How to price your product is among the most important and difficult decisions you can make. Your pricing strategy can affect both your revenue, profitability and your user growth, all of which are at the core of defining a startup. There are no definite answers to resolve the pricing question, however, there some principles to follow.
Charging for your product early, even before the beta, is the best way to validate whether the problem you’re solving is big enough and monetizable. When you come up with an idea and approach potential customers, almost everyone will tell you they’ll buy. Ask for their money, however, and 99 times out of 1000 you’ll get a different answer.
Charging early is also great for getting valuable feedback. Giving your beta away for free empirically generates different kinds of feedback than when your users feel invested in it. The infographic above shows an early experience of a customer support startup Intercom. Free users asked for more features while premium users asked for improvements to existing features. Now, what’s the more valuable better feedback? Comments that lead you towards building a product that’s more complex? Or feedback that leads you towards a product that’s better?
Offer More Than One Option
With SaaS products, you can often see three different options, with one in the middle highlighted as ‘most popular.’ Usually, the middle option is the one the company truly wants to sell. The three-tiered approach works very well and the reason why is that some customers like a bargain, some like to pay extra for premium service, but the vast majority doesn’t want to feel they overpaid, nor do they want to buy the cheapest version. This has been tested over and over, and in many cases over the last few decades, companies have created inferior versions of their product to in order to create contrast, and ultimately be able to charge more for the premium offering.
In his book ‘Priceless: The Myth of Fair Value’ William Poundstone shares an experiment where customers were offered two kinds of beer: a bargain beer for $1.80 and a premium beer for $2.50. A strong majority of 80% opted for the premium beer. However, when the third, more expensive option at $3.50 was added, 85% opted for the same $2.50 beer while some 10% bought the most expensive one.
Justify Your Cheapest Option or Kill It
A lot of startups start with a freemium as a business model. The problem is that it doesn’t always work. In many cases, free users raise business costs by exploiting support and operating resources while contributing zero offsetting revenue. Premium users on the other hand are paying customers who value the product and provide helpful feedback. Many startups report better revenues when they scrapped their free option. This is certainly something to be tested first. For example, a social media monitoring startup, Mention, reported an almost 300% increase in revenue per account, just by stopping to advertise their free plan. Baremetrics, the analytics platform for the Stripe payments service, raised revenue by 40% when it dropped its free and low-priced plans.
It’s easier to start charging more and lower your prices than the other way around. In many cases, the amount you charge depends on your ability to sell. Of course, the value you deliver is a major factor too, but with more revenue coming in, it’s easier to adjust and improve your features. There are many options that affect how much you can charge, the language you use (“$5” vs. “just five bucks!”), the point at which you reveal your pricing to customers (e.g. some products show better results when the pricing is revealed at the end of the signup process) endorsements, etc. Make sure you have tested and exhausted all of them before you drop your prices.
Plan for Changing Your Prices
The way you price your product can seriously affect your startup’s bottom line. In your early days, you won’t have a good handle on factors like lifetime customer value, average revenue per user or churn rates. Thus, it’s nearly impossible to get your pricing strategy right the first time. Get it wrong, however, and you may end up as one of the vast majority of startups who fail because their business model doesn’t work. Different prices can also get you different results, thus, you should test various price points.
Likewise, your running costs are going to change with time, and that has to be reflected in your price. According to two independent studies by McKinsey & A.T. Kearney, a simple 1% price increase can affect a company’s profits more than any other change. Ultimately, your pricing strategy depends on your business model. Testing assumptions prior to go-to-market by interviewing prospective customers and benchmarking competing or similar companies in your space will give you highly valuable data to inform your strategy, and it’s a great way to start what’s going to be an ongoing process as you launch and grow your startup.