A startup pricing strategy based on customers, competitors, and costs can create true value for your ... [+]
For many entrepreneurs, pricing is as complicated as advanced calculus. But unlike math, there is not only one correct answer to the pricing problem. Rather, it is a judgment call that every entrepreneur has to make and evaluate numerous times throughout the life of a startup based on customer behavior, market understanding, and economic facts and assumptions.
Pricing is one of the most important pillars of every startup. Underpricing, overpricing or not charging, even if the customers are willing to pay, can mean lower revenue, lost customers or even, startup failure. An effective pricing strategy will not only drive your startup profits but also generate higher customer satisfaction and retention.
It is important to have a pragmatic approach towards pricing. Follow these steps and insights to set the right price for your early-stage startup product.
1. Run The Numbers
Every entrepreneur understands the concept of profits. If you’re generating more revenue than what it costs you to produce, market and deliver the product, you’re making money. If you’re running a software startup, those costs can include hosting, transaction fees, customer support, and contract service providers. They are your cost of goods sold (COGS).
In a software as a service startup, gross margin, the percentage difference between revenue and COGS, can be over 80%. In other words, COGS can be as low or lower than 20%. This is the first step in figuring out how much you can charge for your product and how many units you need to sell to break-even.
The reality is that your customers won’t care about your margins or target price. The price they will be willing to pay will depend on their alternative options, the urgency of their need for your solution, positioning on the market, product differentiators, and perceived value.
2. Everything Starts With A Hypothesis
Product pricing, like your value proposition and target buyer, starts with a hypothesis. A hypothesis is a guess and the more educated and research-backed your guess is, the more likely it will be valid.
The first thing every entrepreneur does when evaluating a startup idea is research the competition. Most entrepreneurs set their prices based on what competitors charge. Competitor based pricing is a simple and effective pricing strategy.
Understanding your competitors’ unique differentiators, positioning and targeting gives you a clearer idea of where you want to fit your startup on the market. You can charge more by positioning your solution as a higher-end product and targeting a segment that’s able and willing to pay more. You can match your competitor prices or charge less to undercut the competition and potentially acquire customers faster.
At this point, your competitive analysis efforts and customer interviews are only helping you make educated hypotheses to build your validation tests around. Your prices are likely to change once you start gathering your own data from your customers. At the end of the day, what matters is your buyers’ needs and expectations. Researching the competition serves to set you in the right direction.
3. Understand The Perceived Value
The perceived value from your product simply answers, how much value the customer feels your product delivers for the price they pay in comparison to the competition. Your product is perceived valuable if the value they feel is higher than the price. The bigger the difference, the more valuable your product feels to them. Keywords like the product is definitely "worth" the price or it is a "no-brainer" signal high perceived value.
In theory, this can mean three things. You could either lower the price, or increase the value, or do both, lower the price and increase the value. In most cases, what you should be focused on is figuring out what in the product the customer feels important and worth the investment that it becomes a buying decision they cannot refuse, even at a higher price.
Netflix charges $8.99/month for one account streaming in standard definition. The company understands that its product is built for the family, and every member can have a different preference for shows and movies. For just $4 more, not only can you stream in high definition but also watch on two devices as if you have signed up for two accounts. This is a deal hard to refuse.
In evaluating Netflix pricing, we used their base price. This is referred to as price anchoring. It is an effective strategy that serves to help the customer quickly realize their perceived value. Without Netflix’s three pricing plans, there wouldn’t be a plan to compare your needs to so you may start thinking about the competition to compare your options.
When developing your startup idea, use the above steps and strategies to set your initial price. However, at the end of the day, you want your customers to influence the numbers you choose. This influence comes in the form of key metrics like customer acquisition cost, churn rate, feedback, referral rate, and net promoter score.
No pricing strategy or tactic has ever built a billion-dollar business without a solid product that people benefit from and happily pay for. In your research and planning, focus on figuring out what makes your price an offer people cannot refuse.
