it is willing to pay.
Customers vote with their wallets. The clearest indicators your packaging strategy is flawed will be the buying choices your customers make. If the distribution of package purchases does not match your expectations or desires (e.g. 75% of customers purchasing “good,” when you forecasted 40%) or your sales reps are consistently unable to upsell customers to higher-level tiers, you can be confident your issues lie within your packaging strategy.
The specific packaging issues we see most frequently are outlined below:
Too Much in the Base – The base package is just too good. The vast majority of customers are happy with what is included in the base package, and they don’t value the extra offerings in the higher-level packages enough to justify an upgrade. The majority of the business then shifts to the entry price point, which drops revenues unnecessarily.
Decoy Choices – A company has followed the conventional wisdom that the goal of GBB is to draw customers to the middle version. Now the good version is too light. And the best version is so incremental in value to the better version, that the middle option is the only realistic choice. In this situation, the other packages serve only to make the middle option look better. You will get the sales velocity benefit of packaging, but nothing more.
Unrealistic Comparisons – The difference in price of the packages so large that any differences in value between packages are immaterial. It’s easy to imagine a customer choosing between packages costing $200, $500, or $750 a month. But can you imagine them truly considering options that cost $200, $2,000, and $20,000? When this is the case, the customer doesn’t really have a genuine choice anymore. They will feel forced into the one option designed for them. Now the benefits of having a choice-based packaging system erode.
Too Many Sources of Difference – Tiers do not work when the packages differ across too many attributes, particularly attributes that cut across different and unrelated use cases. It is likely that a customer will attach value to some of the sources of package differentiation, but not to all of them. This can result in the customer objecting to paying the premium for the higher-level package, since they feel that much of that premium is for items they don’t need (this effect is particularly marked when the price difference between packages is also high).
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Best Practices for Designing the Good, Better and Best Tiers
The solutions to poorly-tiered packaging are not complicated, but require a solid understanding of your customer segments, needs, and willingness-to-pay. All of this can be obtained through robust customer and prospect research.
Align on a suitable base – Developing a base (“good”) package, with the necessary minimumfeatures, is a critical step in the design journey. Price differentiation is about giving your customers something that they are satisfied with at a price they are willing to pay. The segment of your customers with the lowest willingness-to-pay should be satisfied with the base package. Thus, the base package should be the lowest spec package you can produce while preserving this satisfaction. All items which are “table stakes” should be included, along with any low-value items that would be a distraction while selling.
Tier by only the key value drivers – The next step is to determine what are the few key value drivers that truly drive value perception to the segments with higher willingness-to-pay. These value differentiators can be comprised of multiple features, but the breadth of overall functionalities or capabilities that they enable should be limited. Less is more in this case, since this will allow sales and marketing to build a clear value story around the higher tier packages and will make the upsell case more compelling.
Build in up-sell triggers – You can further strengthen the upsell pathway by incorporating thresholds into your package design. Placing caps on capacity or usage by tiers can drive upsell to the next tier when the customer’s needs outgrow the current tier. This is a particularly effective strategy when the threshold is the customer’s amount of usage of a highly valuable feature or function, since the up-sell trigger will then be self-selected and a natural reflection of increased value consumption from the product.
Consider scaling prices separately – Large price differences across packages are often primarily driven by companies trying to address large differences in customer scale and willingness-to-pay through the packages alone. For example, “we will make our ‘best’ version focused on Enterprises, and so will put capacity constraints on the ‘better’ version.” As mentioned above, this creates unrealistic choices. A better approach can be to remove ‘scale’ factors from the packages (make packages vary by quality components alone) and use a price metric to scale the price of each package to the customer (for example, package A may cost $500 to a customer with 500 employees, but $5,000 to a company with 100,000 employees).
Break out niche functionality – Sometimes certain features or functionality will be valued very highly by a small portion of customers. However, unless this group happens to be the highest willingness-to-pay segment that you’re targeting your “best” package towards, these features do not belong in a GBB framework. Similarly, if these features address very different use cases to the core product functionality, their inclusion in the GBB framework could cloud the value stories. The best practice is to monetize these niche features separately as add-ons instead.
Price the tiers to value delivered – For most buyers (especially B2B), low-priced offerings signal poor product quality. This can create a perception of risk, and so bring doubt into the purchase process. Therefore, for sales velocity as much as value capture, it is important to price each tier at an appropriate level for the amount of value delivered.
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Although more detailed decisions will need to be made, following these simple guidelines around pricing will help startups avoid falling into the common pitfalls of ineffective good, better, best packaging.
In our next article in Pricing Pitfalls, we will be exploring the next startup pricing challenge – selecting an undifferentiating price metric. You can email the authors at Fuel@McKinsey.com for more information. And please follow Fuel on LinkedIn and Twitter for more pricing insights.
About the Authors
James leads the pricing practice for Fuel By McKinsey, helping our clients maximize revenue growth.