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Pricing for Startups

“You’ve found market price when buyers complain but still pay” – Paul Graham

Pricing is a crucial component of any successful business. Most companies, especially startups tend to under-price fearing losing out on an account resulting in leaving significant money on the table when they finally come away with a customer win. Offering free products, free trials, fremium etc are different strategies startups employ in winning customers and they all work for some and don’t work for the rest. In fact, there is no clear cut, ready-made, cut-out pricing strategies for any company to emulate or follow. Startups work in a highly dynamic environment with constantly changing market dynamics.

An Ideal Pricing is an art that results from a series of experimentation and also in knowing and understanding the true value and positioning of your product. Startups must, hence, use a framework to chalk out the best pricing scenarios and also analyse the feedback/ response from the market to tweak it. The broad framework for startups to work on their pricing should consider the following factors:

Positioning:

Brand positioning is one of the most important factors that influence pricing strategies for any product. In fact, both goes hand in hand. Pricing strategy does reflect on the brand as well. Imagine buying a Ferrari for the price of a Toyota or buying an iPhone for the price of an entry-level Android phone. Same goes for technology products as well – In the FSM (Field Service Management Software) segment, a product like Servicemax might be able to charge a premium while the SMB focussed mHelpdesk might not be able to charge that premium. Same goes for the other software categories as well. In the CRM space, a Salesforce commands a premium which a Zoho or a Nimble will not be able to get.

The message should be clear across all touchpoints – website, collateral, ads, PR, Sales pitch and every other channel the brand gets visibility. The pricing strategy reinforces the brand positioning be it Premium, Mid-market or low cost alternative.

Sales Team Structure:

Pricing defines the structure of the Sales team. Higher price points are very attractive from a revenue perspective but they also require a larger sales cycle, a much more sophisticated sales rep, increased chances of opportunities lost and volatility.

Nimble CRM for eg. has a pricing of $15/user/month and mostly sells into the SMB market. With a deal size of $3k-$5k, typically an inside sales person should be able to close 3-5 accounts a month. This is a much predictable model with a steady revenue coming in every month through these closures. However, for, a higher priced product like a Siebel CRM system, an inside Sales team will not be the right fit. They would be multi-million dollar contracts and would require specialised field sales person who would charge anywhere from $250k or above.

The Market at Large for your product:

It’s important for organizations to scope the market at large for them. The value of any organization is broadly the NPV of its earning (profits) for the next 5 years. Reducing price points might enable you to sell more, increase the closure rate, however in the longer run you need your product to be profitable as well. Any product will have churn, so the net revenue that you make out of a customer should be at bare minimum equal to the cost of acquisition. Also, the market size for your product is the price point multiplied by the number of potential customers. If the no. of potential customers is not a very big number and your product’s price point is relatively low, then the max market you can address might be very less for investors to have any interest in your company.

Pricing Model:

Pricing models can be different for different organizations. One could have a one-time license based pricing structure to subscription based pricing. Even with subscription based pricing – you could have a monthly or quarterly, bi-annual or an annual plan. For subscription based pricing model, I had in my previous post discussed the benefits of having an annual subscription model not just from a cash flow perspective, but also from a revenue predictability perspective and in reducing the overall churn numbers.

Like any function in a startup, pricing is also a constantly evolving function that changes with time. The best way for any startup is to broadly identify each of the parameters discussed above and create a framework which they can rely upon in revisiting pricing few times a year.

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How Pricing Strategy Can Make or Break a SaaS Startup?

I’m sure if you have ever been part of a startup, you would understand the importance of managing cash flow at an early stage and how it can make or break your startup. It becomes even more important for a SaaS company which depends on the recurring revenue to sustain itself.

Cash is the lifeblood of any startup. It let’s the management invest in the business not just in terms of growth but also with regards to beefing up the intellectual capacity of the team. It helps the startup take a faster trajectory to achieving its milestones – It’s virtually a no brainer that any startup should focus on improving its cash flow at an early stage.

Let’s analyse the pricing & payment collection strategies a SaaS startup could adopt to improve its cash reserves. Assume a hypothetical startup generating a MRR of $60k in the first month, growing 10% YoY and with a burn rate of $250k per month. Startup has an existing cash reserve of $3 Million from series A.

SaaS Pricing Strategy - Payment Collection

I have put down 5 pricing strategies ( payment collection) options :

1) Monthly – Customers pay at the end of each month

2) Quarterly – Customers pay at the end of each quarter

3) Bi Annual – Customers pay at the end of each 6 month period

4) Annual Pre Payment – Customers pay for one full year at the beginning of the year

5) Annual Post Payment – Customers pay at the end of one year

See how in the case of Bi Annual and Annual Post Payment systems, the startup runs out of cash and is on the verge of bankruptcy. It’s a a situation you wouldn’t want to address as a startup founder. While the Annual Pre Payment system infuses a ton of cash into your reserves which will help you pump in more money into your business to grow. Remember, this is an effectively zero interest capital that your consumers have provided you access to that you can leverage for rapid business expansion.

So how are you collecting payments from your customers? It might make complete sense for a startup to shift their pricing strategy to a annual pre-payment option provided you don’t see an increased reduction in conversion because of a change in the pricing strategy. Certain segments and markets do react differently to annual pre-payment pricing strategy especially the SMB segment where the owners of these business themselves would in all probability be in a cash crunch situation to run their businesses.

Do your math and run the experiment!