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Stop guessing! Use A/B testing to determine ideal price for your product

Posted in How To on January 26th, 2011

Oh, the question thou fear the most:

What price should I offer my new product X at?

Determining right price for your product is perhaps one of the most difficult tasks when you are launching a new product or service. Pricing for physical goods is simple. For example, if you are manufacturing staplers, all you need to do is to calculate cost of production and distribution, slam 20% margin on it and there you have the price you can sell your shiny stapler machines for.

Economics 101 (price elasticity of demand)

But for digital goods with no cost of production, it is not that simple. This zero cost of production complicates pricing decisions because then you need to price the product according to how much the market values your product. At the core, idea is quite simple: higher you price, lower the demand is. However, if your price it too low, you won’t make a lot of money even though you might sell a lot. Similarly, if you price it too high, you won’t make a lot of money even though each unit sold brings you greater amount of money. This is the basic principle of price elasticity of demand.

So, as you can see in the graph above, increasing price by 10% reduced quantity bought by 15% which reduced total revenues. Every product has a price point in the graph at which revenues become maximum. Price more than it, revenues will fall. Price less than it, revenues will fall. Of course, you can’t sit over coffee one evening and draw this price-demand curve for your product. It has to be discovered. Your market determines this curve and A/B testing is an excellent way to find out which price-point maximizes the total revenue.

How to set a price range for A/B testing

Theoretically, the price-demand curve is infinitely long. Price runs from zero to infinity (Y axis) and so does demand (X-axis). But, of course, practically you need to have a price range in mind which you think is suitable for your product. For example, if you are selling an eBook you need to see if $15 gets you more revenue than $9. And you would probably be wise enough to avoid testing selling it for $100. The key question here is: how to set initial price range for price testing?

The answer is: don’t just roll the dice. I’m pointing to an excellent, short guide on pricing software [PDF]. Even though it says on the cover that it is about software pricing, I have found it applies to many types of digital products. The basic gist is this: look for other similar products in the market and also look at the value your product is delivering. Set a price range accordingly. Once you have a price range in mind (say $50-$150), next step is to use A/B split testing to determine the exact price which maximizes revenues.

The Dark Art of Price Testing

Price testing is definitely one of the most difficult projects you can undertake. There are so many things that can go wrong. Consider this worst-case scenario: an influential blogger (say Mike from TechCrunch) is trying out your product and somehow gets to see that you are doing price testing. He writes about it on the blog (because, hey, it is fun to write about something controversial). Your customers read the post and get angry at you. Worst-of-the worst, one of the customers turns out to be idle lawyer and sues your company. It is a worst case scenario but quite plausible.

To avoid OMG, we got sued due to price testing, you should be doing price testing according to following rules (which I classify as the good, the bad and the ugly — in reverse order).

The Ugly: never offer exactly same product / service at different price points

Yes, you read it right. This is perhaps the way many companies do price testing but you should NEVER show different prices to the visitors for exactly the same product or service.

It’s illegal and can lead to huge potential lawsuit.

The Bad: have slightly different offering for different price points

This is a less nefarious version of plain-old price testing. Instead of showing different price points for the same product, you show different price points for slightly different product offerings. You can vary product offerings tested at different price points by adding or removing some trivial features. I will give you an example, if you are selling a backup service you can create one version where you offer 5 GB storage for $20, in another version you offer 5 GB storage + SSL (trivial feature) for $30. So, practically both offerings are similar but technically there is a difference and if anyone ever questions you, you have grounds for justifying the difference in price. After all, you are offering different products (no matter how trivial the difference is).

But I consider it immoral. Yes, you can evade potential lawsuits but anyone will know that you are fooling people.

The Good: offer different products (or plans or solutions) at different price points

This is the most ethical way to do price testing. Ideally, you should offer completely different product plans at different price points. Taking backup service as an example again, if on your pricing page lowest tier offers 5 GB for $20, test a version where you offer 10 GB for $40 and 2 GB for $8. You are trying to gauge sensitivity to price here. If your conversion rate 10 GB is same as that for 2 GB, this means your service is so compelling that people want don’t care if it is $8 or $40. So, in the next update you ramp up price as $40 for 5 GB (while still grand-fathering old customers). This way you would know what is the best price point for your service.

Of course, not all digital products have luxury of offering pricing plans. What if you are selling an eBook? In that case, you need to add some extra value (e.g. 15 minute consultation with author) if you are trying to test a higher price and remove some value if you are trying to test a lower price (e.g. shorter version of ebook).

The key lesson for using A/B testing to determe ideal price is this: offer different value at different price points to gauge price sensitivity of target market. Then whatever price offers maximum revenue, start offering your main product at that price point (while grand-fathering old customers).

Final Gospel: measure revenue, not conversion rate

I have suggested it earlier in the article but will make it clearer here. During price testing, you should measure revenue (not conversion rate). Because even though you may end up selling less (hence lower conversion rate) at higher price points, your total revenues may actually be higher.

Visual Website Optimizer lets you measure revenue by integrating with Google Analytics and Omniture SiteCatalyst. So, if you are measuring revenue in one of these analytics tools, you can easily see which price variation resulted in maximum revenue. (Even if you measure revenue in internal dashboard or excel, it should be quite simple to measure it for different variations)

So, ready to do some price testing?

Let me know your comments and feedback on the strategies I guess. If you need help setting up a price testing using Visual Website Optimizer, will be happy to discuss it with you. Just leave a comment below or email me at paras@wingify.com

Paras Chopra

CEO and Founder of Wingify by the day, startups, marketing and analytics enthusiast by the afternoon, and a nihilist philosopher/writer by the evening!

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13 Comments

[...] Read more here Posted in Uncategorized , interesting, science, tech | No Comments » [...]

Kim Biesbjerg
January 27, 2011

Good read!

Would you be able to point me to a ressource where I can read about setting up revenue as a goal in Visual Website Optimizer using Google Analytics integration?

Jeremy Reeves
January 27, 2011

AWESOME post Paras!

I love the way you explained the correct way to do price-testing… brilliant!

Also, I’d like to add 1 thing.

If you’re just starting out, I think only testing which has the highest revenue is the best way.

However if you have a more robust company – testing to determine the highest CUSTOMER LIFETIME VALUE is probably the best way (depending on various factors).

Jeremy Reeves
http://www.JeremyReeves.com

Kim Biesbjerg
January 27, 2011

Maybe I should clarify:

I have VWO up and running with Google Analytics integration and the website is sending Ecommerce data to Google Analytics.

Do I setup the test in VWO and read the revenue amount for each variation in Google Analytics to determine the winner?

[...] Stop guessing! Use A/B testing to determine ideal price for your product « I love split testing –… [...]

Paras Chopra
January 28, 2011

@Kim: Yes, that’s right. Though you would need to see difference is statistical significance. Email me paras@wingify.com if you need help in interpreting.

chad
January 29, 2011

In your third example both prices equated to $4 per gig of data. How do you conclude that you should charge $8 a gig just because more people paid $40. Isn’t it possible people just liked to buy in bulk?

Paras Chopra
January 29, 2011

@Chad: yes, that’s precisely what we are going to test here. How sensitive is your target market to prices irrespective of how you value it.

[...] about whether it’s illegal to do price testing on an exact same product or not. Here is the article I was sent. It states that it’s illegal, but we haven’t found specific laws against it. If [...]

[...] Everyone is scared to put a price on their launch page. They are worried it will scare people away from signing up. But if someone was scared away by knowing your product will cost money you’re going to have bigger problems. [Editor's note: read our previously published post Stop guessing! Use A/B testing to determine ideal price for your product] [...]

[...] Editor’s note: If you liked this article, you may also want to explore another article on price testing we had posted earlier: Stop guessing! Use A/B testing to determine ideal price for your product [...]

Daniel Gonzalez
May 19, 2012

This is a great post! I’m going to try out some of the stuff here.

Laine Billy
June 25, 2012

Greetings! Very helpful advice in this particular post! It is the little changes that make the largest changes. Thanks for sharing!

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