So you've built an amazing product. You've developed a full-scale 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 your product cost?
Learning how to price a product is an incredibly important yet too often overlooked phase of your startup; a phase that too many companies have struggled through despite having an amazing offering. However, with enough research, trial, and error, any startup can develop the perfect pricing formula that keeps customers coming while maximizing profits, and this in-depth guide will get you started.
Product Pricing Strategies
To help you get a better understanding of how to begin pricing your product or service, start by familiarizing yourself with some basic pricing strategies used by numerous startups. In the article, “There Are Only 3 Pricing Strategies For Your Startup”, Tomasz Tunguz outlines the only three pricing strategies he thinks that startups should employ, according to Madhavan Ramanujam (Board Member/Partner, Simon-Kucher & Partners).
Maximization (Revenue Growth) - This approach is designed to maximize revenue growth in the short term, and should only be employed when there are no distinctions between customer segments’ willingness to pay, and when the optimal short term and long term prices are equal. Revenue maximization is ideal for mid-market software companies who negotiate for the highest possible price in each sale.
Penetration (Market Share) - Penetration pricing requires a company to give their offering a low price to acquire the dominant market share. Startups that employ this tactic should begin by pricing low to reduce adoption friction, grow quickly, then move up-market after broad adoption has been cultivated.
Skimming (Profit Maximization) - The skimming method involves first charging a high price for a product, then gradually decreasing it after building a customer base. Skimming is not as common among software startups, as few companies build software that are readily accepted upon launch, and even fewer have built software that have customers already willing to pay high prices.
The previous three pricing methods are certainly worthy of consideration, and any of them will provide a solid foundation for a company’s pricing strategy. Once you’ve decided on the overall pricing direction for your startup, it’s time to get more specific with how you set out to put your pricing plan in action. Martin Zwilling’s article, “Top 10 Product Pricing Models For Startups”, describes some of the most commonly used pricing strategies. Below are some of the highlights:
Portfolio pricing - If your company offers multiple products and services with their own costs and utilities, then portfolio pricing is for you. Keep in mind, however, that because of its inherent complexity, this model requires expert management to work.
Tiered or volume pricing - Tiered pricing is common among companies that have products that may have one to hundreds of thousand of users, as this method allows companies to price their product by user group ranges or volume usage ranges.
Competitive positioning - This model consists of pricing products low in specific markets to drive competitors out, and pricing high where competition is low. But remember, if you’re competing with other startups based on price alone, don’t expect your company to last long.
Feature pricing - If you sell a basic version of your product or service that can be offered at a low price, you can charge more for models with additional features and capabilities. However, this approach requires costly development and testing, and your offering needs to be a good value at each level.
Razor blade model - With the razor blade model, you offer a basic version of your product, often below the market cost, with the intention of generating revenue from supplies to complement your product. But because this model needs considerable funding to implement, early-stage startups should wait before using this one.
Determine Your Product’s Price Range
Once you’ve determined which pricing strategy is ideal for your company, it’s time to focus on picking the right price range for your company’s offering. While identifying the perfect price for your product or service may seem like a mystifying and intimidating endeavor, Sequoia Capital has some stellar advice on this very task in their article, “The Sequoia Guide to Pricing”. Here are some of the most valuable points.
Start by forming a hypothesis. Many startups create products that don’t yet have any competitors, which makes setting a price more difficult. To combat this, companies should hypothesize what they think their ideal price is, and use A/B testing and other analytics to measure it, while also taking into account input from customers and employees, and what the competition, if any, is doing with their pricing.
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, emphasizing their additional worth over the free or lower-priced versions.
Let your product’s price tell a story. The price for a product or service can greatly affect customers’ perceptions of its quality, which is why offerings with a higher price tag are usually seen as better quality. Try horizontal assortment, which is to offer multiple products at similar prices, or vertical assortment, which is to offer versions at multiple prices.
Check your pinch points. Determine which customers consider your offering a good deal and those who would be willing to pay more by monitoring how they interact with your product. By doing this, you can discover which aspects, functions, and features matter the most to your most devoted users, the ones who would be willing to pay extra to access them.
Optimize for ideal first impressions. Because customers don’t often rely on logic to make purchases, it’s recommended that your offering looks as great as possible to reduce the possibility of your target clients to talk themselves out of making a purchase. But don’t trick potential customers into thinking that your product is better than it is (and if we have to explain why that’s wrong, you shouldn’t be an entrepreneur). Rather, the goal is to emphasize the value of your product, as well as its uniqueness and superiority over competitors, in a way that’s clear and upfront.
Click on the image below for a full checklist on testing your product price.
For a lean startup approach to product pricing, Omar Mohout (Professor of Entrepreneurship at Antwerp Management School) has created a useful resource that delves into the topic.
In general, startups should err on the high side of any pricing ranges they set. It’s much better to price too high than to price too low. Pricing too low can hurt your brand, as products that are described as “cheap” or “inexpensive” are often seen as low quality or unreliable. However, lowering the price on a product from a high price can be seen as a brand improvement.
How to Test Your Product’s Price
After you’ve settled on a pricing model and have established price range for your offering, it’s time to test your price and determine what the next steps should be. One of the easiest ways to assess a product’s price is through A/B testing, details of which you can find in the VWO article, “Stop guessing! Use A/B testing to determine ideal price for your product”, by Paras Chopra. Below are some of the highlights:
Offer different products at different price points.
Depending on your offering, your company should ideally present different products, features, plans, solutions, etc., each with a different price. For example, set a price for your base model, then present another product that has twice the value (additional features, functions, etc.) for twice as much, and offer another product that has half the features of your base model but is only 20% cheaper. If the conversion rate for your original base model is the same as the cheaper model (despite having only a slightly higher value), then that means that your customers are willing to pay more for your offering.
This process will take time and may need to be iterated numerous times, but that’s to be expected with most startup “experiments”. Remember, add extra value to your product when you are testing a higher price, and remove value when you are testing a lower price, depending on the what it is you’re offering.
In short, the 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 maximizing your revenue.
Measure your revenue, not your conversion rate.
During the price testing phase of your startup, 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.
For example, your company may offer numerous products (or only one) that sell incredibly well. However, if your products have a small price, you may need to sell a considerably high number of products to make a profit. This problem may be compounded by the manufacturing, development, and maintenance costs of your product, as well. Inversely, selling a higher priced product but at low numbers may be enough to maximize your profits, so it’s essential to focus primarily on the overall revenue your product generates.