Prescriptive Pricing Guidelines

Recently,  I have been advising two start-up’s in SaaS space on one of their key decision – Pricing.  A decision that will have a significant impact on the growth of the company.

Based on these recent experiences and my prior experiences in Pricing & Packaging at world’s largest Enterprise Software companies, I have distilled all my experiences to a set of prescriptive guidelines.   Note, these guidelines are derived primarily from my learnings in Enterprise Software space and I believe they have applicability in the consumer space as well.

 Revenue Maximisation versus Market Penetration

On the onset, a fundamental question needs to be answered –

Are we pricing to gain rapid market adoption (land-and-expand) or are we trying to maximize our revenues?

And the answer to this question will set your strategy for pricing.

At a high level, the concept behind maximization strategy is to choose an optimal point on your price elasticity curve at which the total revenue can be maximized.  This strategy makes sense when we believe we have differentiated and innovative offering and there is not necessarily strong competitive pressure.   In most cases, this might be a good strategy to start with, since it’s easier to lower prices in future as opposed to the other way around.

However, if our goal is to gain rapid market adoption, we can price the product lower compared to the maximization strategy.  This strategy makes sense if we believe the Customer Lifetime Value (CLV) is significantly higher than Customer Acquistion Cost (CAC).   And also, if the switching cost for your customers is relatively high as well.  In other words, sign-up customers now at a lower price and later, you can cross-sell or up-sell or even hike the price.

Once we have answered this hard question and all stakeholders are aligned (not an easy task), next we need to determine what metric shall we use to charge our customers.

The Value Metric
To figure out the pricing metrics question, we have to answer this question –

How will our customers use our product and derive business value from it?

Often, I have seen companies price their solution on per user basis. Since a user will be using our product, they will somehow derive value out of it.  However,  what action is the user performing that is creating value for the business?  Is she monitoring a business process, working on sales opportunities,  analyzing data, running experiments, sending messages, etc?  And that “action” is creating value.  If the user performs that “action” more frequently, more business value is generated.

Essentially, we have to drill down and figure out that atomic unit that drives value for our customers.    Of course,  we have to make sure that particular unit is measurable for us to invoice the customer.    In some scenarios, it may not be one metric, but a compound metric that encapsulates the business value.

Dollars Per Metric

Once we have a figured the right value metric (or metrics), next we need to answer this question –

How much shall we charge for each unit (value metric)?

There is a saying, “Price is what you pay, and value is what you get”.   The challenge here is to design the price in such way that “perceived” value that customers derive from your product is substantially larger than the cost.  The reason I say perceived since every customer will perceive value differently based on their industry, size, profitability, market knowledge, and several other factors.  The best course of action is here to ask your customers, “What are they willing to pay based on their perception of value?”.

When we design new products, we often work with “Design Partners” to provide outside-in perspective.  Similarly, we need to create “Pricing Partners” to provide us outside-in perspective on your pricing strategy.  Create a representative sample of prospective customers and ask them what are they willing to pay or what price-point do they find the product to be super-expensive?   Our goal should be to move the price a bit higher than the acceptable price for our customers to take into consideration discounting tactics.   In the process, you will also learn what price point customers might consider as expensive for your product.

Note, when we talk to “Pricing Partners” make sure we lead the discussion with the value that you think you provide, both qualitatively and quantitatively, and then let them build off from there based on their internal knowledge of their own company and industry.

I wouldn’t talk in detail about packaging, but potentially you can bundle the packaging discussion along with pricing discussion with your customers.  Briefly, packaging involves prioritizing the feature sets for specific persona’s that your product is designed for and using that information to create the bundles or tiers of your product (for instance,  lite, professional and enterprise).

The Model

Now that we have good sense of what our customers are willing to pay for our product per value metric that we selected, next logical question we need to answer is –

Considering our cost and profitability goals, can we sustain our business based on what our customers are willing to pay? 

And to answer this question, you will have to build a model that takes into account your cost model and more importantly, you have to forecast how your product will be adopted in future.   Future is uncertain and it makes this task challenging.  I have leveraged Monte Carlo methods to simulate multiple scenarios to arrive at the distribution of possible outcomes.   To reduce complexity,  you can also use simpler techniques like Fermi’s estimation to come up with reasonable estimates in perhaps, shorter period of time.

Conclusion

Putting it all together,  the journey starts by setting clear goals for our pricing strategy.  Next, we have to determine the right value metric to use for our pricing.  Then, we have to go to our prospective customers for their notion of perceived value and willingness to pay for our product. You can also try to get customer validation of your chosen value metric. Finally, you develop a model to test the viability of your business by plugging the price inputs provided by your customer.

Hopefully, these guidelines will help you in your pricing journey.

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