Dragons in the Algorithm
Adventures in Programming
by Michael Chermside

Setting Low Prices

I am in no way an expert on the tricky art of pricing, but I do have an interesting thought about the pricing of very cheap things.

By very cheap things, I am particularly thinking about electronic goods. People buy information (views of articles and things like that) or applications from an AppStore for prices in the range of $2.00 all the way down to cents (and sometimes less). I was inspired to write this by an article by Rob Walling in which he advised someone not to charge $1/month for a service--almost without regard for what the service was.

That's an interesting position. After all, things vary in value. There are some things for which $46 is a sensible price and some for which $47 is a sensible price. It stands to reason that there would be some things for which $1/month is a sensible price. But I think Rob is right: I think $1/month is nearly always the wrong price, almost regardless of what is being sold.

It is an interesting fact that thousands of times as many people (or more) will sign up for something I offer for “Free” than for something I offer for one cent. They will do so even if the bandwidth it takes to download it and the electricity it costs to view it or run it cost more than 1 cent. There is, you see, a psychological hurdle, a “cost” to making a purchase at all. There is mental transaction cost: you must stop and think to evaluate whether you think the product is worth whatever they are charging for it. The customer must overcome this hurdle PLUS the amount of money you are charging before they’re willing to buy. One of the reasons for the outstanding success of the Apple and Android app stores has been that they reduced (but did not eliminate) this “cost” by avoiding the need to enter payment details for each transaction.

I will make the economist's assumption that this mental effort can be considered to be equivalent to some amount of money (because economists believe that anything is equivalent to some amount of money). I wish I had actual measurements of this amount, but since I don't, I'll just make up some numbers based on my observations of my own behavior. I will speculate that, for most customers at most income levels in western countries (US, Europe, etc), the psychological “hurdle” for agreeing to a recurring monthly payment is probably about the same as an extra $8-20 up front or an extra $1-2 per month.

Put in those terms, raising the price from $1/month to $2/month doubles your gross, while adding just 1/3 to 1/2 to the customer’s “perceived” cost. That’s usually a good tradeoff, so there are almost no goods that are reasonable to sell for $1/month. (Try charging $12/year instead... that is much more palatable, for psychological reasons.) This is also the same reason that newspapers can't seem to sell their reporting online at 1 cent per page: the cost of deciding whether to make the purchase costs customers a whole lot more than that. (Financial reporting is an exception.)

Posted Mon 27 June 2011 by mcherm in Uncategorized