Startups: your pricing should be based on ‘price on purpose’, not a random number

The price of everything and the value of nothing. This Oscar Wilde quote reflects much of today’s business environment: discount retailers have flooded the high-street, online models offer seductive monthly subscription pricing options, off-shoring offers significant cost savings and ‘pay-as-you-go’ is an established enabler of contract free affordability.

But the very essence of Wilde’s quote is that it’s useless knowing the monetary price of something and yet not fully understanding its non-monetary value to your customers. This is the challenge faced by all startups as they struggle developing a pricing strategy due to their lack of insight into their drivers of value, and many simply focus on that’s the market price we can get away with.

Many startups make pricing decisions in a seemingly detached manner from their go-to-market strategy. Many default to a pricing model based on an accounting principle known as cost plus – take all your costs and add your profit wish. Pretty simple. Pretty awful. This is understandable to some extent, as early-stage entities have pressure on their runway to execute and get into revenue. However, making a ‘bet’ isn’t good enough.

There are many pricing playbooks. Software has shifted to the SaaS based pricing model from the traditional ‘seats’ approach; mobile phone tariffs for SIM only and pay-as-you-go, no contracts; printed magazine publishers traditionally offered annual subscriptions, now the offer is print plus digital options with access to a number of articles. Restaurants offer ‘early bird’, ‘two courses for £20’, and ‘taster menu options’. The concept of adding or subtracting product features to create variably priced bundles targeted to customers of varying budgets or those who value features differently is well established.

Pricing underpins your overall market approach and ultimately profitability, so you need a good sense of where to start and be confident in pricing experimentation as part of the learning and iteration process. Startup pricing is more art than science and be willing to have an honest and bold dialogue with potential customers. Each conversation is a signal telling you if you’re moving in the right direction – or if you need to pivot your pricing thinking.

When testing, there are some bad habits and pitfalls to avoid, for example:

Prices are developed without customers You can’t figure pricing out without engaging customers. All the answers are in your customers’ heads not in your spreadsheet, so get out of the building. Your strategy should be to pick a pricing start point and stick with it for a sufficient period of testing to provide validated learning.

Prices are set in stone, not in motion Founders often fall into a common trap: they pick a price, get early confirmation, and declare ‘this is the price we’re taking to market’. They are then challenged on their pricing, get nervous and lose focus, flounder, and end up with a series of random prices with a variety of customers as they seek to close deals instead of testing.

The price is too low Even the most confident founders’ price low. Instead of letting the market tell them where they’re not going to win deals, they price low and end up talking themselves into the dark side of the price pendulum. If you start from a low price, you’re already capping your revenue growth.

The pricing structure is complicated Many pitfalls are rooted in trying to innovate too much on pricing structure. Something you may regard as ‘innovative, can make customers doubt your integrity, and become a barrier to purchase.

Some companies are bold and craft an innovative pricing strategy based on clear customer value and targeting. Here’s an example from the car insurance sector, where prices have always been set in the same way, charging customers annual premiums for unlimited driving. The premium varies depending on a driver’s age, vehicle, driving history, annual mileage etc.

US insurance company Allstate began debating a question: if we could better assess who’s driving safely and how much someone is behind the wheel, could we improve the way we set prices and attract new customers in the process? After research, Allstate decided the answer was yes and launched three new products with their own personalised and clear pricing strategy:

Drivewise, using telemetric technology to monitor customers’ real-time driving habits, such as sudden braking and excessive speed, Allstate could now access accurate data and adjust premiums accordingly. People who considered themselves safe drivers flocked to Drivewise.

Milewise, aimed at customers who don’t drive frequently. Instead of fixed annual premiums,  customers pay a low daily rate for insurance coverage, plus a per-mile fee based on actual driving. Drivers who sign up for Milewise saw premiums drop by 50%. As Covid restrictions reduced commuting, the number of vehicles covered by Milewise increased 725%.

Your Choice. Drivers who went five years without accident claims have no premium increase after their first accident.  Allstate demonstrated that car insurance doesn’t have to be about being the lowest-price game.

So, you’ve built an amazing product, developed a launch plan and a marketing strategy that’s going to attract customers in droves. There’s just one more thing you need to figure out: How much should I charge?   Obviously, it must be grounded by the characteristics of the market and customers you choose to serve, the pricing model of existing competitors, and a strategy you believe is consistent with your future direction.

Your challenge is to set the right price to match value perceived by the customer, with a fair return for you. Here are some options to consider:

Product is free, but you pay for services in this model, the product is given for free, and customers charged for installation, customisation, training etc. This is a good model for getting your foot in the door, but this is basically a services business with the product as a marketing cost.

Freemium In this variation on the free model, used by LinkedIn and many Internet offerings, the basic services are free, with premium services available for an additional fee. This requires a huge investment to get to critical mass, and to differentiate and sell premium services to users locked-in as free.

Cost-based model in this traditional ‘cost plus’ model, the price is set at the product cost plus a targeted margin. If your product is a commodity, the margin may be as thin as 10%. Use it when your new technology gives you a tremendous cost improvement at scale. Skip it where there are many competitors.

Value model If you can quantify large value or cost savings to customers, charge a price commensurate with the value delivered. This doesn’t work well with ‘nice to have’ offerings, like social networks, but does work for new software that solve critical business problems.

Tiered or volume pricing Where an enterprise product may have one user or hundreds, a common approach is to price by volume of user group ranges, highlighting unit economics. Keep the number of tiers small for manageability. 

Competitive positioning In mass markets with competitive environments, price has to be competitive no matter what the cost or volume. This model is often a euphemism for pricing low to drive competitors out, and high where competition is low. Competing on price alone is a good way to kill your startup.

Feature pricing This approach works if your product can be sold ‘bare-bones’, and price increments added for additional features. It can be a very competitive approach, but the product must be designed and built to provide good utility at many levels. This is a costly development, testing, documentation, and support challenge.

While identifying your price plan from the above common options may seem an intimidating endeavour, Sequoia Capital has some good advice on this. Here are some of their most valuable points:

Start by forming a hypothesis Many startups create products that don’t yet have any competitors – first to market makes setting a price more difficult – so hypothesise what you think an ideal price is and use A/B testing taking input from customers.

Increase the perceived value of your product Founders should concentrate on the gap between their price and how much value customers think it delivers – the perceived value – which can be increased through better marketing of the product’s key features, emphasising their additional worth over the free or lower-priced versions.

Let your product’s price tell a story Price can greatly affect perceptions of quality, which is why offerings with a higher price are usually seen as better quality. Ensure you highlight the features, benefits, impact, and evidence of early adopters to showcase value-price trade-offs.

Check your pinch points Determine which customers consider your offering a good deal and those willing to pay more. By doing this, you can discover which aspects, functions, and features matter the most to your users. In general, startups should err on the high side of any pricing they set in my view, highlighting the innovations developed.

This purpose of this process is to ascertain the price sensitivity of your target market. Once you’ve homed in on this factor, you can now offer your product or service at a price that customers are willing to pay while maximising your revenue. During price testing, it’s important to keep in mind that the goal is not to necessarily increase your offering’s conversion rate, but to increase your offering’s revenue. It’s easy to assume that a higher conversion rate means increased revenue, but that’s not always the case.

These customer development questions are part of getting a more informed understanding of how customers think about your product, and helping you to define two key inputs to help shape your pricing strategy that follows:

Your upper price ceiling This is the highest price the market signals for the value you provide. Force yourself to test this, even if it means getting into the uncomfortable zone of pushing for a higher price, you need to find it. You’ll get pushback and refusal, but if you’ve done a good job showing the value of your product, prospects will be interested. I’ve worked with tech product startups where we’ve gone from £5k to £20k in price testing the ceiling.

Your anchor Your anchor is an alternative that customers compare your product against. What are you replacing? Set the anchor to something the customer understands. Make sure you find an anchor that gives you a price point that’s high enough. Don’t expect your customers to figure this out on their own, it’s up to you to paint the full picture. The goal is to get data that will really give you confidence in your upper ceiling and anchor.

Free markets tend to undermine themselves from the bottom upward as Marx identified, which is why we see a race to ‘cheapest price’. Many folks are besotted by ‘market rates’, but as Economist Paul Krugman says, this is beauty clad in impressive mathematics for a convenient truth. Equally, opportunist pricing can make short-term gains, but don’t get too rosy eyed, markets can be easily bewitched and scoundrels seeking easy exploitation ultimately fail.

Respect yourself and your business. Do you want to haggle over price, or do you want to showcase your ideas that will give you innovation, growth, and success, as the basis for your pricing?

Price on purpose. What are you really selling, what are your customers really buying? A florist isn’t selling flowers, they’re selling love; Harley Davison don’t sell motorbikes, they sell adventurous lifestyles; software companies don’t sell technology, they sell innovative solutions. Whilst pricing is an essential element of your business model, don’t get seduced by the numbers in articulating your value proposition – don’t forget that money is the applause, not the reason you’re here.

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