Unlike outside competition and customer choices, product pricing is one such factor, which the business has total control over. Yet, 18% of startups fail due to improper pricing of their product or service.
A common question among most entrepreneurs is: “How much to charge for my product or service?”
In this blog, let us try to understand some useful pricing strategies and tactics that you can apply to your product or service!
The concept of Pricing in startups - fundamentals
The fundamental of startup pricing is to formulate the right product pricing structure with an aim to maximize profits. It is the process of interpreting the value of a product/service in quantitative terms. Knowing not only the undertaken costs to deliver that product but also its value to a target set of customers is the key to setting the right price.
Have you ever wondered how Instagram managed a $1bn valuation with zero revenues? Or how Whatsapp managed a $20bn valuation with no ads?
It was the perceived value and revenue model of these companies respectively. Read more about Instagram’s valuation story here.
By not undertaking pricing optimization and setting up relevant strategies, you are losing a lot of potential growth and profits in the long-term, and basically leaving money on the table!
Pricing strategies and approaches
The truth is, there’s no one-size-fits-all mantra for your pricing strategy.
It depends on several factors like the industry you’re operating in, no. and type of competition, market conditions, brand impact, and so on. Let us discuss some strategies and approaches you can adopt to arrive at the right price for your business!
I. Pricing thermometer
As presented by Kevin Hale at Y-Combinator, entrepreneurs can set up a price between the product’s value (incentive to buy) and cost (incentive to sell). You can start with the cost and added profit margin first, and increase valuation up to the perceived value.
This indicates two very common approaches to pricing which are:
1. Cost-based approach
All the fixed and variable costs, including office space, work efforts, Intellectual property use, etcetera, are added with a certain profit margin on top employing the breakeven strategy. This should be used by startups in the product testing phase mainly.
2. Value-based approach
Under this approach, perceived value or benefit your target customers receive from your product or service is the basis for setting up the price. It is very important to understand the true value of your product in order to convince your customers.
Since most startups offer innovative products in a potentially new market, getting people to change their pattern is difficult. The first 2% to 5% of potential buyers of your market are the ‘early adopters’, willing to take risks and care more about the benefits and value. Go after these people first! Even if you’re getting less customers in the beginning, do not underprice your product/service at a risk of losing it's worth.
Watch the full discussion at: https://youtu.be/jwXlo9gy_k4
Price skimming
It is a concept to capitalize on such early adopters. In this, businesses start by allocating reasonably high prices to their products in a new market and make most revenue out of the early-adopters who are more value conscious than price. Then eventually, they lower prices to remain competitive and attract the price-conscious customers.
II. Price to competition strategy
Under the competition-based pricing strategy, the prices of direct as well as indirect competitors are taken as the key factor in determining own product prices. This is relevant in a market with intense competition offering similar products or services. Commodity business, for example, where customers tend to buy for the lowest price, no matter how unique and beneficial your product is.
Why?
Because as human beings we are more averse to a loss than being affinitive towards a gain of the same value.
III. Market-based approach
Under the market-based approach, the perceived quality and cost are taken into account to assess the price. These are the following 4 quadrants:
High-quality, High-price: This segment is suitable for startups with a really good product, in demand and a defined value proposition despite the existing competition. (premium pricing)
High-quality, Low-price: If your current focus is to increase sales in a competitive market and have a good product, then this is the segment for you. Just keep in mind to cover your overheads. (penetration pricing)
Low-quality, Low-price: This segment is common for the temporary markets where businesses are looking for a quick win and quality is not the main concern for buyers.
Low-quality, High-price: This is a vile scenario for startups to be in because by offering high-price for low quality products, you are drifting away customers in the long-run.
IV. Positioning-based approach
Startups need to decide the aimed positioning they want to hold in the market first, under this approach. They need to decide whether to be,
- a low-cost alternative and gain share quickly, like Zendesk and Airwatch,
- a mid-market solution and differentiate based on product features like Dropbox and Box,
- or to be a gold-standard, premium startup in the market, with a really good-quality product, like Palantir and Workday.
We advise startups in their ‘0 to 1’ stages to price their products or services as low as possible. The focus should be on gaining traction. In fact, adoption is much more difficult than retention. It is when you have gained 10 to 15% of the market share that you have the pricing power to move around as per the market conditions and internal factors of the business.
V. Free, freemium, subscription, and multi-tier pricing Revenue models
Mobile app based startups usually take on the freemium, subscription, or premium, or multi tier pricing etc. The question is when to adopt which.
1. The free apps model is relevant in the early stages for startups to gain traction and maybe to lead customers to some other service of the company. The revenue is usually raised from advertisements.
2. Freemium, as the word suggests, is a combination of free and premium pricing model, where some basic features and app usage is offered for free while some advanced features can be accessed with a premium subscription. This model is also used to generate a large pool of customers, some of which would be intrigued to try the premium. If your startup is providing some useful additional features at reasonable prices, chances are, it can become a big source of income.
Numerous startups are now adopting the free and freemium pricing models in order to acquire a large share in the market. They are majorly into digitizing industries, and their disruptive models can scale really fast by adopting to the low pricing models, especially in the early stages.
3. The paid subscription model is where startups charge to use the app in its full potential and enjoy the services offered. This should be used by startups where the customers know the value of the given product/service and have an effective marketing strategy. This is not suggested for early-stage startups until they have a very valuable product.
4. Under the multi-tier pricing, businesses provide different products and services at different pricing options with add-ons and improvements as one goes higher. This is a very influential model for customers as they have control over what they’re choosing to purchase. Startups can appeal to a range of buyer personas and upsell to a larger segment. This should be adopted by startups who have a strong base of product/service varieties and can maximize revenue with one option leading to the other in future outgrowing process.
VI. Dynamic pricing tactic
It is also known as demand pricing, where different prices are charged for the same product from different customers based on the perceived ability to pay, demand and supply situations for each of them, thus ignoring the fixed pricing. It is profitable mainly for retail startups by helping generate quicker sales conversion and adjusting to competition pretty flexibly. It is very important to conduct proper customer behaviour and market trends analysis before arriving at unique prices.
Read more on dynamic pricing here.
There are other popular tactics like:
bundle pricing - providing set of products and services at a cheaper price as compared to sum of individual prices,
two-part pricing - a captive-market pricing tactic, where prices are broken down into fixed and variable variants depending on usage and service.
geographical pricing - different prices for different locations or markets fueled by factors like transportation expenses, economic differences.
psychological pricing - commonly used in retail settings to have an enticing psychological impact on customers by offering offers like buy one get one, the ‘999’ instead of ‘1000’ charm pricing scheme, and so on.
Pricing mistakes to avoid
Don’t price to time-worked or at hourly rates. In today’s service industry, clients only care about the results, not the time spent.
Don’t follow an approach where you start by adding a markup profit to your cost, which is also called the ‘cost-plus’ approach.
This could mean you are either losing potential gains by not charging enough or are not selling as much as you could because of a high price.
Don’t go after decreasing prices to simply increase sales. This could lower your, otherwise innovative and valuable product’s worth.
Your pricing strategy goal should be to not just maximize sales, but maximize profits.
Not focusing on strengthening the value of your product rather, which would’ve led to profit maximization at the end of the day.
Sticking to one pricing approach solely (except for when you’re absolutely sure, it’s the right one). Remember that you need to keep experimenting with different approaches and manage price changes until you arrive at the right combination of strategies.
At Flyboat, we believe that each startup has their unique products and surrounding factors affecting their pricing. Do your market and competition research, have proper knowledge of your products' costs and value and explore the above-discussed approaches before arriving at your perfect pricing strategy!
Skim through other such reasons for startup failure and avoid them while there’s time!