Pricing is difficult in the early stages of a business. You have neither minimal information on the value your product provides nor your customer’s capacity to pay. Even if you have the right pricing model, almost all startups begin with low pricing, here’s how to avoid this common mistake.
Start with Premium Customers
Problem: Starting with customers who have low budgets makes it hard to appropriately price your product. Even if they use your service regularly, you won’t know how valuable it is to budget customers, because they can’t pay.
Solution: Initially, you should focus on premium customers. Premium customers are those with the most spending power for your customer profile and will often expect personal service. Usually it’s easier to test pricing in a premium customer base, as you need to talk to less people to get a representative sample. This was the approach taken by Uber — they started with a black car service priced ~25% above standard taxi fares. It would be years before they launched their budget service: UberX.
Use the Wince Test
Problem: Most entrepreneurs are afraid of hearing ‘no’ from a customer and set an artificially low price in an attempt to guarantee a ‘yes’. Given a customer won’t suggest paying a higher price, offering a low price sets you up for further downward pricing pressure.
Solution: Take whatever price you get from your market research and triple it. Setting an artificially high price, then waiting for the customer to wince (ie reject the price), forces an interested customer to negotiate it down. Each negotiation down will get you closer to the maximum price you can expect to charge, whereas always getting a ‘yes’ will not tell you if you could charge more. When Marc Andreessen was asked in 2016 for his advice to struggling startups he said 2 words: Raise Prices.
Annual Contracts
Problem: Short term contracts (6 months or less) might be easier to close but they will increase your churn in later months. Separately, signing 2-year contracts, or longer, for your first few customers is also dangerous, as you might be committing to a customer that you later need to de-prioritize or charge significantly more.
Solution: Sign 1-year contracts with your customers. Don’t let customers linger on free trials for more than a maximum of 60 days, 30 days is often enough. If a customer needs your product, they won’t want to lose access. Don’t let the large dollar value of 2 or 3-year contracts tempt you to sign. There’s a good chance your prices will increase a lot in the coming years and having numerous customers on long term bargain pricing will hurt your revenue growth.
After getting your product live, pricing is one of the toughest challenges for startups. Don’t risk the consequences of getting it wrong, give yourself the best chance of finding the right price for your early customers.
If you’re a B2B company at the seed stage looking for help, you can reach me at ash@ashrust.com.
Thanks to Kaego Rust, Sean Byrnes and David Smooke for their help on this article.