How to Price your products/services
From personal experience over 90% of startups underprice their services when they begin.
There has been a lot of attention on guiding startups towards finding product-market fit; however, the emphasis on business model fit has been lacking.
Yes, it is much more important to achieve product-market fit before even worrying about pricing; however, the disproportionate attention on this has lead to many companies applying a lackadaisical approach to pricing. Poor pricing has just as much power to destroy your business as does a terrible product. BOTH need to be in alignment.
The good news is that pricing really isn’t as mystical or complicated as you think it is. There are proven business models and frameworks that have been vigorously and scientifically tested. Your goal should be to identify and iterate on the one that works best for you.
This article will not cover the intricacies of different business models, it will instead shed light on common overlooked factors that influence pricing and specific frameworks that will help you easily identify optimal pricing for your solutions.
Brand Value & Pricing
Should you charge $299 or $300?
This decision, as trivial as it seems, exposes the necessity to begin your pricing journey by having a clear understand on your company’s/brand’s value.
The common knowledge is that $299, though only a $1 in difference (and even if we are aware of the psychological fallacy we’re victims to), gives the impression of a lower price compared to $300. Understanding the psychological reasoning behind that tactic alone is insufficient if we are unaware the contexts with which it is effective.
Let’s say that quality is one of your company’s core value. If that is the case, you might actually benefit more from charging $300.
Affordability/value isn’t always the right message that will resonate with your customer.
Begin your pricing journey (and as a matter-of-fact, every company decision) by understanding the values with which you will evaluate the pros and cons of your decision with. Values are the HOW to your WHY (your company mission).
Starting Price — the quick & dirty way to begin
With the previous point in mind, you now understand what you’re trying to accomplish and have the foundation to decide on where to begin.
- If growth is a priority, you may be more comfortable with a lower starting price that will reduce friction.
- If profitability or quality is a priority, you make take a different route.
Where to begin?
You don’t need to reinvent the wheel with everything
Many startup founders are innovative by nature. If you’ve already designed an innovative and new solution, you don’t necessarily need to reinvent EVERYTHING. Yes, everything needs to be customized because different situation/products/markets dictate a different approach, but start with what’s tried and tested, then test and adjust as necessary.
-> Mystery shop and copy your competitors (direct or indirect).
Customer Discovery never ends
If you’re in product development, you understand the importance of conducting Cx Discovery and how it will help you with crafting the right solution. The same principle of understanding your customers applies to marketing and sales.
-> Interview your customers to gauge their responses towards different price-points.
- What is acceptable?
- What is expensive?
- What is outrageous?
Again, bearing in-mind your company/brand values.
e.g. If your solution is designed for a premium/exclusive market, you may WANT to start with the outrageous price-point even if it would alienate general consumers (they’re not your early-adopters/target market anyways, so it’s fine).
-> Understand their default expectation.
Do they normally pay by-hour? A % of the transaction? A flat fee?
How much do they typically pay for this/a similar type of service? If they’re normally paying $2,000 for this, pricing lower might not actually win you more customers. It might instead raise flags and make them question your quality.
Define the value that you create for them
Pricing is often considered from a cost perspective, but cost doesn’t often scale in correlation to your customer or the size of your project.
e.g. if you run corporate workshops and decide to charge by the # of participants that you’re facilitating.
You now have the opportunity to facilitate a workshop with a much larger and reputable company (that you know, definitely has a much larger budget for these types of workshops), should you still price solely based on the # of participants, you may be leaving a lot of money on the table.
-> Instead, consider value-based pricing
Most solutions add value in these 3 ways (not mutually exclusive). This is really very much a rough estimation and by no means vigorously tested, but it’s a starting point. If you:
- Help your client make more money — charge them 10–25% of the expected additional monthly income.
- Help them save money — charge them 10–15% of their annual savings.
- Help them save time
- First identify what their time is worth
- or the opportunity cost associated with what they could be doing instead.
- Then charge them for ~10% of that missed opportunity cost/mo.
Optimal Price — a scientific approach
Now that you have a foundation, here’s one way to quickly hone in on your optimal price.
But before that, some reminders:
- Begin with your objective in-mind. If your priority is growth, you may be willing to sacrifice profit in favour of decreasing CAC (see below).
- Do cohort analysis in controlled groups to ensure that pricing is the only variable that is affecting the change in your customer’s behaviours.
Keep a close eye on:
- CAC (Customer Acquisition Cost)
- As you increase price, it will make it harder for you to acquire new customers — it might result in lower conversions (less customers willing to purchase), customers might take more time to decide (thus increasing cost since time = money), or you may require more time/capital intensive steps in the funnel to convert them (e.g. products >$300 typically require at least 1 in-person touchpoint in the funnel, and we all know, in-person = higher cost compared to marketing automation).
- Try to account for all costs — not only marketing budget, but also salaries for employees who are involved in activities leading up to acquisition.
- LTV (Lifetime Value)
- LTV is the main thing to pay attention to, but Churn is the underlying principle that affects it.
- Price is inversely correlated with customer loyalty — the more expensive your solution is, the more readily someone will leave (either because they can no longer afford your service, or because they are able to find a more affordable alternative/compromise).
- Higher churn doesn’t necessarily = lower LTV (example below).
The fastest way to fine-tune pricing is to start by doubling your price.
e.g. $50 -> $100 -> $200 -> $400 -> $800 -> $1,600 -> $3,200
As you can see, depending on where you start and how greatly you’ve underpriced your offering, $50 vs. $100 may not be a meaningful difference if your customer is typically familiar with paying in the $1,000 range for this solution.
Once you do this, you’ll very quickly find the range between expensive vs. outrageous.
While you increase price, track on a spreadsheet the related LTV and CAC associated to that price-point.
Optimal pricing is where you have the highest LTV to CAC ratio — this is where it’s most profitable. You’re getting the most from them (price X lifecycle) while CAC is minimal in comparison.
Understand Absolute vs. Relative Discounts vs. Psychology
If your product = $250
Absolute Discount = $25 off
Relative Discount = 10% off
-> Absolute discounts are better if your price is >$100.
-> Relative discounts work better if your price is <$100
Same applies not only to discounting, but also to how you charge.
e.g. if your business model is transactional. $10/transaction vs. 2%.
Better yet, give away
Depending on your service and values, instead of reducing price (which reduces perceived value), consider giving away (value add).
Option 1 (Price)
- Package A ($100) = 10 hours of service (at $10/hr)
- Package B ($180) = 20 hours of service (at $9/hr)
- Package C ($300) = 40 hours of service (at $7.5/hr)
Option 2 (give away)
- Package A ($100) = 10 hours of service
- Package B ($200) = 20 hours of service + 3 free hours
- Package C ($400) = 40 hours of service + 13 free hours
If giving more isn’t an option, you can also play around with other alternatives/bonuses without reducing pricing
- With COVID-19 affecting businesses in 2020, many companies were unable to afford existing services with reduced business and increasing cost. Instead of lowering price, an alternative would be to offer flexible payment terms.
- During the 2008 recession, Hyundai offered a job-loss guarantee — if you loss your job, you could return your car. This addressed customer’s fears and concerns and it actually allowed them to leapfrog over many of the other automakers and capture a larger market.
- Risk/Reward — Taking payment in shares/revenue share instead of $$$ (if appropriate).
- Providing white-glove service.
- Bundling offerings.
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