Far too often, startups treat pricing as an afterthought. Upon going to market, founders seldom blame pricing should their company fail to reach expected sales. Rather, they see fault in what they believe to be an inadequate product or service.
When a price does not work, the most common answer is simply to lower it without regard to other factors. However, instead of arbitrarily adjusting price downward, founders should determine how it can better match customer value.
As an entrepreneur, you are required to understand pricing as a strategy, the different methods startups can use and how to select the optimal route. Here’s your guide.
The importance of pricing
First, let’s discuss how price is established and why it matters.
- Costs influence price. On a rudimentary level, price is the markup applied on a set of inputs. When viewed from this lens, it makes sense. You can’t run a business if your costs outweigh your revenue, so figuring out ways to reduce costs in an early startup and determining a price that exceeds these costs is crucial.
- Consumers determine price. On the other hand, there exists a certain equilibrium with pricing. If your price is set outside the range that customers are willing to pay, no one will buy whatever you are selling. For this reason, price is primarily influenced by the market. It may be entirely unclear what the willingness to pay is, which should lead you as a founder to analyze the competition and obtain feedback directly from consumers.
- Prices set expectations. On a psychological level, pricing conveys meaningful information. Beyond the principles of supply and demand, price is a sign of quality. While the new iPhone may cost much less to make than what Apple charges, customers are willing to pay the high price because they believe it to be the most advanced smartphone on the market.
- Prices affect cash flow. From an operational standpoint, cash flow is derived from both price and sales. Expected sales will vary as a result of your pricing. Therefore, by pricing strategically you can maximize cash flow and avoid strenuous ways of raising capital, such as dealing with investors or taking out loans.
4 common pricing strategies
As a founder, you need to see pricing as a means of growth for your startup. Depending on which route you ultimately decide to pursue, pricing can be used to accomplish different objectives.
With this in mind, let’s look at four ways to approach pricing.
- Penetrate the market.
If your sector is currently dominated by existing players, charging lower prices initially and subsequently raising them is a viable option to establish a name for yourself. Although you’ll likely operate at a loss for a short period, the market share you attract will offset any deficit. Slack, for example, used this strategy to gain widespread brand exposure in the market for communication tools. Once they had built a solid reputation, they were then able to charge far more profitably and have continued to flourish.
- Charge a premium.
In contrast to a penetration strategy, you can price a product or service higher than the norm of a respective market, thereby positioning yourself as a premium brand. This strategy can often be tricky for early startups, but highly valuable in the right space. The “unlimited” subscription plan offered by Salesforce is a prime example. When combined with a free trial, premium pricing thrives as prospects can recognize through use how vastly different the product or service is from anything else on the market.
- Maximize your price.
Similar to charging a premium, startups that employ a maximization strategy will seek to levy the highest price consumers are willing to pay. This approach is ideal when little competition currently exists in a market, allowing new entrants to capitalize on unmet demand. As the market develops however, this strategy is more difficult to maintain. With the arrival of new players come similar offerings, likely at lower prices. Unless your startup is categorized as a premium brand with status, it’ll be hard to justify higher prices.
- Skim the top.
While starting low and moving higher in price may work, as in a penetration strategy, startups always run the risk of losing customers at an elevated cost. For this reason, a skimming strategy is attractive and involves gradually reducing price over time. Customers regularly welcome a decline in price for products or services in which they are interested. Therefore, when the novelty wears off around whatever it is your startup has to offer, skimming the price will allow you to maintain a foothold in the market.
4 tips for choosing a pricing strategy
Now that we understand the importance of pricing and the various strategies to consider, let’s discuss how to make the right pricing decision.
- Determine your objectives.
Consider whether the price you set today is driving a short-term gain at the expense of long-term success. For example, underpricing your product or service may lead to an influx of one-time purchases from customers who are not loyal. If your business relies on repeat purchases, this will undermine your efforts.
- Conduct market research.
When breaking into an established market, it is always recommended that you analyze what prospects are paying for similar offerings. So, reach out to potential customers, identify their willingness to pay for your product or service, and map out the existing landscape of competitors along with their respective prices.
- Evaluate your unique selling proposition.
If a product or service provides immense value that no one else is able to offer, customers will be willing to pay above market rate to reap the benefits. Knowing if your price is equal to perceived value is crucial in determining whether your product or service is underpriced, overpriced or priced correctly.
- A/B test prices for engagement.
As with many different aspects of an early startup, experimentation is often key. When determining what price is most attractive in the eyes of a consumer, engagement is a useful indicator. Offering the same product or service at multiple prices to different customers is an effective way to identify what works best.
Ultimately, price is more than a number. It conveys value, signifies the earning potential of your business, and plays a pivotal role in countless other decisions. These tips will help you select the best pricing strategy to unlock your startup’s full growth potential.