Cracking the Code on Startup Product Pricing Strategies

If idea validation is about taking your business idea for a test-drive, then pricing your product is where the rubber really hits the road.

This is it. You’re done piloting. You’re done validating. You’re really done living on Ramen in an apartment you share with five roommates. You’re ready to come out and tell the world: “I have a product or service that provides value – and this is how much my product is worth.”

Needless to say, product pricing strategy is an essential piece of the startup puzzle – and it’s a notoriously tricky piece to get right. There are about a dozen moving pieces you have to take into account. Getting them all aligned just right is like unlocking the most complicated combination lock ever.

Britt Crawford knows a thing or two about product pricing strategies. As VP of Analytics at Rafter, he built a pricing and inventory system that managed more than $50M in sales per year. He has also advised tons of startups on how best to price their products and services, spanning everything from SaaS to energy drinks.

Britt joined us for this session of Startups Live to share his insights about product pricing strategy – and unlocking the value of your product.

FIRST THING’S FIRST

Let’s get one thing out of the way right now: yes, you should charge money for your product.

It’s crazy that we even have to say that, but we live in crazy times. The biggest companies in the world – companies with names like Google and Facebook – built billion-dollar empires without charging users a cent. And that’s led to this weird shift in thinking in the startup community at large.

Suddenly, people seem to think that not charging or under-charging customers for your product is the model of success.

“You’re providing a product or service of value. Don’t sell your team and yourself short by not asking for value in return.”

But this is one of those fallacies that Jonathan Siegel talks about: an idea that you might think is true but is actually a sinkhole waiting to swallow your business whole.

The reality is that these companies that can keep running seemly infinitely without monetizing their product appropriately – they are the exception, not the rule. If you happen to be one of these ultra-ultra rare businesses that can make it work, cool.

But don’t be one of those people who doesn’t monetize your product and assumes VC’s will underwrite your expenses for all eternity until maybe, someday you decide to flip the switch on a revenue stream – and then wake up to the rude reality that that’s not going to happen.

You’re providing a product or service of value. Don’t sell your team and yourself short by not asking for value in return.

triangulating your Product pricing strategy

Okay, so now that we have established that you are going to charge money for your product, the next question becomes: where do you start?

According to Britt Crawford, a good starting point is to think about three key factors about your business: who your customer is, what your product offers, and what the conditions in your market are.

Britt breaks it down for us:

a. Know your customer

“[Knowing your customers] will help you select what sort of pricing methodology to use as you consider setting price. Are your customers looking for a bargain? Is high price actually a feature, like at an exclusive resort?”

b. Know your product

“[Knowing your product] will help you figure out how to scale your pricing. How does your customer derive value from your product? This will help you figure out whether you should price per seat, per server, as a percentage of gross revenue, etc.”

c. Know your market

“You need to understand the market you are entering so you know how much freedom you have to set price. The more competitors or substitutes available the more the market will set price for you.”

As you triangulate between these three aspects of your business – your customers and what they’re willing to pay, your product and the value it provides, and the market and the conditions that it presents – a picture will start to form of whereabouts your product or service’s pricing will probably live.

From there, you can start the process of tweaking and fine-tuning the specifics.

AVOID THESE product PRICING POTHOLES

Britt has worked with dozens of founders on setting pricing for their company, and he’s seen his fair share of pricing missteps along the way. So, in keeping with our belief that looking at failure is valuable, we asked him to share a few.

When it comes to mistakes founders make early on in the life of their product, Britt has a whole list: “Pricing too low. Not having a good quantitative understanding of both unit economics and CAC (customer acquisition cost). Going after partner channels and neglecting direct sales.”

The point about unit economics and customer acquisition costs is huge, and it ties into the “know your product” point we’ve already touched on. Knowing your product means knowing what it costs to deliver your product, from the ground up. Materials, marketing costs, salaries, rent – all of that goes into producing your product, and so all of it should ultimately be reflected in how your product gets priced.

Pricing errors aren’t the sole provenance of young companies, either. Britt points out one mistake in particular that later-stage companies are particularly prone to:  “Cash cow disease: keeping your prices high as new low-cost entrants are coming into the market,” he explains. “Especially in software, you will end up with a very small number of very lucrative clients, and it will look great for a while. Then they’ll go away one by one.”

A final big error Britt sees businesses making: going after an incumbent in your space and then finding yourself in a price war. “You may have lower costs, but they have deeper pockets,” Britt points out. And deeper pockets mean if you try to underprice that competitor, they will bid you under the table every time.

KEEP AN EYE ON THE COMPETITION

Speaking of the competition, make sure you have them squarely in your sights as you’re planning out your pricing strategy. This is the “market” part of the “Know your customer, know your product, know your market” model we talked about earlier.

Your competitors are one of the biggest forces you’ll have to reckon with in your market – and it’s important to know where you stand.

As far as where you should set your pricing in comparison to competitors – that’s largely a judgment call, and there are a lot of variables at play: how crowded is the market? How unique is your value proposition compared with what others are offering? What value-adds to you offer that might merit a pricing boost?

“I like to fit right in a middle ground where anything I price offers more value than it cost, while not being the lowest nor the highest. Then it’s up to the marketing to bring branding and value together.”

If in doubt, taking the middle road never hurts. “I like to fit right in a middle ground where anything I price offers more value than it costs, while not being the lowest nor the highest,” says Startups Live regular Humberto Valle. “Then it’s up to marketing to bring branding and value together.”

As Britt Crawford points out, you need to cast your net pretty wide when it comes to defining the word “competition.”

“You’ve also go to look at substitutes,” he says. “How are people getting this job done today? It might be very different but might serve the same purpose as your product. You might be competing against something you don’t see as in the same category but that is really cheap. So, you may need to change the value proposition in order to sell successfully.”

One thing the Startups Live crew wanted to know: is there ever a justification for pricing your product or service above that of your competition?

“If you are first to market with a new product or capability, well that’s one right there,” Britt says. “Also, quality of service and an ability to know the product roadmap and maybe have some input.”

Never underestimate the value of a personal touch when it comes to customer service, either – especially in the B2B realm. Call it the Dunder Mifflin approach. “Microsoft is never going to pick up the phone when you call – you’re too small of an account. But here’s my direct line.”

Take a look at our guide to how to position your product and brand as premium against your competitors, thus making your customers okay with the idea of paying a little more.

BE READY TO CHANGE IT UP

We’ve introduced the “know your customer, know your product, know your market” formula for pricing already. If only it were always that simple – a true formula that you could just plug inputs into and then boom, get a market-ready pricing strategy right back. But the reality is that there are a whole host of other variables on the board that can come into play – and you need to be ready to roll with them.

“We had to raise the retail price of the product we sold to make the  partnership work – and justify the increase to consumers.”

Founder Jude Al-Khalil shared one story about pricing her company’s product – and running into some complications she didn’t foresee at the outset.

Jude’s company, Bikyni, sells high-quality swimsuits. From the outset, they knew they wanted to aim for a price point under $100. “After the Warby Parker wave, many consumer brands that launched tried to follow in their footsteps,” Jude explains. “I think there was this idea that pricing under $100 felt accessible to consumers.”

Then, a few months in, a wrinkle that nobody on the Bikyni team was anticipated: “We got approached by a great retailer to wholesale our product.” The retailer in question: Madewell. That’s right: Bikyni landed the ultimate startup dream: retail distribution, with a partner with the reach to get their product in front of their ideal customer.

Only problem: “Our DTC pricing didn’t build enough margin in to seamlessly fit into the traditional wholesale pricing model,” Jude remembers. “So, we had to raise the retail price of the product we sold through them to make the partnership work – and justify the increase to consumers.”

Bikyni’s dilemma brings up a good question: what do you do when the unexpected happens, and you have to suddenly raise your prices – including for existing customers that have gotten comfortable with your current pricing?

“Just saying, ‘Yo, we love you – but we need to keep the lights on!’ can be a good step.”

The Startups Live crew agreed that communication is key. “Start the conversation early and give them lots of warning,” advises Britt. “Understand their budgeting cycle and fit your price increase into it. If you can give them a reason to pay more – better features or services – do it.”

Sometimes honesty really is the best policy. As Steph Newton points out: “If your stuff is way underpriced, even just saying, “Yo, we love you – but we need to keep the lights on!’ can be a good step.”

Britt agrees. “Customers that love your service and are getting a lot of value for it will understand,” he says. “They might be unhappy but they probably won’t leave.”

As for what happened with Bikyni – it all worked out in the end. “The product sold through our wholesaler did super well,” says Jude. Customers felt it was special and different from our site’s product and when we sold each piece for $5-$10 more than what we charged, we still moved the product.”

CONCLUSION

There you have it: the Startups Live crew’s thoughts about pricing. Know your customer, know your product, know your market. Look out for typical pricing traps. Keep an eye on the competition. And always be ready for the curveball you didn’t see coming.

Pricing is a moving target, and it takes a ton of calibrating, re-calibrating, and re-re-calibrating to get it where it needs to be. But once you get it right – really right – once you see those green numbers in your P&L sheets trending upward, and you know that each of those numbers corresponds to a paying customer who sees value in what you’ve built – well, that’s what the whole entrepreneurship thing is all about.

GOT IT. WHAT’S NEXT?

Looking for an expert to evaluate your pricing strategy?
Head over to Clarity.fm to find a mentor today.

Want to learn more about how pricing fits into the bigger picture of sales?
Hear Hiten Shah talk about Sales Funnel Optimization.

Looking for more information about how not to price your business?
Read Stephen Moore’s piece on the perils of underpricing.

Want to learn more about startup missteps to avoid?
Check out Tristan Pollock writing about marketplace mistakes that are killing your startup.