Marketing 303 for Engineers: Understanding Pricing

(Photo by Alvaro Reyes on Unsplash)

How do you know what the value of a product or service is?
How do you know what the value of a product or service is to someone else?
How do you know what they will pay for that value?
How do you know what you can, or need to, charge for that value?

These are the core questions of pricing.

Pricing is its own specialized field of research in economics, psychology, and business. There are research firms and consulting shops built entirely around helping businesses find the best possible price for your thing for your market.

In this post, we’ll talk through how to think about pricing from a marketing perspective.

Programming notes: this post is n in a series of indeterminate length on GTM topics mainly for startup people, mainly leadership, mainly coming from non-GTM backgrounds. There’s a list at the end.

Pricing is marketing

Pricing broadcasts explicit and implicit messages about your product. Much of which you only have tenuous control over.

For similar products, is this a cheaper alternative, on par with the average, or a premium?
Relative to similar products, do the capabilities and value created align with the price? Is it cheap because it does less or is it a better value because it does the same for less? Is it premium because it does more, or something special, or something niche?
Is the pricing and how pricing scales transparent and predictable? Or opaque and unpredictable? Are you easy to do business with or hard to do business with?
Does the price structure and unit of consumption match the target buyer’s procurement process and how they’re used to paying for things?
Is this price marketable inside the org? Will paying this price make me look good or bad to my boss?

Corollary: the pricing page is a marketing page and pricing page actions are significant indicators of qualification and intent.

Advice!

Pricing needs a marketing intent and purpose.

Know where you want to fall on questions like those above and explicitly find a price structure that gets you in the vicinity.

Then validate that that’s the case with your actual market.

Then decide how to communicate that online, if at all, and make sure that it’s perceived how you expect it to be by your actual market.

More advice!

Are you a startup? You’re probably just going to look at what competitors charge and what it it is you think you need to charge to bring in the right amount of revenue given some assumptions about how much of the market you can capture in order to hit some more or less arbitrary milestone set by an investor in order to raise the next round of funding.

You should still work out everything discussed above after the fact. This will form a useful baseline to inform pricing and other go to market decisions in the future.

Pricing has positioning power

Pricing is a signal of what category a customer should put your product in. Not just in terms of being on the scale of fungible commodity to bespoke premium service. But also in the sense of what you are comparable to.

Example!

If you sell a marketing automation product but meter and charge on a purely usage based model — as opposed to database size x feature package — are you really selling a marketing automation product?

Another example!

If you sell a premium service that customizes and installs made-to-measure software using a heavy forward deployed engineer model but charge less (net) than a pre-packaged COSS product, are you really selling an unmaintainable erector set?

Pricing changes sales cycles

The more you charge, the higher the power needed to say yes to paying for it. The higher the power needed to say yes, the more work your sales team has to do and the more likely you are to need a sales team in the first place and the more people you’ll have to convince of the value you provide and the more value you’ll have to provide and/or the more critical your product will need to be (need to have not want to have) and the stronger the business case for it will need to be and the more negotiation that will take place and the more likely it is that there will be someone on the customer side whose sole purpose is to negotiate your price down and the longer your sales cycle will be. Etc.

On the flip side, the less you charge, the more likely it is that if your product is even halfway good that it will spread like wildfire because everyone has the authority to pay nothing for something.*

*Except for specifically regulated industries where even free things take multiple layers of approval.

Pricing is friction.

Growth vs Revenue

Another way to think about sales cycles is in a frame of growth vs revenue.

The less you charge, the more likely it is you will grow. The more you charge, the more money you will make. This would seem non-controversial on the face of it. But it’s not remotely how the real world works.

Charging nothing might make it seem like your product has no value. Charging any specific price might limit your adoption so much that you never get enough revenue or adoption or growth to either raise money or have a sustainable business.

One of the reasons VCs care about product-market fit is that it indicates there is some path by which you might figure out this tradeoff in a way that generates money either through investment or revenue or some combination.

Pricing vs Packaging

Packaging is how you organize what you sell for consumption.

Are there different tiers?
Do customers get different versions of the product depending on how much they pay?Do customers get differentiated service depending on how much they pay?
Is there a base fee for access to the platform and then additional fees for different capabilities or additional scaling units?
What is the unit of consumption?
What is the unit of price?
Does the pricing unit scale with the cost unit (fixed margin!) or superlinearly (growing margin!) or sublinearly (negative margin at scale!)?
Is everything a la carte?Etc

The combination of pricing and packaging is a strategic decision that determines margins and how revenue scales for your business. Whether you make it strategically or not is another question

These decisions, once operationalized by staff and built into your systems, are hard to change.

When you are early stage, you inevitably change them and end up with some customers on one pricing + packaging scheme and others on a different one. Some of those customers will be aggrieved and you’ll have to manage that.

Advice!

Try not to mess with this more often than twice a year when you’re tiny and once a year when you’re any bigger than tiny.

The longer you wait to automate this and embedding it into organizational practice, the more degrees of freedom and optionality you will have to find an optimal-for-now price structure. This is not for the feint of heart. But if you can stomach it, do it. A small optimization here will pay compounding dividends into an unpredictable future.

Pricing is an elemental part of going to market

Your pricing should complement your messaging, your design, the nature of the problem you solve, the power seniority of your customers, the budget authority of your customers, the money you help people save, the money you help people make, the pain you take away, the sales experience your prospects have, the ease or difficulty of implementing your solution, etc.

Your pricing should not cause cognitive dissonance.

More advice!

I have extensive experience trying to change how buyers think about the unit of consumption of some product or service. Even when we were providing greater value at a lower price — because the model was different from how they were used to thinking about, modeling the future cost of, and procuring — we were inevitably pushed into either reworking our pricing to match customer expectations or (maybe worse!) creating an overlay pricing model with a bunch of fine print where we still priced the same way as we always had but changed the presentation of it so it was easier for customers to deal with. The last is a landmine that someone inevitably steps on when their expectations deviate from reality. One of the parties will eat that deviation in lost dollars.

Pricing approaches

This is a very basic rundown. Please consult an expert if your needs are more sophisticated (color me skeptical). Or, as Patrick McKenzie says: just charge more.

Cost plus (least thought)

Basic: charge some uplift on your cost of providing the product or service

Less basic: charge some uplift on the fully burdened cost of providing the product or service, including staffing, real estate, etc etc

Value (most rev per account)

Basic: charge some amount that’s reflective of the perceived, market set, or realized value you provide to the customer. This amount might be completely arbitrary.

Less basic: have a business case that proves the independent range of value a customer will realize, like money saved or money made or PR disasters averted etc

Growth (land grab)

Basic: charge zero

Less basic: charge just enough so that people feel committed to giving the product a shot but not so much that there’s any real friction to purchasing

Intermediate: freemium

Land and expand (more revenue tomorrow than today per account)

Basic: charge little enough that it’s super easy to adopt with the intention of monetizing expanded usage through a growing license/subscription base within an account over time — this is effectively what freemium is

Less basic: the SFDC model where you land at the individual and then sell to the manager of individuals and then sell to the manager of managers, working your way up an org over time until you’re indispensible

Advice!

You can mix and match the above! People do it all the time. You can spend hours, days, weeks, and months figuring out what to do. Don’t do that. Get in market and get feedback. Know what kind of business you’re trying to create and manage your risks for that kind of business.

More advice!

However you charge, ultimately you want price to scale at least linearly with cost — preferably super-linearly, which really means that cost scales sub-linearly as you provide the product/service because you get economies of scale on one or more dimensions.

Which means margins are consistent or growing.

Even more advice!

On the flip side, if pricing scales sub linearly with cost, you need some confidence that 1) you can capture enough of the market or have rocket ship growth such that you have so much revenue that it doesn’t matter or 2) that you will find additional sources of revenue in the future through up-sell, cross-sell, data sell, selling your users/customers to third parties, etc.

Posts in this series (and templates)

Reading List and Resources