You just finished building your MVP. Now you’re looking to launch and start getting paying customers. The problem is, you have no idea how you should be pricing your product. You are probably asking yourself:
“Do I create multiple tiers?”
“Should I be charging less than my competitor, or more?”
“Should I gate off specific features, or charge by a metric like number of users — or maybe both?”
And the list of questions goes on…
This article aims to help you find answers to all your pricing questions by asking: Who is your ideal customer? Having a deep understanding of your ideal customer will enable you to build pricing which directly targets them by showing them the value they need to get from your product at a price they feel comfortable with.
You must know your customers to know your pricing
A Buyer persona is a representation of who your ideal customer is with as much detail as you can muster. Some of the things you should be thinking about when coming up with your buyer persona are:
- What is your buyer’s role in their organization
- Which of your features do they care the most about
- What marketing channels can you find your buyer in?
- What value does your buyer hope to get from using your product?
- What price are they willing to pay?
Ideally, you would research this information by interviewing your customers and giving out surveys asking questions about themselves, and worst-case you just have to make estimates yourself and fill in the blanks as you gain customers. Beware asking non-paying customers for any information — these people are usually not going to be an ideal customer and will affect your strategy by optimizing for people who don’t pay.
The more details you can get, the better; these personas are useful not only for your pricing model but also as a framework for every single decision you make for your product.
What does your customer care about?
One of the most important things to consider when it comes to pricing strategy is what your different customers actually care about when they use your product.
When building buyer personas for Servicebot, we made a spreadsheet mapping value propositions to personas, giving us an understanding of what parts of the product our potential customers care the most about.
A basic mapping of value proposition to buyer persona for Servicebot
By realizing who wants what, you can understand which features all customers should have, and which features can be gated by tiers. If you can figure out that the CFO of a large organization is one of the few that cares about a specific value proposition, you may consider gating that value behind a higher tier because you can expect them to have a larger budget than, say, the bootstrapping startup founder.
Build your pricing strategy on top of your personas
In doing this exercise of fleshing out your buyer personas, you now have the information you need to build a logical pricing strategy. It’s tricky figuring out what your different pricing tiers should look like.
Pricing By Value Proposition
Having more expensive tiers offering more features is a strategy a lot of companies use price their SaaS product. When executing this strategy, you need to pay close attention to which customers care about what features and create a logical progression of company size to the need of a specific value proposition your product offers.
Pricing By Value Metric
Pricing your tiers based on value metric(s) is another common strategy. A great value metric is one that as it increases (causing the cost of the product to increase), will also increase in the value the customer receives from your product. For example Stripe charges based on the amount of revenue processed.
Finding a combination of bundling features with value metrics is the essence of coming up with an effective pricing strategy. The goal is to create a logical, easy to understand pricing model which will allow you to grow as your customers grow.
What prices should you actually be setting?
Now that you have a strategy formulated, we need to finally plug in prices. There are three different approaches pricing models generally take:
Cost-based Pricing
A cost-based approach takes your product’s internal costs and adds a margin on top. For example, if each customer costs you $100/month you could price your product at $120/month, giving you a $20 profit per customer. The problem with this approach is that it only looks at your company’s costs and does not take into account the customer’s feelings about price.
Competitor-based pricing
A lot of startups end up pricing themselves compared to their competitor, which may or may not be effective. Trying to match or undercut your competition’s prices can suffer from problems like a race to the bottom (think of how Uber subsidized their prices to drive out competition). It is generally better to optimize your price for your own value provided to customers, especially if you are offering more value than the competition.
Value-based pricing
Value-based pricing is the most effective (but hardest to implement) type of pricing model because it’s tailored uniquely for your company. You need to understand how much value your customer is getting out of your product and price in accordance to that. Many companies use the “10x rule” when it comes to value pricing: Give your customers value worth 10x the price you are charging them.
How do you figure out what people are comfortable paying?
To figure out what people are willing to pay, you can’t just ask them directly “what do you want to pay.” Dutch economist Peter van Westendorp recommends asking four questions to gather valuable price data from a specific customer segment:
At what price would you consider the product to be so expensive that you would not consider buying it? (Too expensive)
At what price would you consider the product to be priced so low that you would feel the quality couldn’t be very good? (Too cheap)
At what price would you consider the product starting to get expensive, so that it is not out of the question, but you would have to give some thought to buying it? (Expensive/High Side)
At what price would you consider the product to be a bargain — a great buy for the money? (Cheap/Good Value)
Be wary of freemium
A lot of companies offer a “free tier” which has limited features. The idea is that people will start using the product, get value out of the free tier but see a lot more value if they were to start paying and eventually upgrade. In theory this sounds great and for some companies it is. The problem with the free tier is that you may start running into problems such as the high cost of providing support to the free customers, the free tier bringing in the wrong type of customer, and requiring you to spend resources to try and convert the cheapest customers to actually pay you. Early-stage startups feel this pain the greatest since they can only afford spending resources on critical operations. Look at your buyer personas and product — sometimes the freemium model works well and sometimes it does not.
Pricing your product is an ongoing process
You will never be done with your pricing strategy. As you get more data and feedback from your customers you will change your personas to be more accurate and change your pricing strategy to better target those people.