Last week I was supposed to be at an event but it got canceled at the last moment. My topic for the event was Smart Pricing Strategies for Startups. This post is the same deck in the long-form. This post is meant to help early founder think about pricing from multiple angles.
Pricing is a powerful level of growth. Most of the largest platforms grow by giving things away for free. Others charge thousands of dollars to each month and have multi-million dollar Annual Run Rates while growing their businesses.
If you just started up, or have some revenue coming through the door, you probably are getting a lot of advice on pricing. You may be fearful to change the status quo or maybe fear people leaving your product as soon as you introduce a pricing plan. The job of this post is to help you think about pricing from multiple lenses and see how you can better price your product and grow your business.
- It is all about Margins & Unit Economics
- Price Based Positioning
- Price on Value
- Pricing is a Tax
- Price should be easy to understand and predict
- Price can be hidden
- Price is not set in stone
- Free/Freemium or Paid
It is all about Margins & Unit Economics
A business without margins is pretty much a failure. At this point, you would be thinking, “but Ravi, look at the multi-billion dollar startups, they don’t seem to have margins”. To which my answer as of today would be a single word, which is trending in 2019, “WeWork”. Having bad unit economics or low margins put others in control of your long term destiny, which may be fine for a small percentage of people, but unless you can raise a billion dollars, you need Margins.
On the SaaS side of things, you need large margins, around 80% to be more accurate. This is a number you will come across time and again. Tom Tunguz, David Cumins, Jason Lemkin, and others have written a lot about it. Here is a more detailed post by David Sacks
If you are still not convinced, here is an exercise, project 12-24 months of expenses & income in detail. Put in all your pricing tiers, possible churn rates, your sales & marketing expenses, your possible people & infrastructure cost, put it all down on a sheet. If your projections have you making money, you are in the right place, else you need to give a deep hard look at what you are doing.
Price Based Positioning
Human trust works in weird ways. When we are giving low prices products we assume the low price is achieved by cutting corners or some sort of compromise. The opposite is true too, if something is priced higher we assume the product is a premium product. Thus it is usually bad to price too low or to use price as a competing factor.
That being said it is not impossible to price yourself against the market trends and win. Apple prices their phones on the premium side and wins, Zoho wins on the lower side of the price bracket.
Personally, I advocate on pricing higher, because you want to price on the value, more on this in the next point.
Price on Value
Value is a word you will hear a lot, from me too. At the end of the day what you are charging for is the value provided to the user. More importantly, it is the value that the user can comprehend. If they can’t then figure out the value they are receiving they won’t pay. On the same lines, if they think the value you are providing is too low, they might not want to pay your asking price.
Let’s take Slack, for example, the value users get from Slack is fully managed simplified, collaborative communication between people. The value is not derived by Slack killing email for you, it never can, neither is it derived from Slack enabling one on one communications, or having any number of chat rooms/channels. If it was, the pricing would be based on the number of chats or channels, etc. Most users would not be able to comprehend pricing based on any such abstract mechanism.
On the other hand, if you are PubNub, you will charge on the number of messages, and the value you are proving is delivery of chat messages and APIs for the same, thus you would charge on the number of messages and in this case, your users will understand what they are paying for.
What you need to figure out is what is the value you are providing to your users. In addition, just because everyone is charging on seats, does not mean you need too. A great example is Basecamp, a product, and a team that almost always does things differently.
Pricing is a Tax
Ever wondered what taxes can be used for other than earning revenue? What if using Twitter was taxed? Would its users reduce Twitter’s usage? Governments around the world are trying to introduce a “Sugar Tax” to try to reduce the consumption of soft drinks. So how is pricing a Tax in SaaS and other products? How you price defines how your users will use the product. Price per seat, users will start sharing passwords with other users. Price on events and users will stop sending events to your system. You get the flow.
Thus you want to look at your product’s value proposition and define what you want your users to do or not do and plan your pricing around it. If you are Canva, do you want users to make more images? If yes, would you charge per image? Nope.
Your pricing can also define how your free users behave. If you are on a popular slack group you will notice a change in the behavior of free groups once they hit the 10K message limit. The admins start to shutdown unused or un-needed channels so that they can still find value in the group and not have channels where they can’t see past the last chat posted.
Price should be easy to understand and predict
I have mentioned part of this in passing above, where we talked about the ease of comprehension of value. In addition, pricing should be done around a metric the user can predict. Example, If you are an analytics product you can charge in 3 possible ways, with pros and cons:
- Monthly Active Users
- Easier to make sense of
- Is tracked by everyone
- Can have a lot of variations as events get added and removed
- Hard to estimate, but not impossible
- Data Stored
- Can have a lot of variations as events get added and removed
- Hardest to estimate
You might have the same challenges based on your product. In which case, think of who you are selling the product to, and their capability to estimate pricing month on month.
Price can be hidden
Many SaaS products decide to hide pricing behind a “Book a demo” button. While I personally dislike this, it can be a useful tactic. This ideally only works when you are targeting enterprises with large ticket values and don’t want to take the effort of trying to sell/support self-service users. If almost all your revenue comes from the sales channel, this might be right for you.
Price is not set in stone
One generic advice you will find around the internet around pricing is: “Raise your prices”. It is not wrong per se, but many founders can be afraid to increase the price in fear of increased user churn. Whenever you want to experiment with pricing you should do it in sales calls and check how prospect behave, if they don’t finch, you know the price is right. But make sure you grandfather old users on old pricing else you might really have a lot of churn coming your way.
Discounts are usually the first weapon a company can use to sell its product. The most popular tactic is the Annual Pricing discount, where your user gets a small percentage of discount for paying upfront. This helps SaaS companies with cash flow and more importantly retention (not bulletproof).
If you are a sales organization, remember to have a pre-planned discount strategy, where the percentage of discount can go higher based on the size of the deal. You can go above and beyond your usual discount, only if you get something in return, usually a Testimonial, Logo placement or other marketing activities. Ideally this customer someone you want to have that company in your customer portfolio.
Free/Freemium or Paid
When starting up the most important thing to think about will be should you have a free/freemium offering. It is probably the hardest to zero in on. At the end of the day, it is a combination of capital available, cost of free users and product-market fit which will function as inputs to the decision if you can have a free tier or not. Let take a look at 2 scenarios
- You are bootstrapping and working on product-market fit: At this stage ideally, stay away from free offerings, especially till you find product-market fit. What you can have is a free trial that converts to a paid offering. You don’t have the capital to support free users, more importantly, you need to talk to every interested customer to better understand their needs. Free users might not give you great feedback, worse they might not even give you the time to get feedback.
- You have raised capital: In this stage, you can have a free/freemium offering, but think of it as a marketing expense and have a marketing-oriented goal to it. A goal of a free offering is to get as many people talking about your product which helps in long term growth and retention. But make sure your product is stable and does its job, else users will be talking about you in the wrong ways.
Those are my 9 points on pricing. Do you think I missed any? Let me know on twitter
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Special thanks to Joel Johnson for his help on the draft.