Pricing Strategies For Startups

28th May 2012
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Pricing your product or service is an important step towards launch. Getting the pricing right is very important, because it will directly affect how much revenue you will be able to make. The price of the product has obvious implications on revenue and volumes, but it also affects several other things - How your product or service is perceived by the market and your competition, how your customers evaluate and purchase your product and even how stable your revenue streams will be!

Pricing Models

It used to be the case that pricing was very simple - You calculated how much it cost you to build a product, added a margin, and charged that amount to your customers. But in the brave new world of the internet, there can be several pricing models. For example, mobile apps can be monetized in several ways. Pay per download, Free download plus advertising, in-app payments, Freemium pricing and more. Different models will work for different types of products.

Each of the models has some pluses and minuses. Pay-per-download works better on some platforms than on others - It's largely based on the demographic of the users and how easily the platform can bill the user. Amazon and iOS do better here than Android. Having a targeted audience segment - For example, a travel site - works well for advertising-based monetization, but you'll need very large volumes to make it profitable. In-app payments work well if your app has virtual goods to sell that users really really want. Freemium models work best when your customers want to try out the product first, and then buy it later. But for this to work, your paid version needs to have some features that the users really really want, otherwise, they'll be satisfied with the free version.

You'll also need to think about how to price upgrades, whether your pricing is for lifetime of the product, if you'll charge for support, how often customers will need to renew their contracts etc...

Pricing Strategies

Once you've decided on what model to use for pricing, you'll also have to decided on a pricing strategy. Pricing strategies can vary from simple to the very complex, and are best illustrated with examples.

Google Apps for Enterprise uses a very simple pricing strategy. $5 per user per month. This is a very simple and easy to understand, and most customers can easily predict how much it will cost their company to buy Google Apps. Simple pricing strategies work best for self-serve kind of products where customers can come to the website, register and start using the product with little-to-no interaction with your sales team. Beware, though, that this strategy may get perceived as "low-end", since most self-serve users are likely to be small corporations. You'll have to actively fight this perception if you want to go after the direct-sales channel as well.

Contrast this with Microsoft's pricing strategy for enterprise products. For example, check out the SQL Server pricing page. How much it will cost you to run a SQL Server instance depends on many factors like edition, how many licenses you want, if you already own Active Directory and Windows clients, how many users you expect to have and many others. The pricing reference is a 21-page PDF. You're going to have to call up Microsoft sales to buy the product, which is what Microsoft wants, since that'll give them a chance to up-sell and cross-sell many of their other enterprise products. This strategy works well if you have a whole suite of products that you can bundle and have a strong sales team.

A third strategy is followed by Amazon's AWS. AWS pricing is complicated - Different hourly pricing for spot and reserved instances, pricing per instance, data transfer. Plus, support services like CDN and databases are also priced separately, and are a tad difficult to understand. But what AWS has done is to make it super-easy to onboard a customer. The whole pricing strategy is oriented towards making it really really easy to try out the product. They're saying "Come in and give it a try. See how much it will cost you and if you like it, you can continue, or else, it is really easy to leave AWS too! No contracts!". This strategy works brilliantly if it is really easy to onboard and provision new customers. By making it really easy to leave AWS and there being no lock-ins for a customer, they also make it really easy for a customer to come in.

Beware the Caveats

Many products fail because of wrong pricing. While you are selecting a pricing model and strategy, be careful to think about the gotchas for your pricing. For example, the freemium pricing has a serious risk. If your free version gets the users 60% of what they want, they may decided to just live with 60% of the features rather than paying for the other 40%. Sometimes, this can mean that you'll sell fewer of the paid version in the freemium case than if your product had no free version and was fully paid.

Another thing to remember is that it is always easier to price higher to start with and to lower prices through discounts and offers if you discover your price is too high. Doing it the other way is dangerous - If you find that you've priced too low, increasing prices becomes harder.

Charging users on a pay-as-you-go basis or through subscriptions means lower initial spending and more stable revenue, but for this to work, you need to be able to bill customers and be able to renew their subscriptions quite easily and without friction. Otherwise, you risk a large % of users failing to renew, and you've left a lot of money on the table.

Pick what fits your Product

At the end of the day, there is no one strategy or model that works for all products. You'll need to think through what fits best for your product, what the risks of your particular pricing strategy and model are, and decide if you can live with those risks.

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