5 Key Concepts for a Smart Startup Pricing Strategy
Building a company is no easy task. From creating a product to hiring the first employee, there are a multitude of things an entrepreneur must do to get the company off the ground.
One of the things that often gets lost in the shuffle (and really shouldn’t) is the startup’s pricing strategy. Too often the task of pricing is left to the very end of a product launch, but entrepreneurs should really take the time to build a thought-out pricing plan to achieve larger goals for the company.
The result? For many startups, it’s going to market with an unachievable revenue model, diluted value in the product and the company, and limited pricing capabilities to address current and future market pressures.
So what can entrepreneurs do today to ensure value is not lost? Here are five essential concepts you need to understand to start building your pricing strategy.
Know your product’s (pricing) value
Today’s entrepreneurs have been doing their homework and now understand that pricing is a function of a product’s value. Yet when asked what value means, they find that the question is much harder to answer than it appears. For most entrepreneurs it is easier to create value through products than to extract value through pricing.
In the simplest terms, value in a pricing context is the benefit customers receive through your product or service. This is not a feature or a price point, but the reason why customers want to use your product. Even if this seems obvious, it’s often one of hardest exercises for startups because it is overlooked during the product development and customer discovery stages.
The heart of a high-impact pricing strategy is identifying two drivers: what brings customers to your product and what gets them to pay. While subtle, the distinction is material—just because a customer is willing to use your product doesn’t mean they’re willing to pay for the product. Get to the heart of your product’s value and you’re one important step closer to building your pricing strategy.
Leverage insight powers of pricing
Many startups actively do research on the market, customers, and competition. This research can be anything from collecting answers to short one-question surveys to longer and more involved studies. While conducting this research, many entrepreneurs ignore pricing as a signal, because they fail to realize how pricing and specifically the development of a pricing strategy can provide invaluable insight to the customer and market.
Unlike other forms of research, pricing research is focused on understanding the one thing customers are less willing to part with—money. When startups start to dive into pricing questions, new insights on product-market-fit are generated that would otherwise be difficult to determine.
For example, it may turn out that a killer feature all customers loved during product testing may not be one that those same customers are willing to pay for. This raises questions not only for pricing, but also for the product, sales, and marketing teams. Should the company continue developing the feature? Will changing the price level change customers’ willingness to pay? How will sales and marketing fill the gap between current perception of value and the desired pricing?
These are difficult questions, but they can provide vital insight, not only into how a product should be taken to market, but also into the startup’s objectives and its capability to successfully execute them. Failure to capture this insight into a pricing strategy can lead to a rude awakening.
Pricing is a strategic and tactical weapon
There is often a “set it and forget it” mentality when it comes to pricing, but the best companies understand that a strong pricing strategy is a source of competitive advantage.
With clearly defined objectives and planning, startups can use strategic and tactical pricing to achieve larger goals. For example, Apple rarely discounts their prices, and instead often offers discounts via iTunes gift cards. This is an intentional, well-designed strategy. Strategically, Apple’s prices are purposefully positioned to signal to customers and competitors that its products are premium-tier. This also makes price a non-negotiable factor, causing customers to evaluate other factors to determine their own willingness to pay.
Pricing is also a tactical tool to achieve measured and often short-term goals. One example is the use of promotions to increase basket size (i.e. the number of items purchased in a single transaction) or move unwanted inventory. In other situations, a company can use pricing to unbundle products or features to increase the perception of affordability. This tactic is commonly used, for example, by airlines. Features such as baggage and food are unpacked from the overall offer to bring the presented airfare price down and increase the likelihood of a sale.
Mindset for leaders and teams
One of the most important success factors to an effective pricing strategy is the mindset of the company’s leaders. Company leaders set the vision for the company’s pricing strategy, but also the development, execution and maintenance of pricing. This is a classic example of success starting from the top.
Whole Foods’ co-founder John Mackey brought organic foods into the American mainstream and reshape how people viewed healthy eating and food sourcing. He also introduced prices to reflect the value he saw in foods that delivered this value.
While earning the store the cheeky nickname “Whole Paycheck,” Whole Foods’ prices were both intentionally and purposefully high: they shaped perception of premium value, created a sense of uniqueness and practically, and helped to drive profitability and growth. This pricing strategy started from the top, with leadership setting the goals.
A purposeful pricing mindset isn’t found only in large corporations, but in startups as well. The Information, a digital media company founded by Jessica Lessin, went against digital media trends and put up a paywall to monetize for the quality content they were creating.
How much value did Lessin see in their product? No less than the Wall Street Journal. The Information’s annual subscription is priced at $399 or 18% more than a comparable digital-only WSJ subscription.
When pricing starts at the top, it sets the tone for the rest of the company. Leaders guide their teams on what value means and how pricing decisions are made. For startups where leaders don’t take up the pricing mantle, their product’s value is diluted through poorer pricing decisions and impact opportunities to drive revenue and profit growth.
Way to keep your light on
This is perhaps one of the most obvious essential pricing concepts, but the pricing strategy should be designed to help the company grow financially, starting with not losing money (for too long). Many companies disassociate pricing and financial objectives, often to the detriment of the startup.
It is vital for startups to understand that they are building a business and this means that their revenue model needs to be built on better and stronger pricing. When prices are misaligned with value and willingness to pay, the financial results for the company often reflect that truth.
Building a pricing strategy also means identifying financial tradeoffs. For startups this can mean speed of growth, market penetration, and profitability. It is critical for startups to assess desired short-term gains, but also the implications those decisions have for sustainability beyond. Many startups end up discounting and competing on lower prices for short-term gain, only to find themselves either unable to retain customers or stuck with a broken revenue model.
Startups are challenged by many things inside and outside their companies – from limited resources to competitive pressures. Pricing is one area where startups have some power to shape their own destinies, but it requires a thoughtful strategy built on actionable insight and leadership.
It’s easy and common for startups to push pricing to the backburner, but before too long, they find out that it’s too late. Make the effort today to understand the components and work required to build a strong pricing strategy. It can create be a well-earned advantage many of your competitors will overlook.
This article is intended for informational purposes only, and doesn't constitute tax, accounting, or legal advice. Everyone's situation is different! For advice in light of your unique circumstances, consult a tax advisor, accountant, or lawyer.