What your price communicates

Photo by Juraj Gabriel on Unsplash

Netflix recently announced price increases of 20% for their individual tier. Which makes me wonder: why this increase, and why now?

It’s not like there are supply chain or resource issues that are raising their input costs. These services are not adding new features which add to the offer’s utility for me. There are no currency issues, new taxes or labour cost increases that merit a price hike at this moment.

I also find the price hike timing strange as most of their customers are experiencing the impact of high inflation eating into their discretionary income. As people have less money to spend, the perceived expense of these services as a proportion of the money left over after the essentials makes the price increase even more apparent.

How are digital goods priced? The difference between digital business models and more conventional brick+mortar+equipment (BME) models is that the biggest costs are upfront: building the infrastructure. Once this is done, the marginal costs of adding customers are minor. In conventional BME businesses, your physical plant can only handle so many customers or build X widgets, then you need to build more physical facilities.

Digital models, especially mid-size ones, should not have significant cost scaling issues. Agreed, you may need to increase server capacity or bandwidth or improve the website.

Granted, streaming companies such as Netflix, Apple and Disney + also face increasing content production costs because of the competition between them. But does the increase in content quantity (or, questionably, quality) justify an additional $24 a year? Especially after I’ve been paying $120 a year to access content? Is Netflix really providing 20% more utility or, in this case, pleasure?

Digital pricing is opaque to start with. Sometimes I wonder if they throw darts at a board to get their $5.99 a month or $99 a year. Digital prices are set to achieve target ARPU (average revenue per user) and profitability targets, which are independent from the cost of goods sold.

Netflix may raise prices to ensure their revenue stream as they roll out their lower-cost ad-supported tier. However: this is ad-supported, I.e. Netflix gets revenues from both the watcher AND the advertiser. I expect the sum of the two streams’ ARPU (subscription + subscriber’s share of the ad revenue) at this tier would be greater than the full-price tier ARPU.

The tell that prices are artificially set is the nice round figure: $5.99, $9.99, $12.99, etc.

And it’s not like I explore Netflix’s entire catalogue. I’ve noticed that I watch the same 4-5 old TV series and maybe a dozen old movies, primarily as background noise when doing housework or admin stuff. My Netflix use reminds me of my parents, who kept the TV on all day.

The unfortunate side effect of Netflix’s price increase is that it made me aware of that monthly charge on my card. If they had kept quiet, I would probably let it continue. Now, I will be more conscious of how much I really use the service, turning it off or on depending on the time of year.

Streaming models have to be very careful about the message that their price communicates. Apple iCloud bills me $1.99 monthly at their lowest tier of 50GB, which is enough for my iPhone backups. Every month, like a poke in the arm, they remind me. What if they only charged once a year, maybe $30 (or $29.99)? I gain at least that amount of value from the utility at this tier. I would be willing to pay this price on an annual basis, they would make a higher ARPU with lower transaction costs, and everyone would be happy.

The new Chief Twit, with his price announcements for the blue Twitter checkmark – one day it’s $20 a month, the next day he says $8 a month – only undermine consumer confidence in how digital goods are priced. The price increases announced by Netflix, and now, I see, Apple TV Plus, will probably make me more careful about spending my discretionary subscription budget.

When digital pricing reflects the real utility for the end-user, this increases user confidence in the product. An example of the other end of the spectrum is Hubspot, whose B2B subscriptions are in the thousands of dollars a year. Other CRMs set their prices in the hundreds of dollars a year. The signal the others give with their pricing is that “CRM is a cost, so save money with us”. The signal that Hubspot sends is “CRM is an asset, so MAKE money with us!”. Another way I look at Hubspot’s price message is how they replace one or two human hires in the marketing department while improving overall team productivity.

I believe that the most crucial principle in setting prices is to understand the utility you offer to your user. This is what validating problem-solution fit is all about: how your offer solves their most important job-to-be-done, what are the pain relievers and gain creators, and how much value is generated from each.

It takes a significant sample size to understand problem-solution fit, which is why, in Momentum Scaling, the first horizon ($0-$1M revenue), the Credibility stage, is where you really need to understand your customers. Every time someone signs on, take the time to talk with them – not a survey, do an actual phone or Zoom call. After a couple of hundred calls, then you get a clear message about how users perceive your utility and why they choose you.

At this stage, you can do all kinds of pricing tests to get a sense of what value your customers perceive. If anything, push the higher end of the envelope. At the first horizon, avoid freemium offers which provide no information to you about how your users perceive your utility.

Your value proposition is not the benefits you say you offer. Your value proposition is the utility your user perceives.

Once you have a deep understanding of the utility your user perceives, then you can set a price structure that communicates that utility while building trust and loyalty, which locks in long-term profitability.