Three approaches to pricing

Edited excerpt from There Are Only 3 Pricing Strategies For Your Startup by Tomasz Tunguz:

Maximization (Revenue Growth) – maximize revenue growth in the short term. Startups should pursue maximization when there are no clear differences in customer segments’ willingness to pay, and when the optimal short term and long term prices are equal.

Penetration (Market Share) – price the product at a low price to win dominant market share. Then move up-market after developing broad adoption.

Skimming (Profit Maximization) – start with a high price and systematically broaden the product offering to address more of the customer base at lower prices. Skimming is widespread in consumer hardware. Apple sells the latest iPhones at the highest prices, and repackages older models at lower prices to address different customer segments.

(1) Tomasz adds: “Startup should be explicit. Decide which strategy to pursue, and align sales, marketing, product and engineering efforts along those lines.”
(2) Cf. How to price your product based on quality versus the competition and How to set the price for your product.

How to price your product based on quality versus the competition

Edited excerpt from Five Words Of Wisdom From SaaS Office Hours With Bill Macaitis (CMO of Slack, ex-CMO of Zendesk and ex-SVP Online Marketing of Salesforce) by Tom Tunguz:

The price a software startup can charge is a function of the difference in net promoter score between that startup’s product and its competition’s. In other words, a startup product with a very high promoter score compared to the competition can charge a premium in the market and vice versa. High promoter scores indicate great product market fit, good customer relationships, and substantial value creation, all of which translate into pricing power.

(1) I like this a lot, because it reinforces the centrality of product quality (in this case measured by NPS, net promotor score) for everything a startup does.
(2) For more on NPS, see Net promotor score — how to set up the survey and How to use net promotor score surveys to improve your product.

Pricing your product? Don’t be afraid to ask for a *lot* of money

Edited excerpt from My Startups’s Dead! 5 Things I Learned by Judah Gabriel Himango:

When I acquired my first client, I had no idea how much to charge. For me, there were a few hours of work involved. I dared to ask for the hefty sum of $75, which seemed totally reasonable for forking a codebase and tweaking some CSS. After all, it’s not that much work.

What I didn’t understand was, you charge not for how much work it is for you. You charge how much the service is worth. A custom Pandora-like radio station, with thumb-up and –down functionality, song requests, user registration, playing native web audio with fallbacks to Flash for old browsers – creating a community around a niche genre of music – that’s what you charge for. That’s the value being created here. The client doesn’t care if it’s just forking a codebase and tweaking CSS – to him, it’s a brand new piece of software with his branding and content. All he knows is he’s getting a custom piece of software doing exactly what he wants. And that’s worth a lot more than $75.

It took me several clients to figure this out. My next client, I tried charging $100. He went for it. The next client $250. The next client $500. Then $1000. I kept charging more and more until finally 3 clients all turned down my $2000 fee. So I lowered the price back to $1000.

Money is just business. It’s not insulting to ask for a lot of money. Charge as much as you can.

(1) Thank you for the link.
(2) Compare the way Judah experimented with raising prices to Jason Fried’s advice for How to set the price for your product.

Five psychological tips to optimize your pricing page

Edited excerpt from 5 Psychological Hacks That Will Make Your Pricing Page Irresistible by Neil Patel:

1. Place a third and mispriced option to nudge customers toward the preferred purchase. This is the decoy effect, which occurs when customers are presented with a third option (a decoy) that causes them to choose the higher priced of the two original options. For this option, make sure that the value is significantly lower than the most expensive option, but the price is almost as high. Considering the middle option seems absurd. For just a few dollars more, the customer could have the highest option that provides far more value.

2. Put your best option in the middle. People prefer the middle option, regardless of what type of person they are, and regardless of what items are available to choose from.

3. Show the value of pricing options, not just the price. The framing effect states that people respond in different ways to a choice, depending on how it is framed — as a loss or as a gain. By showing customers how much they are saving, you can frame a purchase in a more positive light, even though the cost itself is higher.

4. Point out which option is the most popular. People are more likely to choose what others have chosen. This is called groupthink, or the bandwagon effect. For customers who may not be familiar with the various features of each program, selecting the most popular choice make sense.

5. Make your prices relatively consistent with each other. When making decisions, people tend to focus on the facts before them, ignoring facts that are generally true about that given situation. This is known as the base rate fallacy. If you want your pricing to appear fair, then you should allow each of the pricing options to be relatively the same, so you don’t cause the customer to think more broadly about the pricing. Your goal is to keep your customer’s thinking on the price within a certain range — the range that you define.

(1) Note the conflict between the decoy effect — introducing a pricing outlier to make the others look more attractive — and base rate neglect — ensuring your prices are consistent with each other. Which should take precedence?
(2) Here’s our pricing page for Seeking Alpha PRO. How should we improve it?

The pricing valley of death

From Software’s Valley of Death by Raj De Datta:

Let’s say you want to build a $100M recurring revenue SaaS business. There are really only two fundamental ways of doing it:

1. Tackle the enterprise: Sell 1000 companies @ least $100,000 per year deals with a market size of at least 5,000 companies.

2. Tackle the small & medium business: Sell 100,000 companies @ least $1,000 per year deals with a market size of at least 500,000 companies.

The valley of death is often in the middle. It’s the company with the long sales cycle (often because you are selling something that is pretty complicated to enterprises). You still require expensive sales people, have a limited market size and low price points (often $5,000 to $30,000 a year. ) Over time, the model simply doesn’t work.

The valley of death is totally avoidable, but only if you deal with it pretty early in the lifecycle of your start-up. Basically, you’ve got to pick your market segment in tandem with your product. You’re either enterprise, or you are mid-market (at least initially). You can’t be both.

When a potential customer tells you it’s too expensive

From What does, “it’s too expensive,” mean? by Seth Godin:

What does, “it’s too expensive,” mean?

“It’s too expensive,” rarely means, “we can’t afford it.” Often, it actually means, “it’s not worth it.” This is a totally different analysis, of course.

Culturally, we create boundaries for what something is worth. A pomegranate juice on the streets of Istanbul costs a dollar, and it’s delicious. The same juice in New York would be seen as a bargain for five times as much money. Clearly, we’re not discussing the ability to pay nor are we considering the absolute value of a glass of juice. No, it’s about our expectation of what people like us pay for something like that.

Start with a tribe or community that in fact does value what you do. And then do an ever better job of explaining and storytelling, increasing the perceived value instead of lowering the price. (Even better, actually increase the value delivered).

Over time, as influencers within a tribe embrace the higher value (and higher price) then the culture starts to change. When people like us start to pay more for something like that, it becomes natural (and even urgent) for us to pay for it too.

(1) “Start with a tribe or community that in fact does value what you do.” Cf. The biggest risk of freemium.
(2) Thank you Daniel Reidler for introducing me to Seth Godin’s remarkable blog.

How to set the price for your product

From 37 Signals’ founder Jason Fried:

The good news about pricing is that you can guess, be wrong, but still be right enough to build a great sustainable business. Maybe you’re leaving some money on the table, but, like my dad always says, no one ever went broke making a profit. However, you are not allowed to ask people:

  • “What would you pay for this?”
  • “Would you buy this for $20?”
  • “How much do you think this is worth?”
  • “What’s the most you’d pay?”

And these are the questions I hear people asking over and over. You can’t ask people who haven’t paid how much they’re willing to pay. Their answers don’t matter because there’s no cost to saying “yes” ”$20” “no” ”$100”. They all cost the same – nothing. The only answers that matter are dollars spent. People answer when they pay for something. That’s the only answer that really matters. So put a price on it and put it up for sale. If people buy that’s a yes. Change the price. If people buy, that’s a yes. If people stop buying, that’s a no.