The Art of the Double Dip: How Two-Part Pricing Can Boost Your Bottom Line

I was recently asked about two-part pricing by a client. They’re an industrial supplier of goods and services. Some of the equipment they supply requires consumables, so they have the opportunity to make additional sales (and higher margins) from the supply of those extra products.

Their problem is that they don’t get many additional sales. And that’s because the consumable is a generic item that anyone can supply.

That made me think about the whole issue of two-part pricing, and what advice I could offer.

First, let’s start with a definition. Two-part pricing involves charging customers an initial fixed fee to access a product or service, followed by a variable fee based on usage or quantity consumed.

I hope that made everything clear. No? There are better ways to explain this.

Imagine buying a razor. You pay an upfront cost for the razor handle, and then you continue to purchase razor blades as needed. This is a classic example of two-part pricing. Similarly, think of a printer: you buy the printer first (the initial fixed cost), and then you buy ink cartridges as you use the printer (the variable cost). Another example is Nespresso machines and their capsules.

Two-part pricing works in both consumer and commercial markets.

Let’s have a look at business to business sales first.

There are some clear advantages to two-part pricing. The first, and most obvious, is recurring revenues – normally an important objective for industrial companies where the sales cycle can be very long and potentially lumpy. Secondly, contracts are often won on very thin margins, and it’s possible to gain higher margins on the consumable supplies. Finally, regular interactions with a client help to develop and strengthen relationships.

The main challenge is ensuring that the customer receives and experiences clear value. If they feel that the relationship is being abused and they are being taken advantage of, it will destroy the relationship. So avoid price gouging!

Some examples of industries and companies that do this well include…

Software as a Service (SaaS) Companies: Many SaaS providers use a two-part pricing model. For example, Salesforce charges a base subscription fee for access to their platform and additional costs based on the number of users or features.

Industrial Equipment Leasing: Companies like Caterpillar lease heavy machinery with a base rental fee and additional charges based on usage hours or maintenance needs.

Telecommunications: Providers sell the equipment and might have additional usage fees, such as a price per minutes or per Gb of data used. Many web hosting companies go one further – the initial implementation is free and the client pays for usage. Fasthosts, for example, charges different monthly amounts depending on number of domains and amount of storage.

How do you go about developing this kind of model? There are three key steps:

1.        Undertake a detailed needs analysis for your customers and their needs.

2.        Develop genuine value solutions that are differentiated from your competition, and where possible, include some element of bespoke design or defendable IP.

3.        Create clear and understandable pricing models for the different options.

There are similarities with two-part pricing in consumer markets.

Just as in commercial markets, a key advantage is recurring revenues. There is another important reason why this is popular, though – it allows manufacturers to supply the initial equipment for a very low cost.

In fact, in 2021, TechPowerUp reported: “Sony Confirms It's Selling PS5 Consoles Below Manufacturing Cost, Ships 4.5 Million Units”. That allowed them to gain massive scale quickly, and they then made money from software sales.

On the other hand, customers might resist the idea of being saddled with ongoing payments. The model only works as long as the company controls the supply of the consumable item; if it is not protected and lower-cost copies are made available, the repeat sales stop. The need to protect the consumable, such as investing in patents or other protection, also costs money.

We see examples of two-part pricing all around us. Classic ones have already been mentioned:

Gillette: Known for its razors and blades model, Gillette charges an affordable price for the razor handle but makes significant profits from selling replacement blades.

Nespresso: Sells coffee machines at competitive prices but the capsules are where the real profit lies.

HP Printers: Offers printers at low prices with higher-margin ink cartridges.

The implementation steps for business to consumer are the same as for business to business: analyse your customers, design solutions, then develop clear pricing.

So my top tips are:

1.        Ensure the up-front price and the recurring prices are balanced

2.        Potentially use bundles and other pricing tactics to make the total offer seem more attractive.

3.        Use the repeat sales to develop loyalty programs, to gamify purchases, or do other things to strengthen relationships.

4.        Use the repeat transactions to gather data on customers, which can then be used to develop additional services.

Two-part pricing isn’t the right solution for every market or business, but it is an often overlooked option, particularly in B2B markets.