How to Effectively Price Your Product to Drive Growth
When building a company, there are three key components to fast and healthy organic growth: pricing, sales volume (e.g., subscription, usage, etc.), and profit margin. Whatever happens with the combination of these three components and their interaction will determine the trajectory of any organic growth. Today, we are focused on pricing, which significantly impacts the other two components.
Pricing is a powerful tool to drive, not just in driving revenue growth but in strengthening your relationship with the customer; hence it’s not something that should be approached without a clear strategy. Viewing pricing as a strategic choice will allow you to differentiate yourself and accelerate your growth. Today I want to discuss how you can strategically approach pricing with an emphasis on SaaS products. However, I do believe this applies across all business models.
Don’t Reinvent the Wheel
First, don’t try and reinvent the wheel when it comes to pricing models. Your customers are used to the pricing models already out there, and if you have to educate them on pricing, you risk losing them. There are a lot of great resources on choosing the best pricing model for your business. Review them and make a data-informed decision about which one to use. This article from Cobloom is a good overview of the various well-established pricing models: https://www.cobloom.com/blog/saas-pricing-models.
In addition to not reinventing the wheel, don’t be too arbitrary in setting your initial price points. Yes, you can always change pricing, but the influence of the initial pricing lingers. Once you set a price, even if done arbitrarily, it becomes established in your mind and will not only influence you now; it will influence your future pricing decision. Learn about the various pricing models, find what fits your business, and as you iterate, be conscious of the fact that the early price becomes a mental anchor.
Adopt Value-Based Pricing
Pricing should reflect the value you’re giving the customer. Identify the value creation activity of your software, then try to tie pricing to it. When I started TheraNest, many of my competitors were pricing based on the number of users a practice added to their account. In my opinion, the internal user wasn’t really where the value was for our customers, mental healthcare providers. We took a different approach and priced based on the number of active clients a practice saw and allowed our customers to have an unlimited number of inactive clients in their account. As their practice grew, they could add as many users to TheraNest as they wanted – everyone from the office assistant to supervisors and practitioners could be added. We chose to align our growth with their growth in terms of clients because that was the relationship that actually gave them value from the product. Limiting users just limited the number of people that could help the practice get work done. The fact that people didn’t have to worry about who had access and who didn’t was really powerful and helped us have a different kind of conversation with prospects. They couldn’t simply compare us to others based on who was cheaper per user.
Value-based pricing gives you an advantage over companies that are pricing based on their costs or competitors' prices. Cost-based pricing (sometimes called cost-plus pricing) seems like the most intuitive method to maximize revenue. If you want to recoup your costs, you should charge your customer enough to do so, right? This reasoning is flawed for many reasons. Costs aren’t fixed. Are you going to change your price every time your costs change? This strategy also disregards the customer. Your customer doesn’t know your costs, so why would they evaluate what they’re willing to pay based on them? Customers make decisions based on the value you provide. Your pricing should reflect that. If you’ve established your first customer and are orienting your growth strategy around them, you should be differentiating yourself, not mimicking your competitors unless it’s clear your competitor has it right.
An eye on value-based pricing should be part of your customer discovery and continuous improvement processes. Your customers are the ones who know the value of your product, so listen to them. Use customer insights to identify your primary value proposition. Build out your pricing from there.
Offer a Low-Risk Entry Point and Create an Upgrade Path
Once you’ve established your pricing scheme, it’s important to give customers a low-risk entry point. Even when you’re doing big, enterprise-level deals, giving people that low-risk starting point is essential. Typically in SaaS companies, this is a free trial and a low-priced tier. You want to make it easy for the customer to get started with your product, regardless of their size. Get the product in their hands and demonstrate your value so they’re willing to pay now and pay more over time. The whole point of a free trial is to build trust. Building trust by providing clear value from the get-go makes customers comfortable with your pricing. This may extend beyond a free trial to a money-back guarantee or other similar strategies. The point is that you want to remain customer-focused and make it clear that you believe that the value you’re delivering is genuine.
Creating an upgrade path is very important and drives margin expansion so that as your customers grow and get more value, you also capture more value.
As much as possible, you don’t want to give away an unlimited amount of your value drivers. Giving unlimited benefits for one payment is almost always a bad idea, especially if what you’re giving away is a core area of value in your product. Doing this caps your growth and limits your revenue opportunities. It can also limit how much value the customer perceives that they’re getting from the product. Just as your growth is capped when you do unlimited quantity pricing, your customer may reach a point where they psychologically assume their value is also capped. Keep providing opportunities for them to upgrade their value.
Be Wary of Underpricing
It’s common for SaaS products to be underpriced in the early days. Sometimes this is a strategic choice – other times you do it on the assumption that you can beat your competitors by undercutting them on price. I’ve addressed above why I think this strategy is a bad idea. However, underpricing is often the result of arbitrarily setting your price. Regardless of how you came to your price, be wary of setting it too low. Even if you gain customers quickly because your prices are so low, this is not a sustainable growth path. You’re at a greater risk of losing those customers because they haven’t properly weighed the value of purchasing your product and if low pricing crimps your ability to increase your product value due to margin and cash compression, you will provide less value over time. You want customers who are willing to pay for your product’s value. Even if they take longer to acquire, you’re more likely to retain them. Adopting value-based pricing should help you avoid this pitfall. If you’re pricing based on the value you deliver, you won’t be underpriced.
Pricing is Never Finished
Your pricing should continue to evolve as your business grows. For example, if you discover that you have in fact been underpricing your product, you should adjust accordingly. It can be scary to change your pricing because the customer response is uncertain. However, there are creative ways to approach adjusting your price. In the early days of TheraNest, we discovered that we were actually underpricing our product. We didn’t want to raise our pricing, but we looked at the value we were providing our early customers and realized that if we decreased our value by half, it wouldn’t impact most of our customers. We made the decision to update our plans accordingly. Under the new approach, the same price got you half the number of active patients (of course, we grandfathered in our existing customers). That change allowed us to indirectly raise prices without seeming like we were raising them. It better reflected the value we were giving our customers and supported our ongoing growth. This is just one of many creative ways to maximize value without simply raising prices.
Your customer success efforts can also be used as pricing research. Customer feedback surveys can reveal a lot about your pricing strategy. Gather data on what features customers love–the ones they feel they couldn’t live without. As these preferences get stronger, you will be able to raise prices. You should also continue to gain insight into which features are “nice-to-have” but not must-haves. These can be priced as add-on services or included in your highest tier. Just as you continuously improve your product through data collection, keep optimizing your pricing. Your customers’ willingness to pay for your product should keep rising as you grow, and your prices should adjust to reflect that.
Let me know how you’ve been thinking of your own pricing strategy here, on Twitter (@sotulana), or on Instagram (@shegun_otulana).