How you price your product or service could affect the number of people who become customers, revenue per customer, customer lifetime value, and ultimately, it can mean the difference between profit and loss.
How do you get it right? What’s the best pricing model: subscription plans, license fees, one-off payments, a fee per user, or a mix?
“Believe it or not, I actually believe executives worry too much about pricing,” says Reed Holden, CEO of pricing consultancy Holden Advisors, and author of Pricing with Confidence. “What they need to worry about is the quality of the user experience.”
Holden says another common mistake people make is not taking the time to truly understand their customers. You should have a clear idea of the value of the problem you are trying to solve. However, the approach will be different, depending on whether you’re selling to consumers or other businesses.
Pricing for business
Business customers may be more concerned with price factors than your average consumer. You’ll need to understand the dollar amount you’re saving them. A procurement team will also likely play a role in choosing a provider. As Holden wrote for HBR, offering a tiered approach allows some flexibility in dealing with a company’s procurement team, and can allow you to ‘discount’ without severely reducing your margins (i.e. a company may opt for the bronze package over the gold).
“What you need to do is develop an understanding of how the customer’s business operates. You need to understand how your offering will change operations in terms of reduced costs and increased profits,” says Holden.
“Although there is a tendency to overcomplicate these things. I’m a big believer that you should be able to explain your model simply on a page — it’s got to work for your salespeople.”
OneSaas CEO Jeff Perlman says his company initially set prices by benchmarking against other SAAS services. As a cloud-based tool for integrating services such as MailChimp and Xero, it was important that pricing was similar, or below, the cost of other services. However, this approach was by no means the most efficient, as it paid no reference to the cost of operating. More recently the company reassessed its pricing.
For OneSaas, that meant taking into account the cost of goods sold (‘COGS‘): the cost of data bandwidth and traffic and the average staffing resources required for each customer. One of the company’s major costs has been sales and marketing staff.
“We got a feel quite quickly for how expensive it will be to maintain an API,” says Perlman. “We were able to determine the costs and can average this out for our customers.”
Meanwhile, OneSaas has been building its referral program — it offers a commission to partner companies that refer customers. By shifting the cost of acquisition to a third party, OneSaas saves money, while the referrer maintains control of its customer relationship.
In fact, Perlman says communicating how the pricing works has been more of a challenge than determining it: “People see four different price points and can sometimes ask which is appropriate for them. We need to make sure we’re communicating this clearly.”
OneSaas is currently trying to refine the way it communicates its pricing, and a key strategy has been asking each customer calling its support line for their feedback.
“We talk to our customers all the time with our support desk, and each month we have something we want to know. At the moment we’re asking about pricing.”
Communicating your pricing clearly can be challenging for startups, says OneSaas CEO Jeff Perlman (Image: Zach Kitschke)
Consumer Pricing
Holden says selling to consumers can be more complex; the perceived value of a product becomes more dependent on how people think and feel, and in some cases price can actually alter the value perceived by a customer.
“I don’t think anyone could have predicted the success of the Apple iPhone or iPad. Apple is great at coming up with products and people are willing to pay a premium for them.”
Patrick McKenzie argues the benefits of a tiered model segmented by usage is a more effective way of pricing, compared with a linear approach, such as a charge per user, or cost per additional resource (a server in this case). The benefits, he argues, include self-identification by consumers (‘I’m an enterprise customer so I need the enterprise plan’), more predictable costs for a customer over time, and a simpler decision to make upfront.
FLT recently explained about some of the cognitive biases which affect customer decisions. Yet, there’s one which often applies to pricing: the decoy effect. Apple effectively uses it to influence customer choices; that is, it prices a product with fewer features at a higher price than you would expect. In turn, customers tend to opt for the more expensive version.
Over at Smashing magazine Eran Galperin argues pricing higher can often boost the perceived value for a customer. He suggests in order to determine an appropriate price for a new product involves considering:
- The objective value of the product (in time/money saved),
- The perceived value of the product by a customer, and
- The value the pricing should convey.
Holden points to Jim Geisman as an experienced advisor on consumer pricing, and says his work is a good starting point for those wanting to learn more (here’s a useful webinar with Geisman talking about pricing Saas platforms).
How have you priced your startups’ product? What books/articles/websites have you found useful? Share your experience with FLT.