Startups change the world. They solve the problems, they tackle the pains, they scratch the customers itch, they innovate. But startups are business ventures and while saving the world and solving the problems is a game I love the most, I must constantly remind myself that startups MUST make money. Both for the founders and the investors. And to make money they must know how to monetise the ideas and they need to price the product well. Well enough to survive and to thrive.
Surely one of the toughest decisions for a startup is how to price their product or service. And from my experience, entrepreneurs for some reason or another tend to be rather careless about it. The alternatives range from giving it away for free (like Twitter), to pricing based on costs, to charging what the market will bear (premium pricing). What you must remember though is that the implications of the decision you make are huge. Pricing strategy and business model define your brand image, your funding requirements, and your long-term business viability. In short: you better think before you price.
The revenue model you select is basically the implementation of your business strategy, and the key to attaining your financial objectives. And that is something every entrepreneur should keep in mind. Especially that most startups play defence when discussing pricing with customers. They are fairly often lost between asking for too little, leaving money on the table, and asking for too much, only to lose the customer’s interest. Pricing is one of the most difficult and complex and crucial decisions for the business. Especially that startups operate in newer markets where pricing standards haven’t been set. In addition, these new markets evolve very quickly, and consequently, so must pricing. To make things easier for entrepreneurs I have prepared the list of factors you should consider when thinking of your pricing plan.
When you are pitching you do not need to know the answer to all the questions but when you talk pricing strategies you should definitely know the answer to the question why did you choose this strategy and WHY you want to charge this much (or this little) for your product/service.
These are the five crucial factors I truly believe entrepreneurs should consider when crafting a pricing strategy:
The Basis for Pricing: There are three ways to justify a pricing plan:
- value-based pricing,
- cost-based pricing,
- competition based pricing
Value-based pricing charges customers a fraction of the incremental value created by the product or a fraction of the costs saved by the product. With competition based pricing startups craft their pricing strategies in comparison to competition. This works well in markets where the price and value of a particular type of product are well established. Startups adopt the pricing model well known in the industry.
Positioning: Positioning is the most frequently forgotten of the 4 Ps in Marketing. Remember that when used strategically, pricing can be a weapon, a source of competitive advantage in the market. Your company can choose to price below the market in order to gain share and grow quickly. You can choose to price at the market price and differentiate based on product features. You can also charge a premium for their product. This reinforces your positioning as the gold-standard in the sector. Always remember that a startup’s pricing strategy must align with its marketing case studies, website messaging, PR releases and sales pitches.
Customer Base Size: The number of total potential customers multiplied by the selling price of the product equals the total addressable market (TAM) for a startup. Generally speaking, bigger TAMs are better.
Contract Length: Many SaaS startups launch with monthly pricing which encourages customers to try the product and engenders demand. From my observation at some point, most SaaS startups switch to annual contracts for one of three reasons:
- First, revenue becomes much more predictable;
- Second, annual contracts often include terms that require pre-payment up-front which rewards the startup with lots of cash to grow faster;
- Third, contracts mitigate churn rates because the customer is only making a renewal decision once per year, instead of 12x per year.
Your Startup’s Unit Economics: Your pricing plan has to enable the company to become profitable at some point. The value of your business is the discounted sum of all its future profits.
Overall, I’m a huge fan of the “keep it simple (KISS)” principle – customers are typically wary of complex or artificial pricing. They want simple plans, they want simple contracts, they do not want to think too much. Your challenge is to set the right price to match value perceived by the customer, with a fair return for you. It’s not a game show, so don’t guess – do your research early with real customers and if you can’t decide yourself, book a consultation with a good mentor. Someone who knows from experience.