We get interested in companies when customers start getting interested in their nascent product. Pricing is often the first question asked when we start working with companies to get that product to market.
There are many books and blog posts on pricing but here’s a simple checklist we made that companies have found helpful. The checklist only aims to ensure that you consider all the ways in which pricing can effect your business.
Return on Investment
The fundamentals of pricing revolve around value. Customers’ conceptions of value can be somewhat rational, so are a good place to start. What’s the basis of your product’s value? That is, what job does your product do for your customers, and what is that worth to them? Ideally, you will have a crystal clear, quantitative explanation of what value your product delivers to your customers in the form of a Return on Investment calculation for which the value delivered is the numerator and the price is the denominator.
Do people use the product an on individual or team basis? If the value is in a team’s use, then charge based on team size or collaboration-related features. If the value accrues to individuals, charge on a per seat basis. If the value accrues to the manager, charge for administrative and analytical features.
How does your pricing model allow you to earn more revenue as you deliver more value to your customers? Whether you start with small or large deal sizes, you want to utilize some of the leverage your product gives your customers. Expanding through use or transactions is not the same as expanding through features.
How does your pricing integrate with your product roadmap? You should be able to charge for the features you’re planning to build, and know the basis on which those features deliver value to your customers.
Does your pricing allow you to profitably acquire customers? That is, does your Customer Acquisition Cost cover the Lifetime Value of a customer given the price you’re considering?
How does your pricing affect who buys the product? Higher priced products have to get sign-off from those higher up in the organization, and perhaps go through a formal procurement process. Pricing high will decrease sales velocity but allow for increased deal sizes. Lower priced products are sold to line managers or individual users. Pricing low will increase sales velocity but may not allow for large, initial deal sizes.
How does your pricing allow for high revenue quality? Revenue quality is essentially a synonym for revenue predictability. Revenue predictability is important because predictable revenue allows you to invest in projects that require significant amounts of capital. Recurring revenue is good because it’s relatively predictable.
How does your pricing allow you to be a profitable, sustainable business? Essentially, the price has to cover your costs — all of them, not just those above the Gross Margin line. Or — more realistically for a startup just entering the market — there needs to be a path from a price that affords you an entry point into the market to one that allows you to be profitable through expansions, up-sells, cost reduction through economies of scale or otherwise. In software, this usually means pricing such that you’re earning more than 80% gross margins from the outset.
How does your pricing convey the value of your product in the market? Think about pricing as an aggressive, not defensive, mechanism. Pricing high can signal to customers that you have a premium product. If you have a premium product and better data from which your customers can derive business insights then you should communicate this superiority in the form of higher prices.
What is the potential market for your company’s product at your pricing? That is, (price x total customers in the market) must be sufficiently large for you, any investors and others stakeholders to be willing to invest their time or money in the company.
Here’s a summary of the questions asked herein.
- What’s the basis of your product’s value?
- Do people use the product an on individual or team basis?
- How will you earn more revenue as you deliver more value to your customers?
- How does your pricing integrate with your product roadmap?
- Does your pricing allow you to profitably acquire customers?
- How does your pricing effect who buys the product?
- How does your pricing allow for high revenue quality?
- How does your pricing allow you to be a profitable, sustainable business?
- How does your pricing compare to competitors?
- How does your pricing convey the value of your product in the market?
- What is the potential market for your company’s product at your pricing?