A detailed step-by-step guide on how to create your first pricing strategy.
Bogomil Balkansky, Partner at Sequoia Capital, recently outlined in a popular Linkedin post that, while pricing is one of the most important pillars of a successful startup, it's too often one of the most underutilized levers.
It's an unseemly paradox but one that I can understand because, in my opinion, there is a serious shortage of quality playbooks and guidance tools, tangible advice and frameworks, available to founders and operators to follow.
With this article, I hope to right the ship by sharing a structured approach for how you can create or optimize your pricing and packaging.
In this first article of a two-part series, I'll focus on pricing and in the second post, I'll dive deeper into the packaging aspect.
Below are the three core steps I believe all startups should think about when they set pricing. Note that this is mostly focused on B2B Enterprise companies but most of the topics will be relevant for all kinds of companies.
1. Aligning pricing with the business model & GTM strategy
2. Outlining the pricing objectives
3. Defining the four pillars of pricing
Step 1 | Aligning Pricing with the Business Model & GTM Strategy
Your pricing will impact your GTM strategy. This is often not clear at the very beginning when you have only a few customers but, over time, it will dictate how you develop your product and how you go to market. Most companies customers will fall into one of the below three buckets:
- Consumer: <$2K ACV
- SMB: $2K-$20K ACV
- Enterprise: >$20K ACV
If your customers are either Consumer or SMB (below $20K annually) in most cases it is hard to justify an expensive sales force as the margins will not be sufficient to cover the additional resources required to sell the product. You, therefore, need to build self-serve into the product or a very transactional selling process.
Here are two simplified examples of how ACV impacts the GTM:
- Low ACV (<$20K): You won't be able to hire an expensive outbound sales force and will instead need to rely on online and inside sales. Sales cycles will have to be short (less than 3 months), which means your product should be relatively simple to sell.
- High ACV (>$20K): You'll be able to hire SDR's and AE's to generate leads and close deals. The product can be more complicated and sales cycles can be longer (3 - 6 months) due to the higher ACV.
Key takeaway is that the price point you set determines how you can go to market.You want to make sure you aren't charging SMB prices for a product that is sales-led, and have enterprise sales cycles and complexities.
Step 2 | What is Your Pricing Objective?
While the objective is ultimately to generate high revenue and profits, your early goals can differ. It's important that you reflect on this as it will help you to understand what pricing strategy will make sense for you to pursue.
Whilst it's broadly agreed that, over time, value-based pricing is the best strategy for monetizing your product or service, you'll often see companies initially launch with pricing more focused on the existing competitors. Below are some of the most popular pricing strategies and examples of companies that have pursued them.
Uber is a core example of Competitor Based Pricing. In the early days, they would find out what competitors were charging and price 30% below in the cities they launched, regardless of the country and the market dynamics. They knew that, as long as they were 30% cheaper, it would create the sufficient flywheel effect and get people to use the service and refer it to their friends.
Besides the macro-economic changes and the cost of capital, Uber has also been able to win and now dominate many markets, which has enabled them to slowly increase prices over time and charge close to what the taxis they originally competed with did.
Step 3 | The Four Core Pricing Pillars
When you're ready to set your pricing strategy (or optimizing an existing one), I like to use the four Ps of Pricing.
1. Pricing Metric
Many will argue having the right pricing metric is the most important aspect to get right when it comes to pricing. This is what determines what you charge for and how customers can grow with you. The pricing metric should be very closely aligned with the value the customer sees in your product. The closer the better, so the more of the metric they get the more value they receive.
Value Metrics can be either functional or outcome based. A few examples below:
How do you find the right pricing metric? This is most often through a combination of actions. Most importantly, it is about creating a few potential value metrics. Often these will come by looking at industry peers and from an assessment of your product. Once you have a list of 5-10 potential value metrics you should reach out to existing and potential customers to confirm that these align with the value they see in your product. Finally I like to ask the following three questions regarding the value metric:
2. Pricing Model
The pricing model is the next thing to determine. How and when are you going to charge the customer? For the majority of SaaS companies recurring revenue that is invoiced Monthly or Annually is still the preferred way to charge. More recently many successful companies have implemented usage based charging into their pricing models.
- Subscription: This is still the preferred way to price for most companies and normally what I would recommend - particularly for B2B Enterprise companies. It’s simple and easy to understand and most buyers will be used to agreeing on a monthly or annual amount. Companies particularly like the predictability of knowing the price each year and being able to budget with it.
- Usage based: Completely aligning incentives is why usage based pricing has had a surge in the past 5-10 years. Companies like AWS and Snowflake have pioneered this and shown how powerful it can be. It can also be very powerful in competitive situations as you are aligning value and price so closely together.
How do you find the right pricing model? The default approach is to create the first pricing model using a subscription model. This is what most customers will be used to and makes it easy and predictable to buy from you.
- You should have a look at the five companies that are most similar to you and see how they are charging. I wouldn't recommend innovating on the pricing model this early on.
3. Pricing Level
How much should you charge for your product? That is a core question that all companies need to ask themselves. This will depend on your business model and GTM strategy. How much you decide to charge impacts the kind of GTM channels you can afford and also how your product is perceived in the market.
- Affordable: Being affordable will often be the strategy of startups. You will often have a product gap to incumbents and need to compete on price as well early on. It will also often lead to great adoption of your product which is valuable early on.
- Premium: Premium pricing is normally only relevant in the cases where you either have a premium product or have created a product in a new category.
How do you find the right pricing level? Normally a combination of inputs will ensure you land at the right price. How you value the various inputs will depend on your market and business model. In most cases I recommend a value-based approach where you are charging based on the willingness to pay from the customer. In order to do so I would look at the below four sources to determine the price.
If you already have pricing data you can use. A data point to indicate if your pricing is the win ratio. For B2B companies they should normally win between 20-50% of the deals they get through the door with a good single benchmark being 40% win ratio. If yours is a lot lower, you might need to reduce price. If it's a lot higher, you might need to increase price.
4. Packaging
How you decide to bundle up your product is an important consideration which will also be depending on your GTM. Below are the 5 core packaging archetypes that you can leverage. In most cases I recommend a Good-Better-Best approach but we will be digging more into how to segment and package your product in the upcoming article on packaging.
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To wrap up the first article of this two-part guide, I wanted to mention some of the most common mistakes I see startups make:
1. Too much complexity: Your pricing must be easy to understand for the buyer. It should be super simple to buy from you. You do not need to innovate on pricing early on. Just keep it simple.
2. No upsell path: Have some kind of limitation in your pricing. There are two ways to do this. Either based on feature limitations or usage limitations. Ideally create packaging that has both. Something that aligns with value and allows you to either upsell or charge more as the customers sees more value
3. Not doing value based pricing: Value based pricing is crucial early on. You need to constantly be testing your pricing and keep pushing the envelope for what you can charge.
4. Pricing too low: They price too low. Rule of thumb. Keep increasing until you lose 20% of deals on price.
5. Understand willingness to pay and customer segmentation: Different customers will value your solution differently. You need to price discriminate. Figure out how much the various segments of customers are willing to pay and charge that.
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