The Winning Pricing Strategy for Earliest Stage Startups
Pricing can make or break your business, but determining prices for an early-stage startup isn’t without its challenges. We sat down with Patrick Campbell, Founder & CEO of ProfitWell and Core Member to help you uncover the winning pricing strategy for your earliest stage startup.
From an early-on perspective, or from an overall view, pricing involves a couple of rules:
1. Don’t set it and forget it.
Setting your pricing and leaving it be is terrible for your business. No matter what you are selling — whether it is subscription or non-subscription — it signals your product’s value. The price of your product is the exchange rate on the value you are providing for your users. Dynamics change – your market evolves, your brand evolves; there are myriad drivers that affect the exchange rate, ultimately affecting the value of your product and its perception in the market. If you price a product at the beginning of the evolution and then leave it static, you are not keeping up. The downside is that you could be leaving a significant amount of money on the table, and revenue growth and sustainability is the lifeblood of almost every entrepreneurial venture.
Changing your prices does not necessarily mean you are constantly pushing them upward; it means that you are iterating on the pricing and packaging such that you maximize the amount of revenue you can earn over the long-run.
2. Leverage value-based pricing.
Value-based pricing essentially means basing your product or service’s price on how much the target consumer believes it is worth. It reflects the value your customer sees in your product. As opposed to looking inwardly at your own company’s costs to deliver or laterally toward your competitor, value-based pricing looks outward. You seek out pricing information from your customer, setting it by the data you collect or strictly the mental model that you use to go after those folks — because ultimately, they’re the ones who make a decision to spend.
There are three overarching motivations for implementing value-based pricing:
1 | Willingness to pay (WTP): You need to know what your user will actually pay for your product, and although competitor-based pricing does this in a roundabout way (if they’re willing to pay $100 for your competitor, they should be willing to pay the same for your product) it misses the point that your product should be inherently different than theirs, with yours offering more value and priced differently.
2 | Building the best product: Pricing is about what you are offering your user. Your end goal should be a happy customer, and value-based pricing helps you understand what they fundamentally want — what features they want to see developed over time, what packages you should offer. Once you have established your minimal viable product, these assets should be driven by user demand.
3 | A genuine user understanding: Your users are your allies. By placing a premium on their opinions, you are focusing on the right people, who are making the ultimate buying decision.
Determine your pricing strategy at an early stage startup
Understand who you are selling to.
And this understanding has to be specific. Do not use a generic, “We’re selling to developers” mindset, for example. It has to be specified: “ We are selling to developers who use Python who are at companies with teams of 10 to 20 people.” This is so crucial because when we start out, we think we need to be everything to everyone, in reality starting niche and with a smaller focus allows you to nail the basics and then move on to learn more. This feels ironic because most people think that if you have more information, you will learn more, but in reality, when you start smaller, the information is richer and deeper.
So this gets into buyer personas. Buyer (or marketing) personas are research-based representations of your ideal user. They’re fictional and often generalized — but based on current market research — to describe the type of user that finds value in your product. There are two categories within buyer personals — qualitative and quantitative — to help you determined these types.
Qualitative personas are rough sketches of your customer that include details like job title and interest in the product.
Quantitative personas are backed by data, including information like WTP, customer acquisition cost (CAC), and price sensitivity.
To start determining your buyer personas, start with the list below:
- Conceptualize five to ten buyer personas.
- Determine the data you need to collect.
- Collect the data methodically.
- Segment and analyze the data.
The data you need to collect will vary by company and product, but to collect this research you can start with demographic information, feature value and value proposition preferences, and data on WTP.
Figure out how you are going to charge.
Determine the value metric you should be charging on. In its basic form, your value metric is essentially what and how you are charging — for example, the video platform Wistia might charge for the number of videos hosted or bandwidth per month. Identifying and pricing along your proper value metric is the difference between surviving and thriving, because companies that leverage this tactic grow at more than double the rate of those that do not, and see a higher proportion of their revenue come from expansion. Gross churn rates of value metric companies are less than half of those using feature differentiation.Identifying and #pricing along your proper value metric is the difference between surviving and thriving, because companies that leverage this tactic grow at more than double the rate of those that do not. - @Patticus Click To Tweet
To evaluate your own value metric, ask yourself:
1 | Does it align with your customer’s needs?
We have said it over and over, and we will say it again: figure out what your users want and what they need. Discover what they value at the center of your product and then a way you can charge for that value.
2 | Is it easy to understand?
Your value metric should be intuitive. Whichever way you charge needs to be so clear, prospects can understand it fully without having to talk to a POC at your company.
3 | Does it grow with the customer?
Be sure your value metric grows with your customer to ensure you are increasing your MRR predictably. The best SaaS businesses are able to grow even if their acquisition stalls because their value metric is so aligned with their customers, they can simply wait for those customers to grow to ensure they do in turn.
Determine both buyer personas and your value metric in your first year of business, and once you figure these out — the champion and the actual buyer of your product, as well as the metric you are basing it on — you can start optimizing.
Lightning Round: Pricing 101 🌩
Q: Should you always send receipts to your users? [Time-Stamp 32:45]
A: Always – Default to transparency in your pricing and billing strategy by sending receipts every time a transaction occurs. Your churn might be lower if you do not, but it will inevitably lead to aggravated users. If your product is worth what you are charging and you are targeting the right user, a reminder that a customer is paying should not cause people to run. After all, everything costs money, and if you are providing value — your product or service should be worth the price.
Alternatively, you could offer an option for customers to opt-out of receipts, but make sure you are not covering up some bigger problem, of poor product marketing or not communicating your value effectively.
Q: Should you display prices on your website? [Time-Stamp 33:12]
A: (Almost) always. The two particular times you may prefer not to include pricing in the early stage are:
When you are optimizing for the people who are willing to get on the phone to learn more. There should be some people so excited to buy into your value prop that their interest is regardless of price.
If a high percentage of the product is the same for everyone and ~20% differs and it affects the cost or price you are offering. Even in this case, there should be some anchoring like, “Prices start at $X per month,” because you do not want to waste your sales team’s time with an influx of crappy leads.
That being said, just as with receipts, pricing displays on your website are all part of transparency — which is key to obtaining the right leads.
Even more specifically, a tactic like price localization can boost your growth by over 30%. The subscription economy (especially) is global, and getting the right price in more than just your home country is key because users buy local and prefer their own currency.
Q: Should you have a tiered approach to pricing? [Time-Stamp 34:05]
A: Differentiated pricing, yes. Tiers are not always the answer. Sometimes you are charging on your value metric (based on usage). There should always be some differentiation, but it does not always have to exist in tiers.
One way people can show differentiation not resembling a tier is with a core product that costs $X and a bunch of add-ons that cost money — which essentially prompts your user to create their own tiers from there.
But when you are looking to use-tiers, it is important to calculate different retention rates for customers on different plans. Just as cohorts of customers who sign up at different times will have different retention rates across the span of their cohort’s lifetime, customers on different plans will likely show different rates of user retention. Customers on your most expensive plans are likelier to have higher user retention while your highest churn is likely coming from your low-tier plan customers.
The high ARPU customers present value to your company, increasing the likelihood that a lot of customer service time and effort is spent on retaining them, while you might take your low-tier users less seriously and direct the appropriate amount of time and effort into retaining them. Though they might not represent a significant loss in MRR when they churn, their choice to discontinue can still affect your brand’s reputation, negatively affecting future acquisition. This is something to keep in mind when tiering, so you can fully leverage the actionable feedback that retention rates provide.
Q: Free trials or Freemium? [Time-Stamp 33:12]
A: Freemium. With free trials, you are putting the onus on time. With freemium, you get the opportunity to own the lead. Your user may or may not be using your product, but at least with freemium you’re not pushing them into a decision.
Freemium is an acquisition model, a measured strategy to unlock lower CAC and the top of your funnel. Some data that may convince you:
- CAC is increasing across the board with B2B and B2C CAC up nearly 50% compared to a few years ago as marketing density continues to increase, but amongst freemium companies is only 25-30% higher than 5 years ago.
- Free has actually become more effective than non-free alternatives. Retention is 15% better on an absolute basis for those companies utilizing the freemium strategy.
- The WTP for an initial tier has rapidly grown.
- Net Promoter Score is roughly 50% better for those companies utilizing freemium.
If you have something that’s higher volume and you want to push that decision in a restricted period of time, you can always turn to your value metric, and in the free tier limit what you’re offering. After 14 or 21 days (a natural trial period) that core user is faced with deciding to purchase more, or wait until the next month to reset their free offer. But ultimately keep users in your system and use that momentum to get them to convert.
Q: Discounts: Effective or Not Effective? [Time-Stamp 35:48]
A: Discounts are effective, but we must remember: they are a scalpel, not a sledgehammer. Use them sparingly, in the right situation, and always with a timebox. (My exception here would be in the early days, when offering that beta user an unlimited discount. Other than that, I do not advise discounts in the long run.)
Using unnecessary discounts can have a significantly negative effect on your operation. We found that over 70% of practitioners believe that discounts should be used in some capacity to get users to convert. We also found that less than 10% believe discounts should only be used as an absolute last resort, which shows that our capacity for discounting is pretty startling.
Discounts often result in a short-term gain, long-term failure. They make growth unpredictable, as we profiled companies who have reached their goals with discounts vs. those without discounts, and found they both cross the finish line, but the success indicates an elementary understanding of unit economics, not to mention a strong correlation to churn with those who were given a discount. Further, post-discount renewal WTP decreases, likely because those users either devalue the product or weren’t the right fit in the first place.
So although discounting is not completely off the table for some businesses, it must be used as a catalyst to lower the activation energy of a prospect to get them to convert and see the true value of your product with potential for an expanded WTP.
What questions do you have around pricing? Share them with us on Twitter!Hey @UnderscoreVC & @Patticus, I'd love to know... (Insert your question here!) Click To Tweet