The Pricing Strategy That Can Triple Your Revenue Overnight

In this article, with the help of a practical example, you’ll find out how your company can adjust its pricing strategy and – thanks to the power of Pareto’s Law – can capture revenue that was previously out of reach. 

First, we have to understand what Pareto’s Law is…

Pareto’s Law applied to business

This principle, also known as the 80/20 rule, is named after the Italian economist Vilfredo Pareto who theorized it at the end of the XIX century after having observed that 80% of the land in Italy was owned by 20% of the population.

This principle has since been applied to many different fields, including business, where it is often used to describe the distribution of sales or profits.

According to Pareto’s Law, 80% of a business’s revenue comes from 20% of its customers.

While the numbers may not always be exact, the underlying principle is that a small percentage of customers are responsible for a large percentage of revenue.

This can be a powerful tool for businesses looking to increase their revenue.

In other words, what Pareto’s Law tells us is this:

20% of customers can spend 4 times more money!

But there is a catch…

For Pareto’s Law to apply, two conditions must coexist.

First condition

The first condition stipulates that Pareto’s Law applies only to distributions with many occurrences.
In business, this means many transactions and many buyers.

In other words, Pareto’s Law cannot be leveraged if your company has just a handful of customers.

Second condition

The second condition has to do with the amount of money that customers can spend with your company.
For Pareto’s Law to work, there should be no limit to this amount.

This means that a business can’t put a top limit to the prices of their services, or at least their pricing structure should follow an ascensional model that allows customers with deeper pockets (or more pressing needs) to spend more money.

For example, if we only sell a product that costs $100 and that a customer usually buys it only once, every customer spends the same amount: $100.

In this case, it cannot happen that 20% of the customers bring 80% of the revenue!

So what’s the solution?

Easy… either give the customers the opportunity to buy more than one product (e-commerce shops do this) or structure your pricing into 2-3 different tiers.

The ascension model

Now that we’ve discussed the basics of Pareto’s Law let’s explore how to use it to capture more revenue from the traffic we already have.

This pricing strategy allows us to capture revenue from prospects willing to pay more for our product or service, without losing revenue from those not willing to pay as much.

The key is adding new price points for our products or services (price tiers).

To better illustrate this concept, let’s refer back to the example we have used above.

Let’s suppose we have 1000 people buying at $100 (note that this applies even if your business uses a subscription model!).

With these 2 numbers, we can draw a curve using the mathematical formula of Pareto’s Law.

This curve represents the number of people willing to buy our product at each price point.

The dark area under the curve represents the total money in the market for our product or service, with its current market fit.

However, since we have only one product and one price point, the amount of money we can capture from the market is limited (represented by the blue area in the image below).

The blue area is $100,00 (that is 1000 x $100).

The pink area represents the amount of money in the market that we CANNOT capture now.
However, things would change if we were to add two additional price points…

According to Pareto’s Law, 20% of people can spend four times the money, so by selling a product for $400 we can capture the area of the curve that was previously out of reach.

This translates into an additional 200 customers (20% of the 1000 customers buying at $100), resulting in a revenue increase of $80,000.

However, the revenue captured from the two price points overlaps (see the blue areas in the image below).

This is because 200 of the 1000 customers we are getting before are now buying the product at the new price point of $400.

On the price point of $100, we then lose $20,000.

So now we are making $80,000 at the price point of $100 (originally it was $100,000) and $80,000 at the price point of $80,000.
The total is $160,000.

By adding one price point (4 times higher than what we had in the beginning), we increased revenue 1.6 times.

Let’s now see what happens when we added the third price point…

If we pick the price point of $25 (four times smaller than the initial price of $100), Pareto’s Law tells us we’ll have 5 times the buyers.

In other words, 5000 people will buy the product at $25.

As you can see from the image above, we have even more overlapping now.

The new area is $125,000 (that is 5000 buyers at $25) and we have to subtract 1000 buyers from it, because 800 of them will choose the price tier of $100, and 200 will pick the product in the package sold at $400.

That shaves $25000 from the new area, leaving us with an extra $100,000.

So the total now is $100,000 + $80,000 + $80,000 = $260,000.

With 2 price points designed in a 4x progression, we can increase our revenue by 2.6x.

In essence, by introducing new price points, higher or lower than the standard price, we’re able to capture more revenue from customers who are willing to pay more.

It’s worth mentioning that we are still far from capturing all the money in the market.
The pink areas in the image above represent the revenue we’re still not able to capture.

However, we cannot add infinite price points, and having three price points is generally a sweet spot for mid-size companies to capture a lot more revenue.

Stick to Pareto’s Law

When choosing price points, it’s essential to take into account that the revenue areas overlap.
While the overlap cannot be eliminated, we shall strive to minimize it.

Pareto’s law tells us that 20% of customers can afford to spend 4 times the money.

Using a multiplier of 4x on each price is our best bet to model Pareto’s Law with great accuracy, thus minimizing the overlap of the revenue areas under the curve.

If we were to choose a 2x multiplier the overlap in the revenue areas would increase, resulting in a 20% loss compared to the situation with a 4x multiplier.

This “less than ideal” situation is represented in the image below.

So, stick with a 4x multiplier when you set the prices of your packages!

In a moment I’ll explain how you should modify the product to offer it at $25 and $400, but first I need to point out that $400 is NOT your upper limit!

Adding more price points

Notice that at the price point of $400 we still have 200 customers.
We can 20% that, and we’ll have 40 customers willing to buy “something” at a higher price point.

At this point, you know the drill, and you should be able to guess that the next price point is $1600 (that is $400 x 4).

Note that at this price point, you can offer a totally different product or service from your core product!
This could be a consulting service for example.

This 4th price point adds $64,000 to our bottom line.

And it’s not over yet… because we can still 20% the 40 customers and end up with 8 buyers for a $6,400 product or service.

This service (maybe executive consulting) would add an extra $51,200 to the pot.

Summing up the revenue for the 5 price points and considering the overlapping areas, we and up with over $360k.

That is 3.6x what we are making today with a single price point of $100.

Let that sink…

What to offer at higher and lower price points

By leveraging Pareto’s Law we can effectively generate more revenue.
But that works only if we figure out what to give to buyers at each price point.

The $25 price point is not much of a challenge.
The real challenge lies in convincing customers to pay four times more for our product or service!

The higher price

The key to overcoming this challenge is to add value to the product or service.
We can do this by adding valuable features that customers are willing to pay more for.

Of course, developing these features isn’t easy and it takes time, but if we can add enough value, we can be confident that we’ll sell the product for a higher price… because Pareto’s Law tells us that.

The lower pice

To create a lower price point, all we need to do is to remove features for the product or service we are selling at $100.

The key is to identify the core feature (those that cannot be removed) and package a stripped-down version of the product, a version that is still usable but lacks the bells and whistles you have in the $100 package.

Conclusion & final advice

In summary, it is possible to more than double the revenue your company is currently making by just using a pricing model with 3 tiers in which prices are set in steps of 4x.

This particular pricing model leverages Pareto’s Law and it will capitalize on the natural tendency of customers to spend more when they can afford it.

Here is some final advice that may help you with this strategy:

 

• • Understand Pareto’s Law.
    This way, it’ll be easier to apply it and to explain this strategy to your colleagues, CFO, CEO, etc…

• • Verify you have enough customers to create 3 pricing tiers.
    Pareto’s Law only works when there are many occurrences (transactions), so make sure you have enough customers coming through your doors before changing your pricing.

• • Talk to your top customers and figure out what they value.
    This will be the information you’ll use to add features to your product and raise its price by 4x.

• • Set the lower price point first.
    It is easier to remove features than to add them. So, focus first on creating the lower price point and then invest the added revenue in adjusting the product for the higher price point.

Take your time.

Developing new features to offer at higher pricing points and optimizing the basic versions of your products or services may take time… but it is an investment that will definitely pay off!