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Add-ons or Version

November 2007 Pricing

When should a C-level executive pursue an add-on vs. a versioning strategy?  What makes one more attractive than the other?  Should every product line include good-better-best versions?  Is add-on pricing a historical legacy or a best-practice approach to managing pricing and product strategy?  Should every executive think in terms of versioning?  Can add-on and versioning strategies coexist or must one displace the other?

While standard pricing literature offers definitions of add-on vs. versioning strategies, it is somewhat weak in the area of guiding executives in choosing between the two.  Herein, we offer some insights to guide executives through the above questions.  While far from exhaustive, it is a good dialogue starting point.

Add-on Strategies

An add-on strategy, as defined here and as used by others, starts with a base product with which different customers can choose additional products, modules, or features in order to customize the overall product to their demand.

Examples abound. Automakers offer a base level vehicle model to which customers can select exterior paint, interior trim, audio system, seat-covers, wheel styles, interior color, and other features.  Mobile handset makers offer base level handsets to which customers can add car kits, wireless headsets, audio adaptors, computer connectivity adaptors, and other chargers, adaptors, and features.  Enterprise software providers such as Loadstar of Oracle offer a base Energy Information Platform to which utility customers can add rating engines, contract management, billing systems, trading, settlements, distribution planning, and much more.

Versioning Strategies

In contrast, a basic versioning strategy, as defined here and as used by others, starts with a base product and increases features and benefits within collections in order to sequentially improve the value proposition.  Or, conversely, version strategies start with a full functioning product from which features and benefits are stripped to produce lower value propositions.  (Versioning is distinct from Price Bundling, but that is left to another article.)

Versioning is also abundant.  Airlines offer first, business, and economy class seats.  Cuisinart offers the Grind & Brew automatic coffeemaker in the DGB 500, 700, and 900 varieties which differ by the amount of coffee held in the hopper, a thermal carafe, and other features.  American Express offers personal cards in the Green, Gold, and Platinum levels differing by event access, purchase protection, global support, and travel privileges.  Intuit offers QuickBooks in the Simple Start, Pro, Premier, and Enterprise Solution editions which differ in the number of users, integration with other software products, industry customization, online backup/access, and other services and features.

Which to Use

If booth add-on and versioning strategies are so common, which should an executive choose?  While cost structure, competitive, consumer psychology and other issues influence the decision, one of the most basic influencing factors is the issue of aggregating customer demands into segments.

Add-on pricing strategies fundamentally take the approach of not aggregating customer demands and not segmenting the market.  An add-on strategy assumes that each additional product, module, or feature is a unique product which compliments the base product, and the decision to purchase one add-on vs. another is an independent decision.  A market researcher might express this as the demand for one add-on feature being weakly or uncorrelated to the demand for another.

Graphically, we can represent the consumer demand as a star-diagram, where each customer has a different level of demand for each add-on.  Using the example of Nokia accessories, one might state that the demand for a hands-free car kit is relatively uncorrelated with the demand for a computer connectivity adaptor.

07-11-add-ons

In contrast, versioning strategies segment customer demands along a single dimension.  Behaviorist marketers often talk of versioning as segmenting customers into those that just need an entry level product to perform a function; those that want a slightly better, but not too expensive, product; and those who enjoy flaunting their conspicuous consumption and demand nothing but the best.  Pricing strategists often discuss the establishment of segmentation fences to prevent what otherwise might be a higher value customer from downgrading into a lower priced product version.

Graphically, we can represent consumer demand along a single variable, where segmentation fences drive customers into their preferred version.  If consumer demand follows the familiar bell curve, where demand is normally distributed about a central tendency, the segmentation fences can be used to separate the upper ends of the distribution from central masses.  Using the example of airlines, we would state that the demand for larger seats is also correlated with the demand for preferential treatment in food, entertainment, and boarding sequence.

07-11-versioning

Putting It All Together

As the above discussion illustrates, market segmentation is one of the fundamental determinants between versioning vs. add-on strategies.

If the market exhibits no meaningful segments or segment aggregation variables, add-on strategies enable a firm to efficiently offer customized value propositions to individual consumers.  In doing so, the company is able to create incremental value for different customers and capture incremental revenue and profit proportional to the level of demand for independent features and benefits.

If, however, the market has meaningful segments that can be correlated with an increasingly valuable bundle of goods and services, then a versioning strategy in which different versions are defined by their ability to fence more valuable segments from the lower value segments is in order.

Importantly, add-ons vs. versions isn’t an either/or proposition.  Companies execute both add-on and versioning strategies concurrently.  Clearly, BMW sells more than the Z4 Roadster and add-on features, they also offer the Z4 Coupe version along with different models, and both the Coupe and Roadster come in different versions defined by engine size.  Likewise, Cuisinart sells coffee grinders, to-go mugs, and replacement carafes to complement their lineup of coffee makers.

Accepting that the identification of market segments and the establishment of segmentation fences are key requirements to selecting a versioning strategy over an add-on strategy, we have yet to address the key issue:  profitability.  Alas, we leave that to a more quantitative conversation.  In this conversation, we needed to establish that the market, specifically the ability or inability to aggregate demand across features and benefits, define the degrees of freedom.

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References

  • BMW Z4 Roadster Car Configurator for E85 Z4 2.5 si Sport Roadster, BMW Ireland – link (accessed 9 September 2007).
  • Mobile Phone Accessories, Genuine approved Nokia mobile phone enhancements, Nokia 6103 Ref:  6103, Mobile Phone Accessories, link (accessed 9  September 2007).
  • Lodestar Customer Choice Suite, Lodestar Corporation – link (accessed 28 October 2007).
  • Cuisinart Products Coffee Bar Collection, Cuisinart – link (accessed 28 October 2007)
  • American Express Personal Cards, American Express Website – link (accessed 9 September 2007).
  • Intuit QuickBooks for Windows, Intuit Inc. link – (accessed 28 October 2007)
  • Photo contribution courtesy of Boeing Media


About the author

Tim J. Smith, PhD is the Managing Principal of Wiglaf Pricing, and an Adjunct Professor at DePaul University of Marketing and Economics. His most recent book is Pricing Strategy: Setting Price Levels, Managing Price Discounts, & Establishing Price Structures.

Tim J. Smith, PhD
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