This post originally appeared on pragmaticpricing.com.
For years I’ve read Seth Godin’s blog, daily. He is awesome. In all those years I’ve never disagreed with him… until recently.
Seth’s blog from August 30, 2016, is titled “Features and Marginal Cost in the Digital Age”. He provided the argument that good, better, best for hardware products was based on the marginal cost of adding more features. He then applied that thinking to digital products since there is no marginal cost to the next feature. The final line of his blog, “Good, better, best is going to have to start being based on something else.”
I have to disagree with his premise that good, better, best was always based on cost. This is the thinking of someone that believes in cost plus pricing. Even marketers of software products, who know that we don’t price based on the marginal costs of producing the next one, often get caught in the trap of thinking other companies use cost plus pricing. We do this because we are shoppers. We see this. One has to conscientiously force oneself to think otherwise.
Early in the morning of a pricing class I emphasize to my students that costs don’t drive pricing. Willingness to Pay drives pricing. After several examples and much discussion, they all nod their heads in agreement and understanding. Inevitably, in the afternoon, at least one student will make a statement that the price should be higher because the costs are higher. This concept of costs driving pricing seems to be hard wired in our brains.
As one of my favorite examples, here is a section from an earlier PragmaticPricing blog.
This is a quote from 19th century economist Jules Dupuit on the railway travel business:
“It is not because of the few thousand francs which have to be spent to put a roof over the third-class carriages or to upholster the third-class seats that some company or other has open carriages with wooden benches. What the company is trying to do is to prevent the passengers who pay the second-class fare from traveling third class; it hits the poor, not because it wants to hurt them, but to frighten the rich.”
Did you catch that? Third-class rail travel was hard benches WITHOUT A ROOF.
In the 1800’s, rail travel had three classes, with third-class being miserable. As Jules Dupuit points out, it would be inexpensive to make third-class better, but they chose not to. Good, better, best is not driven by costs.
Seth might point to this example and say rail travel is a monopoly, so competition won’t drive prices down. Fair. But if I use that logic I’d have to ask, “How does any digital company charge a price above zero?” After all, the marginal cost of serving the next customer is essentially zero. The same way companies implicitly collude to keep prices above zero, they also implicitly collude to keep the prices of different versions at different levels.
Many successful digital companies today offer good, better, best. I just looked at Slack, Wall Street Journal, Salesforce.com. They all have competitors. The marginal cost of serving their next customer is essentially zero. But they are all able to offer different versions at different price points.
Another thing Seth said in the middle of his blog, “In the digital age, all of this thinking goes out the window.” I agree with this completely. My only amendment is that all this thinking should have gone out the window a long time ago. It was driven by a mentality of cost-plus pricing, used mostly in hardware products. He’s right, you can’t use this thinking for digital products. Thank goodness. Now maybe more businesses will learn the lessons of pricing.