The Startup Playbook: Nailing Pricing Strategy
Editor’s Note: The following is an excerpt from The Startup Playbook: Founder-to-Founder Advice From Two Startup Veterans available on Amazon here.
While figuring out your go-to-market strategy isn’t linear, you do need a place to start. We like to start with the pricing strategy. If you have a sense for your price point and model, that can be fundamental to the specific sales and marketing approaches you take.
A significant way you can differentiate your company is by making the pricing strategy (often called pricing model) unique. The place to start with pricing is to get a handle on the general concept. Start by investigating the following:
- Value of your solution. What is your solution worth to your customer? Does it help them save time or money? Is the value emotional? Does it help them generate more income? You’ll need to analyze the benefit of your solution from the customer’s perspective and make your best attempts at quantifying it.
- Costs to deliver your solution. Another factor in your pricing strategy will be your costs. While you’ll likely sell your solution at a loss initially, you’ll want to understand both the fixed and variable costs you’ll have delivering your solution to a customer now and over time. Try to see if there are natural break points or clear decreases in cost as you scale the business. For example, most companies see a substantial decrease in a selling cost when they sell more or additional products to existing customers because they already have an established relationship. Understanding the nuances of your cost model can help you get creative in your pricing model.
- Competitive pricing. There is generally a price point that your competitors have gravitated towards. While you don’t need to sell at the same price, you need to take into account that your customers will use competitive pricing as a benchmark. Additionally, while your competitors won’t always be right, you should try to understand why they price their offering as they do. There might be a very good reason for it. You’ll need to judge how best to play in the competitive landscape, but understanding what you are up against is important regardless of your decision.
- Substitute pricing. For many founders, the often overlooked competitor is the substitute product. Your customers may opt to solve their problem differently than by purchasing from you or your competitors. Ride sharing companies, such as Uber, Lyft, and Grab, among others, are viewed as competitive with the taxi industry. But, what if ride sharing customers used their services in lieu of purchasing a car? In this scenario, wouldn’t these companies be in competition with car manufacturers? The ride sharing business model is vastly different than their substitute competition’s. The challenge here is to think through all the different ways your customer can solve their problem so that you can price your solution accordingly.
- Overall costs of implementing your solution. Sometimes, your solution isn’t everything that your customer needs. They might need to purchase additional products, or perhaps they need to pay for people to be trained or to help implement your solution. Understanding what the total costs are for your customer to gain value from your solution will also help you in the pricing discussion.
Some example models you’ll want to consider are discussed in the next section. This is hardly a complete list of pricing model approaches. Ultimately, our hope is that you can develop a clever pricing model that resonates with your customer – maybe even invent a new one. Note that some of these models can be used together, but again, the primary goal should be to find something that’s natural to your customer and still represents profit for you.
Model #1: Premium-cost/Low-cost provider.
Many companies have built their models around being the highest or lowest cost providers. Either can work as long as you build the rest of your business around such a position. That is, are you delivering what the customer is paying for and therefore expects? Selling cheaply made products at a high price is not, generally speaking, a long-term winning strategy, and selling high-cost products at low prices isn’t sustainable financially.
If you’re the low-cost provider, is your cost model and supply chain built for efficiency and scale? Amazon leveraged the low-cost model to compete against Barnes & Noble and other booksellers, and is now using that same approach against Walmart. In terms of premium pricing, Mercedes-Benz is a perfect example of high-end, mass market cars easily recognized by virtually anyone.
Model #2: Razor/Razor-Blade Model.
This is a model where the consumer purchases a core component of your product (the razor), which then requires the ongoing purchase of a consumable component (the razor blades). The core piece is frequently sold at a discount with the company generating its profits from the continuous sale of the consumable. Think of companies like HP selling printers and ink cartridges and Nintendo selling consoles and games as excellent examples of this model. Can you lock in your customer with the purchase of a core component and then sell the consumable part to them on an ongoing basis? If you can, then this may be a model worth considering.
Model #3: Subscription.
Another popular model (especially in software) is to deliver your solution as a service, or said another way, on a subscription basis. Generally, the customer pays monthly or annually for you to deliver your solution, which usually occurs on an ongoing basis. This model doesn’t work for one-time purchases. Salesforce, the leading sales automation company, was a pioneer of this model in the enterprise software space. On the consumer side, a number of companies are using subscription models for items that we used to buy periodically. Many web-based consumer storefronts offer subscription purchases for consumable items that are regularly needed, like household supplies or personal care items. Most large software companies like Adobe and Microsoft have transitioned to selling their solutions using monthly or annual billing.
Model #4: Freemium.
Another popular model frequently used in software sales is freemium. Freemium makes it easy for customers to try a product for free, then upgrade to a version with more features once they get hooked on it. Giving away your product, even a part of it or for a limited time, can be a great way to generate interest. For the startup, knowing what it costs to deliver this free solution is as critical as knowing why the customer will upgrade. Mobile phone-based games such as Rovio’s Angry Birds or Supercell’s Clash of Clans are great examples of this model. Many games are free, and virtual goods or features are purchased to enhance the game play.
Do your homework on models that can potentially be helpful and then put your own spin on one. A pricing model that is seamlessly integrated with your solution approach creates a significant advantage.
As you think about your pricing model, keep in mind that startups tend to underprice their solutions. That’s okay to start with, but over time, you’ll want to figure out how to find the right price point for your solution.
The good news is we don’t believe you should think of pricing as static. Conventional wisdom says you can’t raise prices once you set them. That’s untrue. While it can be hard to raise prices, it happens all the time and can be a tactic that you use to close the gap between the value that you offer and the price you charge.
Innovative approaches to pricing models have been used by a number of startups to great benefit. Take your time and figure out an approach that can be a competitive advantage.