Pricing sounds deceptively simple but is surprisingly complex to get ‘right’. Your pricing strategy can augment your sales, or it can devour the very foundation your business is built on. The good news is there are various pricing strategies available for all kinds of products, businesses & markets. This is also the bad news.
Understand Business Priorities
The CEO needs to understand what is it that the business wants to accomplish, whether it is just the profits or anything else. If it is the market share that you are after, it may help to decrease the price. Higher market share may lead to network effect where the value of the product increases as more people use it. However, customer sometimes attributes low quality to the cheaper product. So you’d need to make sure that the customer understands that the pricing of your product does not reflect its quality.
Price as a function of cost?
It’s a common understanding that pricing is a function of your cost. Adding margin on top of the cost seems to be the easiest way to price a product. However easy, this is not the best way to treat your business with.
"The first thing you have to understand is the selling price is a function of your ability to sell and nothing else," says Lawrence L. Steinmetz, co-author of How to Sell at Margins Higher Than Your Competitors: Winning Every Sale at Full Price, Rate, or Fee (Wiley 2005). "What's the difference between an $8,000 Rolex and a $40 Seiko watch? The Seiko is a better timepiece. It's far more accurate". The difference is your ability to sell."
Know your costs
To make a profit, you need to cover your costs and then add a margin. Which basically means that you need to know your costs. Manufacturers typically aim for gross profit margin of 50%, retailers usually require 30 to 50%.
While developing pricing strategies for manufacturers, it is easier to start with twice of cost, since this is an easy calculation that gives 50% gross margin.
Pricing for SaaS products
Unlike traditional softwares, SaaS customers pay on a recurring basis. This presents unique challenges, and opportunities for pricing models. To add to the conundrum, you can package saas products differently for different customer segments and price accordingly. This can also add to customer delight adding competitive value.
Identify the value that your product brings to the customer. This value should be the foundation of devising your pricing strategy, not your product features/ your costs/ competitor’s price. This value could be: cost & time savings from reduced travels, providing service to additional customers remotely, cost saving due to switching from existing expensive solution, reduced effort & frustration of not using complicated product etc.
Identify your competition/ substitution for the product.
Identify what does the customer currently pay- in money, time & effort, for comparable solution.
Would you ask your customers?
One of the best things about asking your customers is that you can create a price sensitivity curve without anchoring the interviewee with any prior numeric values. Ask these 4 questions to your ~100 potential customers to get meaningful data:
At what price would the product be so expensive that you would not buy it?
At what price would the product be so cheap that you would feel it is of inferior quality?
At what price would the product start to get expensive that you’d have to give some thoughts to buy it?
At what price would the product be a great bargain- true value for money?
Ask for a specific price as the answer to each question.
However, it has been shown that what people say they’ll do regarding pricing and what they do is not co-related. The issue with customer driven pricing is that they might not fully envision what you offer and the effects it would have on their business. They may suggest a lower price than they would realistically pay.
Pricing at the beginning of the business
Let’s get some marketing advantage while also setting the price. You can go for a pre-launch campaign where first 100 signups get the product for free. You can tell that at some point you are going to start charging, but the first 100 users don’t have to pay ever (or for 1year or any period you deem fit). After you get ~ 250 customers you can ask them, the questions mentioned above. You can use your competitor’s price as an anchor.
Maximize revenue, not customers
Enterprise customers are used to huge licensing fees. They are not as price sensitive. If you are pricing low, you may actually be scaring them off. And if not scaring them away, you may be leaving money on the table. Also understand that it is extraordinarily difficult to raise prices on existing customers. Enterprise customers have entire departments dedicated to ensure that never happens.
Depending on the type of product, more customers could lead to additional support burden where it is costing more than the extra revenue from additional customers. The customers on the lower end of the price spectrum could be disproportionately unreasonable, contact support offensively with inane questions at a rate higher than good customers.
If your sales cycle is 1 to 2 months for getting leads to paid status, you can just double your prices and see how customer acquisition changes. There is a school of thought that says that you should only close a certain percentage of your sales funnel. So if you're getting 90% of deals then you might be pricing too low. But if you're making 10% of sales and you’re selling for 100x more than your guess price then you're likely doing well.
You can start with two price points- A for price sensitive customers, and C for customers which are not sensitive to price. Set A at lower estimate and C at much higher than you think. Ultimately, you’ll want a tier B between A & C to encourage people to choose between A & C. Also, for A you can always add features and raise the features and for C you can offer discount when needed.
You can also A/B test your pricing, twice a year. You can label it ‘sale’ so that your current customers do not get angry. (Price consciousness and deal consciousness are two different things and can lead to some stupid behavior where customer buys the overpriced goods marked on sale rather than buying the same thing at same price without the sales tag.) Make sure that you start at the top of what the people would be willing to pay and work your way downwards. In case of a price drop you may want to lower for the existing customers too. In case of price increase, there is a simple way in SaaS to make to make it a non-event: grandfather existing customers at existing price. This may seem unprofitable but is not. In a growing company new customers dominate your revenue for time period infinity. So it is recommended to grandfather indefinitely. Consider this a marketing expense to reward loyalty. The other opinion is to offer free/ additional things/ services rather than indefinite discount. You’ll have to absorb the cost once, rather than every month.
You can also consider your SaaS pricing based on some fundamental metric of your system, for e.g. on per user basis, per API call basis etc. This is beautiful because as the customer gets more value from your product, you continue to get fair share of that value, which is not possible in fixed price method.
General consensus is that you should price higher than you feel comfortable with. Almost every SaaS team underestimates the real operational cost and devalues their software because, unlike their clients, they were actually capable of writing it. Clients don't care that it was ‘only a few weeks of work’ or ‘really not as good as some unrelated software’ or ‘not as polished as Apple’. You can also raise prices as you grow and add features.
You are not going to get your pricing right, the first time. But that is fine. As you grow you are going to improve your product and get better focused on your customer segment and get more confident in your offerings which will help you raise prices across the board.