There are three parts to increasing revenue: acquisition, retention, and monetization. But many founders ignore monetization, applying weaker pricing their products early on, the effects of which can stick around for years to come. So let’s take a look at strategies for price products. But first, it helps to understand pricing in general.
This information below reviews:
- Why using value metrics is pivotal to pricing your product
- How to find a proxy for your value
- Four steps to revamping product pricing
- How to think about pricing at three different startup stages
Value metrics: The secret to successful pricing
There are several common pricing strategies, but value-based pricing tends to be most effective. At the heart of this model: value metrics. Simply put, a value metric is how a customer pays you, and what they pay for. It could be a dollar amount priced per user, for goods sold, bandwidth, thousand contacts, number of help-desk tickets, and the list goes on. The perfect value metric for every product should align with one of these three customer priorities:
- Revenue you’re bringing them
- Costs you’re saving them
- Efficiency you’re adding for their business
Find a proxy for your value
Attaching a dollar amount to your value-added—and then pricing just below that point—can help you capture the most value. But getting to that magic number is easier said than done. That’s why the next best thing is finding a proxy for your value. Salesforce, for instance, charges per user per month, while video hosting site Wistia charges by bandwidth use and number of videos. Whatever proxy you use, you want your value metric to be as close to the amount of value you’re bringing the customer as possible. So what are the traits of a good value metric? The metrics should pass four key tests:
1. Align with your customer’s perceived value
If your value metric isn’t near where a customer sees value, raising or lowering your price won’t have a desirable effect on profits. The closer your value metric is to where the customer sees value, the more you’ll be able to extract value.
Customers using Amazon Web Services (AWS) benefit from storage, time, and redundancies, so that’s how AWS charges. For a marketing product, the ideal place of value is the number of leads or contacts. Depending on your industry, you’ll want to choose an appropriate area for a value metric. 2. Be easy to digest
Customers will only buy your offer if they understand your pricing. Especially for self-serve sales, customers need to understand your pricing well enough to buy without speaking to anyone.
How digestible it needs to be depends on your customers. You might be able to use a complicated pricing system to sell AWS to a developer, but need a simpler, more user-friendly pricing schedule to sell customer relationship management software to a small business.
3. Grow with value
Too many startups find themselves in a position where they’re selling to both international conglomerates and small outfits, with everyone paying the same amount. If a customer sees more value, you should see more value. After finding product/market fit, many startups struggle to introduce price increases without sparking an uprising among customers. 4. Pass the gut-check
Those three elements are the key fundamentals: they get you most of the way there, but don’t account for everything. Consider whether the value metric would cause any unpredictability or undesirable behavior. Typically, to see whether a value metric would cause this, ask two questions: (1) Can the customer control the value metric? (2) Will they want the value metric to increase, even if that means they will have to pay more?
Take help desk software, for instance. One of the most accurate metrics for value added is the number of support tickets. But charging by support tickets can cause problems since the metric isn’t controlled by the software company’s customers. What if they get more support tickets in December than January? They then aren’t able to predict how much their help desk will cost each month, which would drive their finance team crazy, in turn potentially preventing them from using your software. What if, instead, you priced by their number of seats? While it’s one more level removed from your actual value, this proxy for your proxy may be far much more palatable to customers.
Common pitfall: Using per-user as a value metric
For most companies, per-user is a terrible value metric. Some companies still use it because it’s a holdover from how software companies used to sell perpetual licenses. The problem: tracking users. On a marketing product, for instance, a company may have 10 people on the marketing team, so they’re paying for 10 users, but the company also has a hundred-person sales team that benefits without paying a dime.
If someone can use the same login to get the same experience, never charge per user. If the experience differs—like Salesforce, where logins are lead-specific—per-user may work. In general, though, a per-use measure will still be less precise than an ideal value metric.
How to understand your customers and capture value
The best pricing pinpoints the precise amount a customer is willing to pay. A lot of factors could drive that, including product, brand value and competitors. At the end of the day, pricing is a question of customers. How much are they willing to pay? To answer that, you need to understand your customers.
1. Who is your customer?
Start by asking questions about your customers. Who are you selling to? What are they trying to accomplish? Answer these questions as specifically as possible. You should know your customers to this level of specificity, for instance: Python developers at companies of 5-50 people based in Denver. You may have multiple customers, each with different traits. Be sure to keep those groups separate.
2. What do they need?
Once you understand your customers, you can pinpoint their needs and how much they’ll pay to address them. Look at data, and if you don't have it already choose a data-gathering framework. Then, ask your customers questions as scientifically shaped as possible, to pinpoint how much they’d pay for a solution to their problem. The more data you have on their problem and propensity to pay, the more accurately you’ll be able to capture value.
Four steps to revamping your pricing
To reinforce pricing, startups can follow these four steps:
1. Admit there’s a problem
Many companies price by guessing. But choosing a price arbitrarily—or leaving it up to chance—carries risk. Instead, recognize you need a method and get your team on board.
2. Align across functions
A recent survey of 270 subscription software businesses found that only 17% developed pricing strategies with input from their whole team. This is a loss. Pricing touches on all parts of your business, so all parts of your business should touch on pricing. At a minimum, get input and alignment from:
- Product Your product team builds features based on knowing what users need. This knowledge can contribute insights into your product’s packaging and pricing.
- Marketing Your marketing department understands your customers and their behavior; use them. They also need to be kept in the loop in identifying the right messaging and communicating price changes.
- Sales Pricing needs to drive profits, which means it must allow your team to close sales. Familiarity with your pricing can help your sales team develop a more defined pitch and more accurate forecasts, which ultimately impact your revenue and profit.
- Management Your company’s executives, from the CEO down, tie it all together. Management should take control of coordinating the pricing strategy, bringing in knowledge from all other departments when arriving at a decision.
3. Choose a method
Use the scientific method: do research, develop a hypothesis, and test.
Start by talking to your target customers. Ask a dozen people about their problems. Without leading the witness, ask what they think about pricing. Then run that data through a technical method like MaxDiff or Price Sensitivity Meter. These are incredibly efficient models for determining a person’s willingness to pay; use them.
That process will generate a recommendation for your company. At this point, it’s important that one person has the final say and the authority to decide. Otherwise, you may end up pricing by committee, which can thwart the whole process.
4. Stay current
Pricing is not set and forget it. You should be considering impacts to pricing, packaging, or positioning at least every six months if not sooner. Whenever you put out a new product or feature, consider how it affects your overall pricing.
Common pitfall: beginning too big
This process can seem daunting. Starting small is the best way to avoid analysis paralysis and prevent you from committing to a pricing plan that will be hard to adapt.
Starting with one piece of the puzzle helps get started. Identify your value metric or price a new feature properly by getting input from multiple teams on a deadline. You’ll see the benefit to your bottom line and it will encourage the company to improve pricing across the board.
The above tips can guide a startup of any size. Companies at various stages may encounter specific difficulties. Here’s what to keep in mind at each stage of your business:
Early-stage pricing: Early-stage companies have so much to focus on, which can pose a challenge for re-evaluating pricing every six months. The most important element is your value metric. Figure it out as soon as possible. A well-chosen value metric can give you a lot of leeway. Plenty of companies mess up several other elements but still survive because they chose the right value metric.
Growth-stage pricing: Growth-stage companies—especially venture-backed ones—are expected to grow aggressively. Your first batch of customers are typically the easiest ones—from there, start identifying potential challenges to gaining market share. Deep dive into where your growth comes from. That’s why growth-stage companies should make sure their value metric drives revenue as their customers grow.
If your value metric grows along with your customers’ growth, you can grow from retaining users, even if you’re not acquiring new ones. Stripe, for instance, is paid a portion of customer revenue per transaction. As long as their churn stays low, the company can grow hand-in-hand with its customers.
Series A and B pricing
Once a startup hits a Series A or B round, you should be able to answer whether you have pinpointed the best value metric, aligned price to customer value precisely, and broken down customer personas precisely.
Understanding different personas allows a company to eliminate harmful customers and capitalize more extensively on the beneficial ones. An e-commerce platform, for example, might find some customers are profiting greatly from the platform, costing lots of resources, but only paying the entry-level price. Once you realize that, you can change the price. Thirty dollars per month can become $3,000 per month.
Cost is a measure of perceived value. When you’re charging a customer, set your price where they perceive your value. Neglecting to raise prices can be costly, too. If your customers are growing, and reaping more value from your company, your company will reap value from that relationship.
Pricing well isn’t easy, but it’s worth it.