Influences to Price Levels in Add-on Price Structures

 There are consumer behavioral effects that enable firms to capture higher margins with either
the add-on modules or the base product.
 Both the signpost and optional equipment effect are highly driven by the difficult comparison
effect

Signpost Effect

 Signpost effect argues for a low price on popular or frequently purchased products to induce
purchase of less popular or infrequently purchased items that are priced to yield a higher
relative contribution margin.
 The basic premise of the signpost effect is that prices on certain items can signal to customers
the price of other products.
 The signpost item can even act as a loss leader to drive traffic and sales of complementary
items.
 It relies on the ability of customers to identify and interpret the signpost item accurately as
priced favorably to induce customer interaction.

Effective strategic signpost pricing

 Competing stores are heterogeneous in their format, some having a higher cost structure and
others having a lower cost structure.
 Customers are heterogeneous in their store preference, perhaps due to location or product
availability, cleanliness and décor, customer service, or length of lines
 Customers select which retailer to purchase from based upon the expected utility that they will
derive from patronizing a specific store
 Retailers signal their overall price image through advertised prices
Optional Equipment Effect

 Manufacturers can couple lower-margin base models with higher-margin optional equipment
 Manufacturers have something of a monopoly over factory-installed optional equipment and
they can use these add-on items to effectively price-segment the market to some degree

Network Externalities

 Network effects are a core strategic element

 Network effects have led to the development of “freeware” or freely provided popular software
 Network externalities can lead to aggressive pricing behavior wherein the base product is
offered at a low price
Lock-in with Complementary Products

 Complementary products that increase switching costs of base products can encourage firms to
price the base product high while pricing complementary products low
 Lock-in effect can lead to a pricing strategy wherein complementary products are priced
aggressively to encourage their dissemination into the market, while the core product is priced
to capture profits as customers replace an expired product or extend their purchases within that
category