Pricing Strategy

One of a startup’s most significant decisions is pricing strategy. This decision is critical because it sits at the nexus of so many different dimensions in the startup’s strategic positioning, and coming up with a good, balanced solution for all these dimensions is so strategic. Failure to solve this well can cripple or kill a startup.

As taught in business school, pricing is one of the four pillars of your strategic marketing mix (the 4 P’s). Strategic marketing is determining what you sell (product), at what price (price), and how (place), along with how to tell the world about it (promotion). The reason pricing is critical is that the pricing model you choose will communicate something to the world about the value of your product and its position amongst your competitors. It will ultimately be a major factor in how fast you can grow as well as your startup’s profitability. In other words, your pricing model is one of your most strategic decisions – and it is difficult because it requires you to integrate your thinking around so many dimensions of your business.  

Some of the critical dimensions to be considered in developing a pricing model include the following:

• Customer-perceived value offered (often in comparison to whatever other solutions to the problem at hand are currently in use)
• Typical customer budgets
• Customer’s financial realities that the pricing structure must fit into (e.g., is variable SaaS really a good option? If so, per use? per month? per year? per user? Should the emphasis be on one-time capital costs or ongoing operational costs? Etc.)
• Costs, including variable costs of goods sold plus consideration for underlying fixed costs and scale effects
• Profitability targets
• Possible foreign exchange risk exposure (if your business is going global)
• And likely others depending on the specifics of the business

Here are some reflections on things to think about as you work through pricing model development.

Pricing is a critical element of strategic marketing positioning

For first movers or those who provide premium features/performance, a premium price can communicate that the product offers extra value. Alternatively, a relatively low price coupled with exceptional features can telegraph a much greater value proposition than the competition, upending the existing market dynamics with innovation and capturing the attention of possible customers. Finally, an innovation that drives down cost can enable a much lower price, potentially expanding the pool of potential customers.

For example, price was a critical differentiator at one startup I led. We offered the same performance as the big market-leading competitors at a fraction of the cost. We minimized sales costs by offering a low, no-negotiation fixed price with downloadable quotes. The shock value of how low we could provide a high-performance solution was a major positioning element in our marketing – and we could also be quite profitable. Win-win!

Pricing strategy must find the right balance between customer-perceived value, costs, and profitability

A tempting beginning pricing strategy is cost-plus. The idea is to figure out your costs, apply a profitability factor, and use the resulting price in the market. However, this simplistic approach can result in pricing that does not consider the customer’s perceptions. For example, suppose your costs are high (especially prior to achieving sufficient scale). In that case, the cost-plus approach can result in prices too high for the perceived value, resulting in prospects deciding against buying your product.

On the other hand, if you can innovate to have low costs, the cost-plus approach can undervalue your product, resulting in missing out on potential value capture and reduced profitability. Sometimes, you may choose to strategically set your price to align with typical budget limitations in customer environments. For example, we knew that typical customers could make purchase decisions up to $50K in one of my startups or up to $100K in another startup before additional scrutiny was brought to bear. In both cases, we choose to find a way to offer at least some price points that fit within those boundaries.

Pricing must consider scale effects

When launching your products into the marketplace, your chosen price will often not cover your initial costs when your sales volumes are low. This is because, often, at low volumes, your costs are exceptionally high. To adjust for this, you have to do some financial modeling to consider what your costs will become at different scale levels and what timeframe you might be looking at to achieve various sales volumes. Make sure you think through both upside and downside cases to ensure you can live with the effects of different pricing models. Note that these decisions often have a big impact on your startup’s cash runway. Hence, it is crucial to make sure you are thinking this through so you do not create an unexpected significant cash need while still trying to arrive at pricing that you can live with on a long-term basis since customers’ will key in on those prices. You may not be able to adjust them much without undermining your customer relationships.

Keep in mind that the relative complexity or simplicity of your pricing model will have significant implications on commercial staffing and sales cycle length

Pricing structure choices can have significant downstream effects on staffing that are essential considerations. Since the complexity and variability of a pricing model can raise or lower barriers to purchase, care must be given to what and how many options you offer. Consider the consequences of the complexity of the pricing structure, including the number of choices/line items offered. For example, breaking your product into many line items can allow potential customers to customize your offering to fit their needs. However, that flexibility can create complexity and opportunities for failure on the delivery end.

At one startup, we went through several pricing model iterations to land on a pricing model that encouraged broad adoption of our solution across customer organizations to maximize the customers’ realized value.  This allowed them to implement in phases without requiring repeated navigation of bureaucratic budgeting processes and limiting customer service support needed to handle customers’ desire to optimize their pricing by dynamically changing licenses, which would involve manual intervention every time. This minimized stress and froth on both sides of the commercial transactions while improving our startup’s revenue ramp.

Pricing model choices can drive the amount of people and resources you need to invest to either negotiate each sale (negotiations are resource-intensive!) as well as simplify and streamline the customers’ decision-making or change the deployment scope. More complexity often means more sales, implementation, or service effort required, resulting in more extensive staffing requirements. You must ask yourself whether the incremental revenue you can secure by allowing more customization by customers is worth the additional costs to support such complexity. Do the math. Sometimes fewer choices make the customer’s job easier.

In summary, pricing is a critical strategic decision for every startup. Finding the right pricing model solution should involve customer discovery, creativity, cost modeling, and pricing modeling, as well as thoughtful consideration of strategic marketing positioning. Ultimately, how you describe your pricing will hopefully strike your prospects as simple and straightforward, though getting there will involve careful thinking and market testing.