Do you consider yourself a pricing guru? Someone who can take reliable data about what customer segments are willing to pay, and use it to construct a pricing plan that maximizes revenue?
The experts at Simon-Kucher & Partners–the world’s largest pricing consultancy–hear such bluster from entrepreneurs all the time. And they think it’s nonsense. After more than 30 years in business, they have encountered their fair share of founders who fail to properly price their innovations. In a recently released book called Monetizing Innovation, partner Madhavan Ramanujam and co-CEO Georg Tacke provide several examples of how the science of pricing is more nuanced than you think.
One of these examples involves a quiz about the smartest way to maximize revenue by bundling pizza and breadsticks. Fewer than 10 percent of executives who take the quiz figure out the best bundling formula. Think you know better? We’ll see about that. Grab your calculator. Here’s the setup:
You own a pizzeria. Like any smart entrepreneur, you’ve studied your customers’ spending habits, and divided them into segments on the basis of what they’re willing to pay for certain products. For the sake of easy math, assume each segment has exactly 100 customers.
Now consider this: Since you own a pizzeria, you can’t alter your price from customer to customer. The menu price is the menu price. In other words, you can only set one price per item or bundle.
Your goal is to maximize revenue, under the assumption all 100 people in the segment will buy the pizza or breadsticks or both if your price is equal to or less than their stated willingness-to-pay price. So, for example, if you sell the pizza at $4.50 and the breadsticks at $5, you will make $2,850, since at $4.50, segments A, B, and C will buy the pizza ($1,350, from 300 customers at $4.50 each), and at $5, segments B, C, and D will buy the breadsticks ($1,500, from 300 customers at $5 each).
Got it? Good. Now here’s the actual quiz: What is the maximum revenue you can make? (Figure it out on your own before you read any further; the spoilers commence in the next paragraph.)
If you’re not bundling the products, the maximum revenue you can generate is $3,300. You can do this if you charge $8 for pizza (segments A and B would buy it) and $8.50 for breadsticks (segments C and D would buy them). At these prices, you’d generate $1,600 in pizza revenue (200 times $8) and $1,700 in breadstick revenue (200 times $8.50).
But what if you could bundle the pizza and breadsticks under one delicious price? Surely some of you have already made such calculations. If you have, you’ve likely reached $4,200 as your answer for maximum revenue. You’ve done this by bundling the pizza and breadsticks at $10.50. At $10.50 for both products, all four segments will happily buy the bundle, since their combined willing-to-pay prices are all $10.50 or higher. So, with 400 customers paying $10.50 each, you’d make $4,200.
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