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Lean pricing startups

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Why is this book so important? One of the biggest lessons I have learned within the startup landscape is that even though pricing, together with the business model, remains by far the lever that most impacts revenue, the subject is a sensitive one.

Pricing is a strong — but often underused — tool available to capture a share of value created for customers

Pricing is one of the biggest challenges that startup face. The book is a practical toolkit that positively influences the pricing strategies of startups. It reveals insights in the different pricing methods and tactics used by successful companies.

Lean pricing startups

  1. 1. PRICING STRATEGIES FOR STARTUPS OMAR MOHOUT GROWTH ENGINEER
  2. 2. Omar Mohout 2 ONE TWO THREE FOUR Contents FIVE SIX SEVEN PRICING PRICING METHODS MULTI-AXIS PRICING PRICING STRATEGIES FREE OR PAID FINAL WORDS CONCLUSIONS Slides 3-9 Slides 10-13 Slides 14-17 Slides 18-21 Slides 22-25 Slides 26-27 Slides 28-29
  3. 3. PRICING You can always pay cheaper, but is this what you want?
  4. 4. Pricing Determines Your Market Position Commitment of money is a very powerful validation of your business model. The price your customers are willing to pay validates to which degree you have nailed the solution. Pricing is one of the most sensitive topics in business. It will determine your market position, whether or not your customers can buy from you, the sales and distribution channels and whether or not you can provide the level of service expected by your customers. Most of us determine prices using competitive research and / or cost estimates. A high price may result in less customers whereas a lower price can be seen as leaving money on the table. Often, the price stays where it is, never knowing how many more customers you could have had or how much money you're leaving on the table. Price is the dominant factor for your profitability. Omar Mohout 4 A price increase of 1% results in 11% increase in profit. 1% 11%
  5. 5. Omar Mohout 5 The Relationship between Price and Customers A higher price means less customers. At a $10 price point: 500 customers will buy. At a $20 price point: 300 customers will buy. At a $50 price point: 50 customers will buy. At a $100 price point: 5 customers will buy. $10 $20 $50 $100 500 300 50 5
  6. 6. The Optimal Price-Customers Tandem Omar Mohout 6 $100 $50 $20 $10 500300505 Correlating price points with potential clients is called in economics, the demand curve. $6.000 $5.000 $2.500 $0 50030050 Multiply the number of potential clients with the respective price points to find the optimal price-customers tandem to maximize revenue $20 is the optimal price The optimal price provides the maximumrevenue not the highest margin or the largest number of customers.
  7. 7. Setting the Right Price Price is not what you think you can charge, but what your customers are willing to pay based on the perceived value. Traditionally, the price is the sum between cost and profit, which means that in order to determine your profit, you need to subtract the cost from the price, which is known as lean thinking. A better way to determine your profit is : Sales – Fixed cost – Variable cost. The better way for Start-ups to improve margins is to increase volume with the same fixed costs and less variable costs. It should go without saying that the price must always be higher than costs. Omar Mohout 7 Before setting the price, you need to ask yourself the right questions: • Why would people pay for my services or products? • What value will customers get from my offering? Once you identify the reason why potential customers are willing to pay, you can create a business model to capture that value. In doing so, you need to have a clear understanding of your product’s or service’s value before you set the right price.
  8. 8. Omar Mohout 8 Delivering Value What type of value are you delivering? Make sure your product or service offers more than what the customers pay for. The value hierarchy is the order of values that influence business decision making. Those values are: Features A product’s features represent the basic level of value delivered. Advantage The advantage that a product offers. This is a characteristic that competitive products don’t have. Benefit The benefit is the impact of your product on the customers’ business often measured as Return on Investment (ROI). Benefit of the Benefit At the end of the day, the decision maker is a person that will take a risk with adopting your product in the organization. Often it’s important to understand what’s in it for them to make the decision. This value is called the benefit of the benefit The Pain of the Pain The pain of the pain is having a solution for a problem that is a pain in itself. INCREASE REVENUE DECREASE COSTS REDUCE RISK
  9. 9. Omar Mohout 9 Factors Influencing Pricing For a trader, selling is buying. The purchase cost drives 80% of the sales price. For a manufacturer, selling is production- efficiency. The production cost drives 80% of the sales price. For products based on Intellectual Property, such as software, SaaS and web services, cost is driven by two major factors: the cost of sales and the level of support you want to provide. VALUE Need (B2C) vs. Pain (B2B) Return on Investment (ROI) Must Have vs. Nice to Have CLIENT ALTERNATIVES Doing nothing is #1 alternative Alternative is often the use of Excel COST Variable Cost Fixed Cost Internal Cost Structure MARKET Type and Length of Contracts Competition Regulation $$$
  10. 10. PRICING METHODS There are 11 different pricing methods you can use
  11. 11. Omar Mohout 11 Pricing Methods 1. SILICON VALLEY RULE OF THUMB We charge this much because our customers get at least 10 times that much value. In other words the ROI is at least 10:1. You need to really understand your customers and the value you are delivering. 2. CUSTOMER INTERVIEWS Don’t ask the customers for ballpark pricing. It is better to explain your pricing model. Usually the right price is the one your customers accept, but with a little resistance. Keep in mind that Price Objection is in fact Value Objection. It’s not the price that they are not happy with. It’s the value they don’t like. You need to know the customers’ willingness to pay (value perception) and their ability to pay (how, when, why, where, how). 5. GOOGLE-ADS Lookup the cost per click for relevant search words, using Katalict. The price of a “word” is a starting point to calculate the cost of sales. Fill in an estimate of your sales funnel costs, conversion rates and the lead value. The ratio between the cost estimate and revenue estimate is the ROI for the sales funnel. The simulation will result in the cost of sales, often the largest cost driver for Start-ups. 3. INDUSTRY BENCHMARK The license model typically charges about 3 to 5 times as much as the SaaS model for a lifetime license. Calculate back, based on industry gross margins: Software = 70 - 95%, SaaS =60 - 80%. This is a very effective method but it requires that you know your cost structure very well. 4. BREAK-EVEN POINT You need to determine the potential revenue, costs and margins. What is the right price which ensures you have a viable business? Simulate with halved assumptions as Start-ups tend to overestimate revenue and underestimate costs. LINK : KATALICT
  12. 12. 7. DECOY EFFECT Consider 2 USB keys. The majority will buy USB key B since it provides much more value for money comparing it to Key A. When adding a cheaper USB key than the initial two, the purchase will shift to Key A thanks to the introduction of the Key C decoy. Omar Mohout 12 Pricing Methods 8. “BUY VS. BUILD” PSYCHOLOGY Using this method, you can price your product—on an annual basis—at 10% of the equivalent "build" price if the customers want to build it themselves. For example, if the customer has to pay $100,000 for building a similar product, you can price your product at $10,000 per year. In other words, you will provide your customers 10 years of outsourced value without a huge upfront cost. As additional benefit, the customers get a product that will continually improve, compared to a static product they build themselves. 6. ANCHORING BENCHMARK People can only understand relative value, not the absolute one. Anchoring is probably the most powerful force in today’s economics as you can compare your product or service to something much expensive. Take Steve Jobs for example. He compared the $499 iPad versus a $999 laptop, making the iPad seem inexpensive. Retailers are mastering this art of using “suggested retail price” as anchor, making your “special” price look like a good deal. A B 32GB $29 $39 64GB A B C 32GB $29 $39 64GB 8GB $25
  13. 13. Omar Mohout 13 Pricing Methods 9. PRICING – DISTRIBUTION FIT You need to ensure you have the margins to accommodate resellers, distributors, agents or affiliates. If you have a 40% gross profit margin and a distributor needs a 70% discount off the price, you’re forever limited to direct-to-consumer. You can still increase your pricing and margins after-the-fact, or launch new "premium" products to fix this problem. 10. COMPETITION You stack all of your competitors on a pricing spectrum and decide where you want to position yourself. The benefit of this method is the use of external data indicators that guide the pricing process. Part of it is still guessing, because most products are not completely the same. You should never underestimate the pricing power of established brands when setting your price. At least you have a fairly accurate view of the market. 11. INDUSTRY AVERAGE The monthly average price point on a per user basis, is between $26 and $75, with the initial sale ranging from 6 to 50 users. Typical discounts are 7-15% to those customers that opt for longer agreements. You should remember that churn is the number 1 SaaS killer*. *Source: Softletter Research
  14. 14. MULTI-AXIS PRICING A must for a freemium business model
  15. 15. Omar Mohout 15 Features, Users and Usage The aim of multi-axis pricing is to increase revenue. It allows you to capture more revenue without putting off smaller (budget) customers. In addition, it enables to grow revenue from existing customers. Multi-axis pricing is aligning value creation with pricing as there are different types of users extracting different levels of value from your product or service. If done well, it will lower the threshold for purchasing while maintaining a path to grow the customers as the usage increases. Multi-axis pricing is often around the following axis: Product Features, Users and Usage. Don't use more than 3 axis as the human brain cannot process more than 3 dimensions. 1. PRODUCT FEATURES This is the most common way. More functionality means higher price. 2. USERS The more users using the product, the higher the value creation and therefore they pay a higher price (note that the price per user is going down in this scenario). 3. USAGE More disk-space (Dropbox), more email addresses (MailChimp), etc. are indications of a higher value creation and therefore justifies a higher price. The most common axis of pricing
  16. 16. Omar Mohout 16 Features, Users and Usage These 3 axis are the most common ones. But it is perfectly possible to have pricing based on a service level agreement axis as well: Free: users need to find answers to their questions in a FAQ. Price X: users can email questions and receive an answer within a number of working days. Price Y: users can call a hotline during office hours in the specific time zone of the company (not according to the customer location) Price Z: users can call a hotline 24x7x365 FEATURES USERS Basic Edition Professional Edition Enterprise Edition DEPTH OF USAGE Mailing List Size Database Size Amount of Storage Used Note that the Users and the Usage axis, also impact your cost structure, so it makes perfect sense to put some limits or, even better, capture additional revenue.
  17. 17. Omar Mohout 17 Salesforce.com is the biggest SaaS company in the world and active since 1999. It’s an excellent case as a benchmark for best practices. The pricing of Salesforce.com is based on 2 axis : Features and User Limitation. Salesforce.com is using 1 and 2 year contracts and their monthly pricing is purely a marketing feature. It’s not because of the fact that the Salesforce.com pricing is displayed on the website that it’s fixed. You can contact the call centre to negotiate a volume discount. For Salesforce.com, providing support and training to their customers is not a cost but an additional source of revenue. Case Study The Pricing Model of Salesforce.Com “Basic Support” is included in the price but in reality this is just FAQ. “Premier Support” is +15% (except for Unlimited Editions) “Premier Training” is available. Contact Manager Group Professional Enterprise Unlimited Editions FEATURES 5 Maximum for Group and Contact Manager editions USER LIMITATION
  18. 18. PRICING STRATEGIES Additional elements to consider for your pricing strategy
  19. 19. Omar Mohout 19 Set a Reasonable Price PRICE ELASTICITY Visit the graveyard to see companies that cut prices by 15% to 20% to “cross the chasm”. Without doubt you need a “reasonable” price. Reducing it further might not cause sales growth but it will surely damage margins. Instead of cutting prices, consider reducing adoption risk by offering a performance guarantee or an attractive low-risk financing package. NEGOTIATING B2B “BIGGER DEALS” PRICING In order to negotiate bigger B2B pricing deals you need to make sure you understand the market, your options and the other side’s. You should also identify your absolute walk-away outcome and decide on your ideal outcome. It’s the side that has the most information who controls the deal. Just ask questions and don't make statements. Everything is negotiable, so negotiate everything. If the price is “too high”, ask the following key questions: • What is the number the customer is thinking of ? • How did they come up with that number ? “Instead of cutting prices, consider reducing adoption risk.” “It’s the side that has the most information who controls the deal.”
  20. 20. Omar Mohout 20 Discounts and “Special” Prices DISCOUNTS Discounts work well for companies that compete based on price and not on differentiation. Start-ups should give temporary discounts only to prove product value (it is not lowering the price, it is lowering the order for the specific time period). Discounts are linked to upfront payments (i.e. pay for 12 months and get 2 months free). The formula is simple: if the discount is lower than the cost of capital, go ahead and bootstrap the customer to finance your growth. PILOT CUSTOMERS When dealing with pricing for pilot customers, you should never do it for free. Instead negotiate a cost and a margin deal to pilot the service. Keep in mind that an important condition for a pilot is to build a relationship based on mutual trust. It’s is ok for you to make money on the deal, businesses that don't make money don't stick around to work with them in the future. “Discounts work well for companies that compete based on price” “Negotiate a cost and a margin deal to pilot the service”
  21. 21. Omar Mohout 21 In a two-sided marketplaces, the side with the highest price sensitivity receives a subsidy in order to stimulate demand from the other side. AIRBNB The host received a fee to cover the cost of processing customer payments (subsidy). Why? There are free listing services in the market which create a barrier for hosts to pay Airbnb high listing rates. Buyers are price sensitive too, but Airbnb often is well below higher priced market alternatives (e.g., hotels / BnBs). PAYPAL The existing customers receive a subsidy ($10) for each new user they invite. At the same time, those new users get $10 too. The merchant gets a better deal compared to the transaction cost of credit cards. Two-Sided Marketplaces : Airbnb & Paypal AIRBNB PAYPAL Case Study
  22. 22. FREE OR PAID Should your customers pay for using your product?
  23. 23. Omar Mohout 23 The Freemium Approach Make sure you establish the purpose of your free package. Is it aiding viral growth or is it hooking customers onto your product and upsell them other products later on? You should also determine your ideal ratio of free vs paid customers, in order for you to run a sustainable and scalable business. Your goal should be eating up your competitor's market share and NOT cannibalizing your own offer. Often freemium is a way to go from B2C (free) to B2B (premium). The freemium approach is Tease, Please and Seize. There isn't a standard template solution. B2B is twice of B2C (i.e. Evernote = 6%; Yammer = 15% conversion) A typical Freemium service is 0.5% to 5% conversion range TEASE PLEASE SEIZE
  24. 24. Omar Mohout 24 The Freemium Approach “A good free plan ideally should be similarly to a free trial.” Start with the premium part of freemium first. Since your eventual goal is to charge for your product anyway, why not start there? You can always offer a free plan later, like MailChimp did. A good free plan ideally should be similarly to a free trial. The difference is that while a free trial is time-based, freemium is usage-based. Unless you’re deriving monetary value from free users, the freemium model is less of a business model and more of a marketing tactic to fill your pipeline with potential prospects. Pricing is one of the riskiest and most critical part of the business model and should be tested early on. Freemium delays this learning. Even though the operational cost of carrying free users may seem low, they aren’t zero. Unless free users are adding participatory value (such as network affects) they are an expense. FREE TRIAL Time Based FREEMIUM Usage Based
  25. 25. Omar Mohout 25 Display and Transactional Pricing DISPLAY PRICING Visitors to your website or landing page can be divided into: • Prospects who can't afford you. • Prospects who can afford you but were planning to spend less. • Prospects who were expecting to pay exactly what you charge. • Prospects who were expecting to pay more. The main question is: how big is each group? TRANSACTIONAL PRICING Companies work with forecasts and budgets, therefore predictability is valued highly. Transactional pricing is perceived as a risk such as the inability to plan spending. Exception are industries that have a transactional based business model: i.e. per seat (airlines), per subscription (media), per transaction (banks) etc. If you have to choose between who signs up quicker and who pays the most, pick the former as they are early adopters and have a better influence on your product. In this case the cost of sales is lower and even if they pay less money, it will be easier to hit your target growth rate early on. You should also try to adapt your message to the different groups: "We're more expensive but we're better. Here's why...“
  26. 26. FINAL WORDS Nothing Lasts Forever
  27. 27. Omar Mohout 27 Remember to Revisit Pricing Pricing is not a one-time, set-it-and-forget- it deal. Entering new markets, target different segments, inflation-index, new features etc. can be a reason to revisit pricing. A pricing strategy is a process that utilizes multiple tactics. Unfortunately there is no “one-size-fits-all” answer when it comes to developing a pricing strategy. Pricing can be validated but not made by anyone else than yourself. Every paying customer is an achievement so go find out why they pay. Make sure you don’t over-engineer your pricing strategy and make it difficult to understand. Pricing is also a function of marketing. Cash Flow is as important as pricing, seeing that it’s the only reason why business die. Pricing is all about setting the right perception: water is more useful than diamonds, yet it is a lot cheaper. LINK : PAY NOW MODEL LINK : PAY LATER MODEL LINK : PAY NEVER MODEL REVISIT PRICING
  28. 28. CONCLUSIONS Things to consider when setting the right price
  29. 29. Omar Mohout 29 The Dos and Don’ts Of Pricing Research the optimal price per customer to maximize revenue Price is a continues process Understand why customer will pay you (value) Use industry gross margin as starting point Use tactics such as anchoring and decoy Take into (margin) account the possibility to work with partners Start with the premium part of freemium Offer transactional pricing to transactional businesses only Pricing is a function of marketing Take Cash Flow into account Set-it and forget-it Cut prices to sell more Overestimate Customer Lifetime Value Ask clients for ballpark pricing Underestimate cost structure Over engineer or use more than 3 axis for pricing Give discounts that aren't limited in time Do pilots for free Use freemium as a vanity metric Subsidize the wrong side or both side in a two-sided market model DOs DON’Ts These are rules, not laws
  30. 30. LEAN PRICING THE BOOK More business cases More pricing examples More guidance Leading practices Pricing methods explained in detail ORDER NOW
  31. 31. Omar Mohout Author of Lea(r)n Pricing and Lea(r)n Marketing Let’s Get in TouchLinkedin OmarMohout Twitter @omohout Slideshare omohout

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