Pricing, revenue, cost and profit

Take one product with one cost and put four prices on it. A software tool gives the basic version away and charges for the professional one. A theatre sells two tickets for the price of one on a quiet Friday. An airline changes the price of the same seat several times a day. A clothing seller collects prepayments in September and produces afterwards. Unit cost is fixed in all four cases; price is not. Price is not a markup on cost but a match between what a buyer values and what that buyer will pay.

The textbook places pricing inside marketing strategy and names three goals: the biggest market share, the most revenue or the biggest profit. The three pull apart. A price cut buys share and may destroy profit; a price rise protects margin and may hand share to a competitor. Two identities organise the lesson: revenue equals price multiplied by volume, and profit equals revenue minus all costs. Because revenue is a product, price and volume changes can cancel out. With a 50% contribution margin, a 10% price cut lowers contribution per unit from 50 to 40, so volume must rise by 25% to stand still. That is the intuition behind price elasticity: the question is whether demand responds enough.

Freemium is the first mechanism. The textbook calls it cross-subsidy: a basic service is free, premium services are paid, and the paying users cover the free riders. Skype is the example, free between Skype users and charged for calls to landlines and mobiles. Two conditions must hold, and both are quantitative. The premium must be clearly felt, and conversion must cover the cost of serving everyone else. In the teaching illustration, 50,000 free users cost US$0.15 each a month, or US$7,500. At US$12 a month, 2% conversion brings 1,000 payers and US$12,000, leaving US$4,500; at 1% the same product loses US$1,500. The free tier is not generosity but an acquired customer base with a monthly bill.

Versioning is the second. The textbook defines it as creating multiple versions and selling essentially the same product to different segments at different prices, so that price tracks the value to an individual consumer. A reduced-value version may be free while premium versions cost more, where reduced value means less convenient, less comprehensive, slower, less powerful or less supported. The New York Times allows a set number of free articles a month and then requires a subscription; other sites offer an ad-supported free tier and a paid ad-free one. The textbook illustrates the same logic with car brands and hundreds of models. The design problem is cannibalisation: the free version must be worse in exactly the dimension the paying segment cares about, and no worse in the dimensions that create trust.

Bundling is the third. Ziegfeld noticed that nearly a third of his Friday-night seats were empty and that matinees were often half empty, and introduced twofers: pay for one full-price ticket and get the next free. The textbook gives two reasons. The marginal cost of seating another patron is essentially zero, and many people who would not buy a single ticket will buy a bundle for the same or a slightly higher price. The deeper point is statistical: consumers disagree widely about a single product's value but agree much more about a bundle at a fixed price, so bundling reduces the dispersion of demand. Bundling is not simply a discount. In the backpack example, a US$25 pack and a US$8 cover are bundled at US$29, a 12.1% discount; with costs of US$9 and US$2, contribution falls from US$22 to US$18. The bundle pays only if it raises the probability of purchase or reaches buyers who would never have bought the cover.

Dynamic pricing is the fourth, and the textbook's definition is blunt: the value of a good equals what the market is willing to pay, which may have nothing to do with its cost; price varies with customer demand and the seller's supply. Auctions let buyers bid against one another to establish an instant market price, and suit unique goods as well as commonplace ones such as computers, flowers or cameras. Yield management sets different prices in different segments to sell excess capacity; airlines reprice empty seats every few minutes, sometimes below marginal cost, and large retailers such as Amazon reprice hourly and can track a buyer's comparison behaviour. Flash marketing uses time-limited low prices and has been effective for travel and luxury goods.

Surge pricing is the version that produces arguments. Uber's algorithm raised prices two to ten times or more during storms and holidays; the company describes this as balancing supply and demand, critics as exploiting customers in an emergency. Both can be true at once. A spike does bring more drivers onto the road and allocates a scarce good to whoever values it most; it also transfers surplus from people already in trouble. The textbook records the criticism without resolving it. The practical lesson: dynamic pricing is constrained by rules and by legitimacy, from consumer-protection law in some markets to customers' willingness to keep buying in all of them.

Flash marketing looks like the easiest of the four. A time-limited price clears stock and creates urgency, and for travel seats or end-of-season luxury goods the alternative may be no sale. Applied repeatedly to a full-price product, however, it teaches customers to wait: it is a tool for perishable inventory, not a permanent substitute for a price.

Two practices sit beside these mechanisms because they change when the money arrives. The textbook treats crowdfunding as consumers or investors putting money into a developer, with delivery after successful development and then external sales. Presale is product crowdfunding on a small scale: advertise a new coat, take orders and prepayments, produce to order over seven to ten days, and cut inventory to zero. Three differences matter: the state of the product, the use of the funds and the promise made. Presale sells a defined product and promises delivery; crowdfunding funds development and promises delivery only if it succeeds. Treating them as identical misleads both sides, and using presale cash as working capital is how a delivery promise becomes a default.

All four mechanisms answer one question: who pays, how much and when. Freemium and versioning decide who pays; bundling and dynamic pricing decide how much and when; presale decides when the cash arrives. None of them changes the identity at the centre of the lesson: profit equals revenue minus cost, and revenue equals price times volume. A clever price with the wrong volume, or a good margin on an order that will be paid in ninety days, still fails. That is where the next lesson begins, with a factory, a quotation and a buyer who wants terms.