Setting a price is easy, but setting the right price not as obvious. Last week in my post about the Sparrow acquisition, I mentioned that one of the key warning signs of their pending sale was the low price point. Selling a one-time, perpetual license for $9.99 in a limited market is one way to ensure that you remain profit starved and ramen thin. It was only a matter of time that someone with a big check would come to scoop them up. All that being said however, what should have been the right price and how does one come about figuring that out?
There is a lot of advice when it comes to pricing strategies. Many advocate the freemium model in order to quickly acquire users and build traction. Others suggest pricing based on what the market can bear, whatever that is supposed to mean. Still others recommend asking potential customers, even though the price people like most is somewhere close to free. So in this quagmire of non-helpful non-advice, what is an entrepreneur to do?
Over the next few posts, I want to lay out a framework to help you think logically about pricing and implement the correct pricing strategy specifically around SaaS business applications*. Before we launch directly into the prescription for addressing pricing woes though, it is important to understand why pricing is so critical. While it may seem obvious, diving into the implications of why you price something can have significant impact on how you price.
- Price molds expectation – When you set a price, it sets off all sorts of calculations in the mind of potential customer and creates a set of assumptions about your product that are not necessarily explicit. In the book “Influence: The Psychology of Persuasion”, the author begins with the tale of a businesswomen who had trouble selling some turquoise jewelry to find out that not only had it all sold out one weekend, it sold for double the price. What changed? The head saleswoman misread a note to sell for ½ off and instead doubled the original price. What was originally seen as cheap costume jewelry that went unnoticed prior to the markup underwent a Veblen transformation into a luxury good.
- Price makes markets – In fairly commoditized markets, price usually settles around a single settlement price or a narrow range around a bid and offer price. In diverse markets with a range of quality and features, price is established along a range of price points. The price you set is where you decide to make a market along this continuum. In other words, you price based on where you believe you can generate the most buying interest while maximizing your primary business objectives (generally this means profit, but that is not always the case as I will point out in the next post). Whether customers respond in kind is ultimately up to the market, which is the final arbiter of price for any good or service.
- Price drives revenue – The most direct and purest source of revenue that you can collect is by people paying directly for the use of your product. It is a direct exchange of goods for money in order to fulfill some explicit need. Thus, where you set price will heavily influence the amount of revenue you collect. While revenue generation is not the only part of the equation when it comes to pricing (you need to factor in cost of goods, distribution, support, etc.), the reason you set a price to begin with is to make enough money to create a self-sustaining business.
- Price creates value – When people buy your product, they are making a decision about the value they place on your offering. This is something that can be clearly seen when you introduce tiered pricing, especially when you are offering a freemium version of your product as one of the pricing tiers (note that “free” is also a price, a distinction that oddly seems lost on people). Value matters because something that is not seen of high value (relative to the market) can be easily substituted for another offering. Thus, price has a significant influence on loyalty, or stickiness, a customer attaches to a product or service, negatively impacting customer lifetime value and acquisition costs (two extremely important business metrics I will dive into at a later date). Price in this case ends up being a proxy for value, and a customer that attaches little value to a product (low price relative to market) will be more apt to find a replacement.
In my next post, I will explore the general principles to consider when setting price. The important point here is that price should not be some arbitrary exercise that you toss around thoughtlessly. Price is a deliberate statement you are making to the market about the value you are offering. Your success therefore will be very much tied to how smartly you establish the price of your wares.
* Note while my expertise is in SaaS business applications, many of these principles can be applied to consumer SaaS offerings as well.