One of the key responsibilities of product management, and paradoxically, one of the most perplexing, is Pricing. The act of setting a price at which to sell your product or service. Judging by the number of inches (feet) on my bookshelf I have dedicated to various tomes on the art and practice of pricing, it is clearly something I have thought about a lot, and as do many in the product management field, have struggled with.

At its core, the concept of pricing is straightforward. Identify a product or service that a constituency will buy (or likely buy). Determine its “value” to this constituency, and price it accordingly.

Let’s take a concrete example, Spotify1:

As the first to the “on demand” streaming music party (there were internet radio sites before, but you had no control over what you heard when), Spotify began as an advertisement supported service. You could call up any track in their library, and play it at any time, even over and over, if you are a Justin Bieber fan, and apart from the occasional commercial message, you were just fine.

Behind the scenes, Spotify had infrastructure (servers, software to serve up streams, internet connections), labor (developers to write applications, lawyers to negotiate royalty agreements with the copyright holders, people to create and vet their curated playlists, etc), and royalty payments (a value per each stream of a song served up), so there were some real costs associated with the service.

But, how to get people to pay? What value do you offer to entice them to open their wallet? What is the right price?

Putting on your Product Management hat, what would you consider? How would you assign a “value” to your proposition? How would you market it successfully? What is considered a good uptake rate (people who buy or subscribe)?

Tricky questions, but they are what you need to balance them all when you pull together a pricing model.

Going back to Spotify, sometime in 2014, they crossed a threshold of 10 million paid subscribers1. $9.99 a month, that is almost $1.2B per year in revenue. A mighty figure indeed, but how does that translate to the average “free” user deciding to whip out their credit card and pay.

What you are competing with is people purchasing music. The iTunes music store shattered the concept of buying an album or CD in its entirety, but instead pegged the price at $0.99 per track (or a bit more for “hot” music). This has held rather stable for years.

So the user balances:

  • If I buy tracks, for the cost of my Spotify account, I can buy ~ 10 tracks a month, or 120 a year. I “own” the tracks, and can (largely) do what I want with them
  • If I stream, I can listen to as much music as I want, whenever I want. However, if I should stop my subscription, I don’t own anything. I can’t continue to listen (except as permitted by the free, ad-based, service)

The gamble is that a user will spend $120 a year, every year, to have the unfettered access to a large catalog (yet not complete), and not actually own the tracks in question.

But how was that $9.99 price set?

Since I wasn’t there, I can’t be certain, but how I would do this would be two pronged.

First, I would begin by surveying people who frequent music stores. Both physical stores (buying CD’s) and online stores. This would set a baseline for the frequency of purchasing tracks, and CD’s. Of course, you would need to formally or informally survey enough people to capture the segments that are of interest. I can imagine these segments being:

  • The Enthusiast – this is the person with more than 1,000 CD’s or albums in their collection. They probably have a high end component audio system, and when they “rip” their CD’s they will gravitate to loss-less formats (like FLAC, and will minutely manage their collection. As an aside, they likely have a large intersection with the rising breed of vinyl LP listeners
  • The Serious Listener – this is a bit more squishy of a definition. Think of the person who listens to a lot of top music, who buys the latest releases of the pop. A pretty large collection, but mostly listens on their phone or in their car. This is the target audience of what radio used to call “Top 40”. Trying new music is important, but they probably don’t chase the whole catalog of any artist.
  • The Casual fan – A lot of variety, but not a serious buyer of music. Maybe buys one or two CD’s a year. Perhaps likes some oldies, and some eclectic modern music, but can live without their tunes.

I’m sure with some focused thought, and digging into deep analysis of buyer behaviors, I could come up with more Buyer Personas, but for now this is enough.

If I was pricing Spotify’s monthly subscription, how would I view these segments?

First, let’s dispatch the Casual Fan. They don’t buy enough music to target. They will be your “free” listeners, and it is almost a certainty that they will not open their wallet and subscribe. Alas, your task there will be to balance the advertisements versus the streams to not lose your shorts.

With the Casual Fan covered, you need to prioritize the two other segments above. Let’s look at the first segment, the Enthusiast. They likely spend well beyond $10 per month in music. Probably several multiples of $10, buying 4 or more albums a month. While this might seem like a good target, and you can sell the value unlimited listens to each track for one subscription, if you price this at say 3 albums worth a month ($30), you will likely fail to capture this demographic. Alas, while they will be the heaviest users, they are also a group that values owning the media. They likely revert to buying CD’s instead of individual download tracks from Amazon, Google or Apple’s music stores, and their fling with vinyl LP’s further insulates them from your unlimited entreaties. With this group, you are best to work on a deep catalog, filling in blanks, and then target the real driver – The Serious Listener.

The Serious Listener is your bread and butter. They are fans of Pop music, they like variety, they don’t care so much about the long tail, but if you have what’s fresh, popular, and in demand, this will be a loyal group. Their tastes change almost as often as the wind. But in the old days (pre internet) they mostly listened to radio, and bought a couple of albums a year.

Thus, if I balance the cost per stream (royalties) and the amount of hours of this large demographic, and keep in mind the psychology of pricing, I come up with penny less than $10 a month, or $119.88 ARR per subscriber.

With 10M paid subscribers, that is $1.2B in revenue. Not a bad business model, and as they are well on their way to doubling their paid subscribers (of course the Apple Music offering will slow this) this also is a good growth plan. (update: Spotify, as of March 2016, now has 20M paid subscribers)

In future posts, I will put a lot of effort into the strategy of pricing, and many of the tactical aspects of the process. While Product Management often has the responsibility for setting the pricing strategy, once you get into the thick of it, you will find many struggles, and I can hopefully offer some guidance.

Takeaways

  • When pricing, you need to have some grasp of your user segments (market segments), and take a realistic view of their needs, and your strengths
  • Once you understand the segment dynamic, do a thorough evaluation of your value for this group. Don’t rely on wishful thinking, measure it
  • Pricing is hard. Yet if you do it wrong, you will leave money on the table, or worse, will drive away your sweet-spot segment

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1 – I picked Spotify at random, as it is well known. All my reasoning around this is largely in my head, I do not work there, nor do I have any inside knowledge. This is pure speculation.

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