A Founder’s Guide to Product Pricing
Imagine if Dropbox didn’t offer a freemium plan to users when the company started. It probably wouldn’t be the Silicon Valley super unicorn that it is today. If Apple’s products cost half of their current price, they might still make a profit, but they would not achieve $53B in net income like they did in 2015. What if Palantir didn’t charge customers seven figure fees on a monthly basis with years long contracts? It probably would not be valued at $10B.
Figuring out the right pricing for your startup is a challenging, yet crucial, part of building a successful company. The way you price your product can make or break your startup. So, it’s important to understand the pricing landscape of your market and how your company fits into it to get your startup’s pricing right.
Dreamit recently hosted an educational panel on startup pricing for the companies in its spring cohort. Three founders and investors participated in the panel: Arie Abecassis (venture partner at Dreamit and partner at ICONYC labs), Paul Canetti (founder of MAZ), and Davide Rossi (founder of FitBark).
Below is a guide to startup pricing containing the best advice, strategies, and tactics from the Dreamit pricing panel. Read on to learn more about pricing models, picking the right model for your business, & common pricing mistakes.
Different Pricing Models: B2B versus B2C
The way you price your product will depend heavily on whether it’s business to business (B2B) or business to consumer (B2C). During the panel, Paul Canetti made the point that both B2B and B2C businesses choose their pricing based on cost-plus pricing or value-based pricing.
Cost-plus pricing is the process of figuring out the exact costs of creating your product and charging some price higher than those costs. In other words, you mark the product above its costs when using cost-plus pricing to price your product.
Value-based pricing happens when businesses know the approximate amount of dollar value their products provide to customers. These businesses then set their price below the amount of value customers get from using their products. One great strategy for value based pricing is the 10x rule. For example, if you sell something for $100, it should have a $1,000 perceived value to your customer, at least.
B2C businesses often use cost-plus pricing when figuring out how much they want to charge customers. B2B businesses, particularly in the software industry, use value-based pricing. But these tendencies are not set in stone.
B2B businesses generally have customers pay a monthly fee for access to their software. This type of pricing could be called a SaaS or monthly recurring revenue model. When B2B companies sell to enterprise customers, they generally have them sign contracts where they pledge to pay for at least a year of service. These enterprise customers will pay in full upfront or break the value of the contract up into monthly or quarterly payments. If your B2B company wants to sell to small and large businesses, then it will likely use a combination of monthly and contract pricing.
Sometimes, B2B companies have per-user pricing. For example, Slack charges businesses for each user that has a “Pro” account on the site. Other B2B businesses ask users to pay a one-time license fee to access their products. WooThemes and online course businesses are examples of B2B companies that ask users to make a one-time e-commerce payment to get the product.
Some B2C companies charge consumers a monthly subscription fee to use their products. Examples of companies that do this successfully are Netflix, Spotify, Birchbox, and more. While some B2C companies use monthly pricing, the most common pricing models for consumer companies are free, freemium, and one-time payments for goods.
Facebook, Twitter, and Snapchat are services that offer their products to consumers for free in exchange for the right to use users’ data for advertisements. Freemium B2C companies include LinkedIn, Dropbox, SoundCloud, Evernote, and more. It’s more common to see freemium B2C software companies and startups, but plenty of B2B companies use freemium pricing as well.
Retail and ecommerce pricing models are the most common ones used in B2C businesses. Amazon, Walmart, Alibaba, Priceline, The Home Depot, CVS Caremark, and more all have customers pay one-time fees in retail and/or ecommerce.
How to choose the right pricing model
What should you charge customers for your product and how should you ask them to pay? Here are some ways to find the answer:
- Analyze the set of existing competitive products. This is how most startups and big businesses alike determine the prices for their products. Besides looking at competitors for their pricing information, you should do this anyway to get a sense of how the market looks. Find as many competitors for your product as possible and create a Google Sheet with all of their public pricing tiers and what each tier offers. Then, look for patterns in the pricing data of your competitors and decide where you want to position your product’s price in the market.
- Look at what product substitutes charge. Does your product have no competitors? Is it truly innovative in the sense that it’s the very first product of its kind? If your answer to both of those questions was “Yes,” then you might be thinking that you have no pricing data to use when creating your pricing strategy. But, that isn’t true. Every innovative product replaces some other older, inferior product. The car replaced the horse and buggy. So, if you have a completely new product (which you likely don’t), look at the pricing data for its potential substitutes. Put that substitute pricing data into a Google Sheet and analyze it to find the ideal price for your product.
- Crowdfunding campaigns. If you want to have a trial run (or multiple trial runs) for your product’s pricing, crowdfunding campaigns are an excellent idea. When starting FitBark, Davide Rossi ran two Kickstarter campaigns to fund the company’s initial production runs. In the first Kickstarter campaign FitBark tested a monthly fee model, then killed the monthly fee model, and finally reactivated it later. With crowdfunding, you can raise money to start your business while testing out different pricing models and price points at the same time. Being able to accomplish both of those things is a big win That said, it obviously goes that you shouldn’t run a crowdfunding campaign unless you’re serious about delivering on the promises you make to backers.
- Use AdWords and Facebook Ads to test your product at different price points. Tim Ferriss was one of the first people to discuss this strategy as a way to validate product ideas in The Four Hour Work Week. It’s also an excellent way to test your product’s pricing once you know it resonates in the market. Create several different versions of the same ad for your product where the only difference between each of them is your product’s price. Then, run these ads for a few days with a small budget and see which one performs the best. Use the price(s) from the best-performing ad(s) as your product’s main price(s).
- Ask current and prospective customers two key questions. To determine the optimal price of FitBark, Davide Rossi put plugins on the FitBark website that asked customers two simple questions. These questions were: “At what price does this product become too expensive?” and “At what price does this product feel like a steal?” People who answered the questions got a $10 discount and FitBark got tons of valuable data that helped it choose the right price. With a bimodal distribution analysis, FitBark centered the price at $69. You can use a similar strategy to the one employed by Davide and FitBark to find your product’s optimal price.
Common pricing mistakes that founders make
In the panel on pricing, Arie Abecassis, Paul Canetti, and Davide Rossi spoke about the most common pricing mistakes founders make. Here are the mistakes you should avoid.
- Overcomplicating or overdoing your product’s pricing early on will waste time and discourage early adopters from using the product. Instead, launch your product with one or two pricing tiers (three at the most) and add pricing segments for customers with different needs over time. When it comes to your startup’s pricing in the first 12 to 24 months, simplicity should be the rule.
- Selling your product as having negative value instead of selling how it provides aspirational value. Some products or services allow companies to operate with fewer employees. Telling potential customers about how much they’ll lower costs by laying off employees thanks to your product is an example of negative value. Instead, talk about the aspirational value of your product when selling it to prospective customers. Some examples of a product’s aspirational value are productivity increases, revenue growth, churn reductions, simplified workflows, pageview growth, and more.
- Not thinking about pricing as a dynamic and ongoing value. You can change your product’s pricing at any time and should experiment with it, especially if it’s not effective. It’s not a good idea to change your product’s prices all the time as that will annoy and confuse customers. But, Arie Abecassis talked about how markets, competitors, products, customers, and consumer behaviors will change. As these variables change, your pricing should likely evolve as well.
- Not knowing what different size customers expect in terms of pricing. Enterprise customers expect very different pricing from small businesses, medium size businesses, or consumers. If you want to sell to the Fortune 500, you should know companies of that size expect to pay at least 5-figures and sign contracts when purchasing products or services. On the other hand, most small businesses expect to pay month-to-month for the products they use. Educate yourself about what prices different sized businesses will want and expect to pay for your product.
- Going to retail too early for hardware products. Instead, know everything about your customers before selling to them at retail. Davide Rossi spoke recounted a story about how BarkBox went to retail with a unified brand message way too early. Rossi wished he had done more landing page audience-based marketing to learn about the specific problems dog owners faced when seeking out BarkBox. If you run a hardware company, you should take Davide’s advice and truly understand your customers before selling your product at retail.
Additional articles to read about startup pricing
Business pricing (especially for early-stage startups) is a complicated topic . Here are some great articles, videos, and books that delve into how you should set up pricing for your product.
- Tomasz Tunguz on the 7 Factors to Consider When Pricing Your Startup’s Product
- Pricing Strategy Framework for SaaS Startups from Sixteen Ventures
- Lean Pricing (a book all about how to set your startup’s prices)
- Google Scholar results for the query “pricing models”
- Sequoia Capital’s guide to pricing your product
- Intercom’s guide to “Picking Your Pricing Model”
- Patrick McKenzie talks about the value of and how to test your product’s pricing
- This episode of the Smart Passive Income podcast where Pat Flynn interviews Ramit Sethi
- Fred Wilson on how to prioritize the time you invest in business and pricing models
- The “Pricing” topic on Quora
- A “Study of 386 SaaS Pricing Pages”
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