Comment by zwaps | Hacker News Reader

Comment by zwaps | Hacker News Reader

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This is actually a argument based on the economic theory of pricing. To be quite fair, the statement that 3part is best is not entirely correct.

The idea is he following: In a old-school normal market, where you sell one good to a whole bunch of guys each etc, and everyone wants just one good, you may just post one price. You will not do better, no matter what you know or do not know.

But in most cases, posting a single price will not be optimal for you. This is because you sell multiple units to multiple customers, each possibly very different. And, you do not know what they would be willing to give you. You have asymmetric information. If you KNEW everything, you could tailor a contract for each customer. But you don't.

In economics, we can tackle this problem using Mechanism Design. Using game theory and nonlinear pricing (the non-linear is important here), you may be able to set a menu of possible contracts in a way that the customer self-identifies by choosing the best option for him.

The intuition of the problem is the following: Choose a menu of contracts that allows you, the company, to maximize profit, while also making the customer choose truthfully and thereby "tell you" what he is willing to pay. This is what the three part price may do for you.

Now why is this not entirely correct? There is a (rather theoretical question) as to basically how far a two-part or three-part price is "nonlinear enough" for your set of customers. This is called implementation theory.

An excellent book to get behind this mystery is Tilman Borgers book on mechanism design http://www-personal.umich.edu/~tborgers/ This was a free download for many years, so you can probably find the pdf.

Ok, but for most things you really don't want a three part tariff: rides on uber (SaaS!), gasoline, houses, employee salaries, health insurance, hotel rooms, container shipping. The customer would just be annoyed and go deal with someone else.

So what is the magic slice of products for which 3part is a good idea? All enterprise software? Some enterprise software? Only enterprise software?

The most impressive pricing I've seen is Salesforce.com. The pricing is simple but genius. Per seat pricing, where the cost per seat goes up with functionality. I was boiled like a frog: the cost went from $300 per year to $300K per year, and there was nothing I could do about it. How would a 3-part tariff help them?

Are those real Salesforce pricing numbers? That's frightening. How much did your company grow during the same period?

If you can not differentiate your product at all, it will be pretty hard to price non-linearly. You are right there: Customers will run away.

It has happened on the internet (targeting), but people get very angry. Uber extracts from two sides of the platform, which is a more complicated matter.

For the other examples, you are not exactly correct. Health insurance is clearly a two-part price, indeed it is a classical example. You pick your tariff and coverage. Whenever you pick, it's a nonlinear pricing scheme.

Salaries are another thing. A base and a bonus are very, very common. That's two part. Also comissions and somesuch.

Hotel rooms? Rate and extras? Minibar?

Cars? Extras and bundling...

All of that is non-linear pricing.

So your point is basically correct. If the customer notices you get to extract all surplus, he might get annoyed. But a two part tariff most often seems beneficial to the consumer, because he gets to choose!

Uber’s complexity and lack of transparency around paying drivers is a really bad idea for the company, and only an MBA could think it’s good. Someday Uber will discover that they were just a missing feature in Google Maps, and this is why all the drivers will switch.

Your examples have convinced me that a 3 part tariff is generally bad and an indication of extractive desperation on the part of the vendor, and fundamentally based on deception. If you wonder why people hate their banks, pricing is the reason.

The pricing scheme is derived as an optimality solution for the company. Obviously, it always (mathematically speaking, weakly) benefits the firm.

An all-knowing monopolist will extract 100-epsilon% consumer surplus. That's why economists are big about regulation and taxation.

Is it deception? Not necessarily. A pricing scheme is a menu of deals from which you pick the most beneficial for you. You then optimize as well - just that the company gets to set up the menu.

If a company were to decide to leave a minimum surplus to you, the optimization problem would be almost identical. We just assume that companies set this minimum value small. Perhaps, however, this may not be the best long term strategy? Not all companies may try to extract everything.

But what is a good and fair amount?

Business is about more than extracting the most you can. Most Wells Fargo customers are unhappy, but they stay because the competitors are just as bad. Unhappy customers is bad for business. Startups are often about giving customers a better experience than the incumbents.

Toms writing is targeted to entrepreneurs who need to consider all aspects of the business, unlike product managers at Faceless BigCo, who “win” solely by the shitty little optimizations that you so love.

Ignoring your needlessly hostile tone, it is Tom who proposes nonlinear pricing schemes. If there were no interest in controlling the surplus left for consumers, neither him nor anyone else would have need to employ such schemes.

Entrepreneurs probably employ such pricing methods more often than BigCo as well, simply because they sell less uniform products to less anonymous customers.

Your point?

Yes my point is that the term "optimal" could be misleading. People reading the document are likely to interpret "optimal" to mean that it's the best business decision. But in many cases it's not the best decision.

So my question (not point) is, when/for what is a 3 part tariff the best choice, when you consider all the other issues (like, what would annoy customers, etc).

In the case of Salesforce, the day I signed up, if there were a significant base cost over-and-above the per-seat price, there's a good chance I would have avoided Salesforce, and Salesforce would never have gotten that (eventual) $300K a year from me. So it seems that their pricing is better than a 3 part tariff.

First, your point about optimality is "not even wrong". Like I said, the surplus value you want to give your customers is really up to you and the optimality starts from this point. Yes, people may misunderstand this in the article. But I think that's the reason why the article does not offer any concrete recommendations.

Non-optimality just means you are leaving surplus on the table, out of your control. It certainly doesn't mean you will be better off in the long run. If you are comfortable with that decision, go ahead and choose a flat tariff. Since a business is also driven by cost, I would bet you will consider that decision sooner or later.

Non-linear pricing is "the best" when you are doing a theoretical argument, since you just can't do worse with more instruments than less - if you employ them wisely. That's what is written in the article, and that's what I elaborated on. It may just mean it gives you most control in deciding about consumer surplus, whatever that strategic decision may be.

Second, with regards to salesforce: A x-part price does allow you to set fixed components to zero, if that corresponds to the customer base. The "best" mentioned in the article is a theoretical construct in the sense that nonlinear pricing is simply more general. You are not the only customer, and in the end it depends on the whole demand base as to what is optimal. A product delivering high value per seat may just simply be best off with a low-to-zero fixed component. Again, it all depends on who you are targeting.

You spend 300k a year? So what if I offer you a contract with 200k a year plus a fixed 50k? Will you not take it? What if you do, and I tell you we both win in this deal?

My point is that there is a general thing to understand about pricing, and there is a reason why this article refers to something as best, while being sparse on actual implementation.

The best business decision, as you put it, depends entirely on your assessment of what customers want. This much will never change. But this article wants to point out that you can deal with information asymmetries with a nonlinear pricing scheme, something everyone should study deeply before pricing one's product.

As a consumer, you are faced with price menus in almost every purchasing decision you take outside a supermarket. That's for a reason. If you are an entrepreneur, and you do not understand why or when one may employ a nonlinear pricing scheme, then you are lacking knowledge.

Salesforce.com pricing is genius in its simplicity. I’m happy to discuss or explain, it’s really easy to reach me so please feel free to do so. I promise you can learn something unexpected about pricing. Because you really haven’t read what I’ve written.

Meanwhile, I don’t think anyone but us are reading this thread.

"Business is about more than extracting the most you can."

Um - no. Certainly not once a company is publicly owned or where the focus of the board of directors shifts from focusing on how to be the best company doing whatever we are doing to maximizing "value" for the shareholders. Once the focus is on the shareholders instead of the core business that core business starts to be talked about as a commodity and its value is its cash flow not how good it is at the business it is in. cf: Virgin America.

Regarding the issues with Wells Fargo it may be some stay "because the competitors are just as bad" but may also simply indicate how entrenched the services Wells provided are to the company. Things like credit card processing, loans (which you can't just switch easily), lockbox services and so on. I know from personal experience there's no problem with the folks having to interact with the bank referring to them in highly negative terms all the while that interaction takes place.

"Unhappy customers is bad for business." Really? That's why Comcast is having such a hard time? Why it's facing so much opposition to the micro monopolies it creates and perpetuates? No one likes Comcast. OK, that's a bit broad. I do not personally know anyone who likes Comcast and I know a lot of folks, including myself personally and professionally, who have been and are customers.

They use the 3 tarrif pricing model BTW: you pay the monthly fee for your basket of services which include some amount of unit transactions and an overage when you bust your limit.

I like a pod cast called "Make me smart". The folks who run it have a question they like to ask at the end of interviews: "What's the one thing you thought you knew and found out you were wrong?" I'm 63 and started my first restaurant when I was 21 and my second when I was 23. I thought if I worked as hard as I could, was fair with the people I dealt with, produced the best product I possibly could while keeping costs in check and charged a fair price everything would be OK. I was wrong. For better or worse I held on to my ideals instead of adapting to the realities of business.

It looks to me like the focus of being in business has shifted from business as a way to be better/bigger/faster at whatever the bussiness does to simply being a means to establish a cash flow and sell to a larger business. I don't know if that's inherently good or bad but it certainly looks and sounds like the new normal.

So, from what I see, business has indeed become about extracting the most you can as fast as you can from as many as you can.

> That's why Comcast is having such a hard time?

That is a terrible example. Comcast would be out of business if their customers had something to switch to. But they are a monopoly (or at best a duopoly) in most of their markets.

Most phone plans are 3 part tariffs, at least in Spain. You pay a fixed amount that includes some minutes of talk and some GB of data. If you go beyond the limits, you pay for each additional call or each additional 100MB block or whatever.

I'd say most utilities work in a similar way, maybe with a 2part (fixed costs + metered consumption).

one example of making customers show you how much they are willing to pay is with leather seats in cars. An f150 with leather seats costs 15k more than a model with cloth.

Very interesting but hard to come up with different packages for different types of clients (here 3 I guess ? not counting people who pirate your product) if you're not running a SaaS

If every customer is anonymous and purchases one unit of your product, you can not really do any of this.

If you can identify features of the customers, you may be able to price discriminate on that. Customer usually really, really hate this.

If your product can be differentiated, you can use non-linear pricing. Bundles and other things are known. x-part prices more generally work like this. I have mentioned in another reply many examples showing that companies usually try very hard to implement non-linear pricing and most people don't really notice...

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