Rafi Mohammed

Why Good-Better-Best Prices Are So Effective

Posted on February 8th, 2013 (0 Comments)

Reprinted from the Harvard Business Review website.

SeaWorld Entertainment Inc., operator of theme parks including SeaWorld and Busch Gardens, recently filed for an initial public offering (IPO). Best known for its aquatic shows featuring Shamu the killer whale, SeaWorld's IPO filing specifies that a key future growth strategy will be to "expand in-park per capita spending through new and enhanced offerings...by providing our guests additional and enhanced offerings at various price points."

So the next time you visit SeaWorld, be prepared to choose amongst an array of admission options ranging from Shamu (good = lower price), Shamu-Plus (better = higher price), and Shamu-Premium (best = highest price).

When most managers think about pricing, they harken back to their days of Economics 101: a rote downward sloping demand curve and an asterisked point labeled "perfect price." At this optimal price, elasticity is such that it does not make sense to raise price (because the extra per unit profit is overshadowed by lost sales) nor discount (because increased sales don't compensate for lower profit margin). If you rely on the approach suggested by this graph, pricing has traditionally been thought of as a simple search for one perfect price.

If your company views pricing in this manner, it's not making the most of this powerful bottom-line enhancing strategy. First, a key challenge is few of us have actually seen a demand curve for our product — let alone an asterisked price point. But more importantly, even if you can determine your product's perfect price, you end up in what I call a "Pricing Catch-22": no matter what price you set, you'll inevitably create missed profit opportunities. Some people would have paid more, while others would have purchased if only the price had been lower.

The way to break out of this Pricing Catch-22 is to offer good-better-best prices. Instead of creating missed pricing opportunities with a single price, this multi-price versioning strategy empowers you to capitalize on a downward sloping demand curve. Having an array of price points — low to high — allows customers to choose which price works best for them. At a gourmet restaurant, for instance, dining high rollers (those at the top of the demand curve) opt to dine at the chef's-table (best) while those on a budget (a newly married young couple celebrating an anniversary, for example) arrive before 6:30 PM for the early-bird menu (good). By allowing customers to select the experience that works best for them, companies benefit by reaping higher margins from some customers relative to others. Just as important, they also grow their business by serving budget minded customers (with good versions); early-bird diners would probably not come if this discounted option is not available.

Another benefit of good-better-best is customers are more comfortable with this pricing strategy. Few of us take well to ultimatums, which is exactly what offering a single price is: "Here's the price, take it or leave it." In contrast, good-better-best is accommodating: "If the price is too high, consider our good version" or "You may appreciate the features of our best option."

When this strategy is implemented, it's often surprising how many customers choose the best version and its bottom line effect. In 2007, for instance, Southwest rolled out its Business Select ticket version. For $10 to $30 above the normal ticket price, customers received additional amenities — chief of which is priority boarding. In its first year, I estimate this best version increased Southwest's revenue by $100 million and operating profit by 10%. In addition to reaping higher margins from high-end flyers, Business Select also generated growth by targeting new customers. I, for instance, rarely flew Southwest due to its no-assigned-seat policy. But since Business Select reduces this seating free-for-all, I now fly Southwest more.

If your company believes that pricing strategy is simply the search for a perfect price, it's missing out on significant profit opportunities. Customers are better served and profits are enhanced by serving new customers as well as reaping higher margins.

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