Many startup companies are struggling with their pricing.
The primary reason for this is they are not spending enough time.
“… the average SaaS startup spends just six hours on their pricing strategy. That’s not six hours a week, or six hours a month – six hours, ever, to define, test and optimize everything.”The Ultimate Guide to SaaS Pricing Models, Strategies & Psychological Hacks, by Ryan Law on Cobloom.
When they develop their pricing, the results are not good. There are three reasons for this.
- They are not spending enough time fully understanding their customers.
- They have not followed a good process in developing a pricing model.
- They have not tested the pricing model they have in place.
To do pricing right, you must spend the time. The first thing you need to do is collect or create a number of items.
- Review the pricing models that are available.
- Understand your competition.
- Define your value-based metrics.
- Understand your customers, define target markets, and create user and buyer personas.
- Enumerate current and future product features.
With this work complete, you can develop your pricing. There are seven steps you need to follow.
- Create a mapping of feature and outcome-based value metrics to personas.
- Consider accessibility and priority of target markets.
- Define your goals.
- Develop pricing model(s).
- Test pricing model(s).
- Analyze testing data.
- Decide on your price.
The effort to create a pricing model and price is significant. It will take preparation and time but is one of the most important things that you can do. It can help you achieve your goals or result in your not achieving them. It is at the heart of the success of your company.
Definitions
There are a number of different terms that are used when developing pricing for a product. Here are the terms that I will be using and a simple definition.
Price – the amount of money you want for each product unit.
Pricing – the process you need to go through to figure out what price to attach to each unit.
Pricing Models – the approach to pricing a product.
Preparation
The first and most important step in pricing is preparation. You need to review pricing models, understand the competition, develop a set of value-based metrics, develop your target market, and create user personas.
Pricing Models
It is important that you understand the various pricing models that are available. There are a number of great articles on this topic. Two examples are “The Top 10 SaaS Pricing Strategies” by Inturact and “A definitive guide to SaaS Pricing Models – Types, Examples and Top Metrics to Track” by Charbebee.
Here is a brief summary of the models that are available.
| Per User Pricing | You pay based on the number of users having access to the service. |
| Per Active User(a form of per-user pricing) | A pricing model based on the number of active users in an organization. |
| Per Active User(a form of per-user pricing) | The price is based on the number of users using the service, increasing in bands rather than per person. |
| Freemium(a form of per feature pricing) | Price is differentiated in tiers based on the services available. |
| Usage-Based / Pay as You Go | Provide some functionality for free, then have one or more pricing tiers of additional features. |
| Per Storage Pricing(a form of usage-based pricing) | Usage-based pricing is calculated on the amount of storage required or used. This may be presented in a number of tiers. |
| Freemium(a form of per-feature pricing) | Usage-based pricing calculated on the amount of storage required or used. This may be presented in a number of tiers. |
| Custom / Roll Your Own | The price is based on a customization of their service package. |
| Flat Rate Pricing/Subscription | Flat rate for all services, with no further differentiation. |
| Free, Ad-Supported | The core product is free with advertising. There may be priced tiers with additional features and/or little or no advertising. |
In order to fully understand these models, think about a company that you know that is using each model. Consider whether you think these companies have selected the right model for their business. If so, why? If not, what would be a better model?
Competition
Much has been said about whether or not to price relative to your competition. There is no clear-cut answer. What is important is that you understand your competition’s pricing. Whether you decide to put in place a similar model or not, you must take the pricing of competitive products into account.
While you are doing this, make sure that you have a complete understanding of the features/capabilities of the competitive products. You can typically find all of this on your competitor’s website.
Note: if you are selling an enterprise product, getting pricing is more challenging. Companies typically do not share this information publicly. The best way to get this is to talk to customers – both those who bought from you and those who did not. They may not feel comfortable sharing the pricing that they received from a competitor (they may not be allowed to as a result of a confidentiality agreement). If this is the case, ask if they are comfortable with sharing whether price played a key factor in their decision, and if so, how large of a factor it played. You might also ask if the pricing model that other companies offer is more aligned to the value that they see than yours (or vice versa).
Value-Based Metrics
I feel very strongly that value-based pricing is the best model to pursue.
What value-based pricing means in its’ simplest form is that your pricing is aligned to the value that your customers see. The more directly this aligns, the better. Value-based pricing is based on value metrics or the way you measure the value that your customer is receiving from your product or service.
“A value metric is the way you measure value exchange in your product.
If you’re selling a pair of shoes, then your value metric is ‘per pair of shoes,’ and as customers buy more pairs, your business expands.”ProfitWell
Here are the key aspects of a good value metric.
- It’s easy for the customer to understand.
- It’s aligned with the value that the customer receives from the product.
- Grows with your customer’s usage of that value.
There are two types of value-based metrics. Feature-based value metrics are the features that create the most value for customers. Outcome-based value metrics are the outcomes that provide the most value to customers.
Example – Word Processor
I will use the example of a word processor (eg. Google Docs) throughout this post as it is something familiar to all of us.
Feature-based value metrics for a word processor might be integrated with a document management system or running on Windows and Mac. Outcome-based value metrics might be the number of documents created or sentences automatically corrected.
Value-based metrics will be used to determine the price that you will charge. We will go into this in more detail below.
Understand Your Customers
As I mentioned earlier, startups do not spend enough time fully understanding their customers from a pricing perspective.
I like to think about this in three parts. The first is to enumerate your user personas. A persona is a fictional representation of a group or type of user. The second is to create the target markets that you might go after that contain these user personas, and the third, which may be optional, is to create buyer personas.
User Personas
The first set of personas to create are for your users. You need to understand what is most important to them. The list that you create should not include the basics, but instead, focus on the 3-5 key features /capabilities that would make your product stand out for them.
Example – Word Processor
When defining your user personas, it does not make sense to list capabilities such as the ability to enter words, edit them, change the font, format paragraphs, etc. These are the basics – the cost of entry into the word process space.
Focus instead on the features that make your product a better fit for your users. Something that solves a problem for them, produces a better result and allows them to get more done. Some examples might be AI in improving your writing, smart web searching of the topic you are writing about, and automatic posting to Instagram.
You can find good examples of user personas on the internet. From a pricing perspective, make sure you include a good name, a description of what they do and how they work, and include the key features/capabilities that are most important in their product selection process.
My recommendation is that you create between 3 and 8 user personas. Each should be sufficiently different in terms of what they do and in most cases, the key features/capabilities that are important to them.
Target Markets
Target markets are well-defined groups of customers at which a product or service is aimed. These groupings may be a logical grouping of individuals or they may be organizations within a company. Assign your user personas to one or more target markets.
Example – Word Processor
Bloggers may be a good target market. They write a good deal and could use a product that would help them write better and more efficiently. In a company, the marketing or communications groups are potential targets.
As we think about target markets, it is important to estimate their size and how difficult it would be to reach or sell to them. This can be represented with an estimated CAC (Customer Acquisition Cost). This information will help refine the product and pricing.
Buyer Personas
The buyer personas are important in order to understand what is important in making the sale. This set of personas is only important if the purchaser is different from the user, which may happen in companies (the manager may purchase the product for their staff).
The buyer persona is different from the user persona. As was described above, the user is focused on the features/capabilities that will allow them to do a better job. This is important to the buyer persona as well, but they will also be focused on getting more done, getting it done faster, and managing costs.
In creating these personas, it is important to put yourself in the buyer’s shoes. Understand the larger challenges that they are facing, what is expected of them, how they succeed and are rewarded, and what will make their job easier.
You need to make sure that there are buyer personas for each target market that you might pursue. This will be important in ensuring that you understand what is most important in selling your product.
Product Features
The last thing that you need to pull together is a list of the features that your product provides. As was described earlier, it is not necessary to list the basics (although not a bad idea in general, but not that important for pricing). It will suffice to list the features that you view as key in differentiating your product, that align with customer value, and that differentiate you from the competition.
This list should include key features that do not yet exist. These may be as a result of customers being interested or because they align to a value metric. They should be noted in some way so that it is clear that they are possible and maybe even planned, but not available.
Develop Your Pricing
You have everything that you need to develop your pricing. The approach we will take is to leverage the data that you pulled together to identify the right pricing model, test it with customers and finalize on price.
Create a Mapping
As I said earlier, the best way to price your product is value-based. To do this, review the value-based metrics to see which best aligns with your target markets, buyer personas, and user personas.
The simplest way is to create a spreadsheet. The leftmost column lists the feature and outcome-based value metrics that you have created. Then across the top are the personas. Split them such that the user personas are first, followed by the buyer personas (if these were necessary).
Now place a “+” under the persona where there is a high correlation of the value metric to the persona’s key feature/capability. Place a “=” for medium and a “-” for low correlation. This will not be straightforward as the terminology of each will be different. Do the best that you can.
Example – Word Processor
| Writer | Editor | Graphic Designer | Marketing Manager | Comms Manager | |
|---|---|---|---|---|---|
| Documents Produced | = | = | = | + | = |
| AI Sentences Correction (NOT AVAILABLE YET) | = | + | – | – | – |
| Web Research Items Used | = | + | – | = | = |
| Automatic Posts to Instagram | + | – | – | – | + |
| Integrations with Document Management Systems | – | – | = | + | – |
| Runs on Windows and Mac (ONLY WINDOWS TODAY) | – | – | – | + | = |
Consider Target Market
We talked about target markets earlier. The way we will use this is to consider whether some markets are a higher priority than others. This might be due to feature availability, size of the market, cost to acquire a customer, or other measures.
By taking this into account it becomes easier to identify the most important value metrics from which the pricing can be developed.
In the table above, it appears that the Marketing Manager might be a good target as there is high alignment to the value metrics. We might also go after individual bloggers as they do writing and editing, but not much in the way of graphic design. In both cases, we would look at the CAC and size of the market to help us decide.
Define Your Goals
Startups need to define a pricing model that supports their goals. The article “How to Find & Test the Best Price for Your Product” provides three very different examples of strategies (goals) that will impact pricing.
- Maximization (Revenue Growth)
- Penetration (Market Share)
- Skimming (Profit Margin)
Before proceeding, it is important to understand the startup’s goals. These will not only impact the features that are developed but the pricing model and price that you choose.
Develop Pricing Model
We now have a good idea of the target markets, personas, and value metrics. We need to convert this to a pricing model. The way I recommend doing this is to suggest a few different models. Then test these models against the personas.
Example – Word Processor
The Model. What if we charged based on the number of documents produced? This works nicely in aligning with what the work product created. It also seems that the marketing manager would like it. And it is easy to understand.
Testing the Model. What happens if one person writes really long articles and the other short ones? They would pay a very different price. Yes, but maybe that makes sense as the one that wrote more got more value out of it than the one that wrote less. But this does not use any of the other value metrics that customers think are important. Or maybe it does as they use these in writing their document. I also wonder if we are providing enough value for companies that likely write less often. We do not have any manager capabilities (see who is working on what, how long the articles are, how many are completed each week, etc.). This seems like a miss!
The Model. How about if we focus the pricing on the great AI and Web Search capabilities that we have in the product? Those are important to our customers and it is what makes us unique.
Testing the Model. These are what make us special. Would this cause our customers to use these capabilities less as they are going to be charged each time they are used? I don’t think that it is easy to explain how much it would cost to use our product if these are how we price.
What will happen is one or a couple of models will rise to the top. The others will fall away based on the verbal testing.
Now take the remaining models and flush out the actual prices across any tiers that have been defined. This is done in a very similar manner with one major caveat. The information that you have on the competition as well as any additional knowledge that you have on where customers see value needs to be considered.
The result should be tested again – this time compared to the competition and in terms of how customers will react.
Example – Word Processor
The Model with Prices. I think that we should have a free tier where you can create three documents. When you move to the fourth document you will need to sign up. We then charge a monthly fee for a certain number of documents to be created. To keep it simple, we create three tiers beyond the free tier. One at 5/month, one at 20/month, and one that is unlimited. These are $5, $10, and $20/month.
Testing the Model with Prices. It seems like some bloggers would do $5 and others $20/month. That means $5 or $10/month. In companies, I think they write less frequently. That means they pay us less. But they have writers, editors, and graphic designers. Something seems wrong with the model that does not take this into account. Maybe it is back to management capabilities. The good news is that even if they write less, there are more users that are paying the subscription amount.
The other thing is that our competition is charging based on the storage used. How will we communicate the cost of our solution vs theirs? Is ours cheaper or more expensive? I think that we should be able to charge more based on our capabilities.
As you can see, this is an iterative process. Each time there is testing there might be an update to the idea or model and everything starts over again. But this is a GREAT conversation. It is really trying to understand the value that customers get from the product and price it as such.
This leads to the last step – testing the pricing.
Testing
Testing has taken place throughout the process of developing the pricing. One really important testing effort remains. That is – to test the final or near-final pricing with your customers.
Note: If you already have a pricing model and are changing it, in addition to testing, you will need to run a number of scenarios to determine how the pricing change will impact your customers. It is ok for the price to go up as long as customers see more value. You will need to put together a good case for this value as you communicate your change.
You might assume the simple answer is to use A/B testing. I could go into why this is not a good idea but instead will refer you to “PRICE TESTING: 3 REASONS TO NEVER A/B TEST YOUR PRICING STRATEGY” by Erik Yu at ProfitWell.
What you should do instead is complete a “willingness to pay study”. This sounds daunting, and it can be. It really depends on where you are as a company, the resources that you have available, how urgent launching your pricing model is, and how complex the pricing model is. The purpose of this post is not to solve very large complex cases.
There are six steps that I recommend that you follow in testing your model.
Step 1: Segment the Market
The good news is that, in order to be ready to test, you have already completed this.
Step 2: Review your Goals
Also good news, you have completed this as well.
Step 3: Survey the Buyer Personas
There is some very real science to doing this right. It starts with asking a set of questions that will allow you to gauge the willingness of a buyer to pay for your product. Van Westendorp’s price sensitivity meter was developed to help answer this question. It relies on four questions and the analysis of the results, to identify the ideal price.
- At what price would you consider the product to be so expensive that you would not consider buying it? (Too expensive)
- At what price would you consider the product to be priced so low that you would feel the quality couldn’t be very good? (Too cheap)
- At what price would you consider the product starting to get expensive, so that it is not out of the question, but you would have to give some thought to buying it? (Expensive/High Side)
- At what price would you consider the product to be a bargain—a great buy for the money? (Cheap/Good Value)
Schedule individual time with a cross-section of your customers. There is no perfect number, but it should be meaningful to your product. If you have only 5 customers, you should talk to all of them. If you have a large number of customers from multiple target markets, then it would make sense to include 5-10 from each target market. Make sure that most of these customers have purchasing authority.
Ask them the four questions and capture their responses. Capture any additional comments that they make as this context might be useful later. Then create the Van Westendorp price sensitivity charts.
You can read more on this Van Westendorp’s model in the nice summary article “THE PRICE IS RIGHT: Using the van Westendorp Price Sensitivity Analysis to Help Set Price”.
Note: Not everyone agrees with Van Westendorp’s approach. There are concerns about the soundness of the methodology itself. There are also concerns as to how much knowledge the customers need about your product, the value it can provide (if it is new), how to interpret the graph that is created, and so on. These are valid concerns. There are other options, including conjoint analysis. My perspective is that the Van Westendorp approach is sufficient for most small companies.
Step 4: Analyze the Data
Now that you have data from your customers, you can develop one or more pricing models. This is as much art as it is science. Look at the charts created in the previous step. Consider your target market and goals. Consider any comments that your customers made while being surveyed. And build your models.
If you end up with only one, that is great. You should not end up with more than three.
Step 5: Test Price Points (Optional)
Consider one more round of testing. This is optional as you have done a good deal of work already and may feel comfortable that the result is a model that you are ready to implement.
If you have lingering concerns or have created more than one model, then additional testing is warranted. This testing should be with fewer customers and previously. Pick only those who you think are representative and will give you their honest opinion.
Present your proposed pricing models and ask for their feedback.
Step 6: Decide on Your Price!
Review the feedback from your final round of testing and decide on a model.
You should feel really good about the process. You may feel uneasy about the final model. Know that you can and should revisit your pricing on a regular basis.
Conclusion
Having a good pricing model and price is important, yet many startup companies struggle to get it right.
The primary reason for this is they are not spending enough time. It is also because they don’t fully understand their customers, are not following a good process in developing their pricing, and the process does not include testing.
The effort to create a pricing model and price is significant. The first thing that needs to be done is to prepare. Once this is complete, there is a well-structured set of steps to develop your pricing.
One last thing. You must revisit your pricing on a regular basis. There are many factors that can result in a price that is too low or too high, or even that your pricing model is no longer valid. I recommend a yearly check on at least the product features, market dynamics, and competition to determine if work is required to update your price and possibly your pricing model.
Pricing matters – you can get it right!
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