How to set the pricing of your software product
What’s covered in this article:
- Pricing your product based on value metric
- Choosing your pricing model
- How much should you charge?
- The Van Westerndorp Approach
Pricing your product is a bit of a weird experience, isn’t it?
The business I worked for had an unhealthy relationship with checking to see what the competitors were charging (if they listed their pricing online that is).
Or, if we were in a customer meeting and we closed the order there and then, we wouldn’t leave feeling happy. Rather, we’d wonder if we left money on the table.
But this was for a software as a service (SaaS) with product-market fit and revenue.
When you’re looking at the pricing for your pre- product market fit SaaS… well, that’s a different kettle of fish/roller coaster/ball game. (Pick which metaphor you want).
When I joined a startup and we were determining our pricing, we made a ton of mistakes. Now, in hindsight, you realise it was all about learning and growth mindset, but at the time, we literally thought we were just failing.
We’d devalue our product. We’d offer discounts (when we didn’t need to). We’d give it away for free to people who would have paid for it. It was a bit of a nightmare at first.
The thing is, everyone goes on about getting your pricing nailed. That’s because it’s a core part of your go-to-market strategy.
But we rarely talk about the inbuilt anxiety around getting it correct.
There’s a ton of pressure because what we are trying to do is price for maximum revenue.
I don’t know about you, but I wasn’t taught that at “startup” school.
So, like most things during the process of navigating the messy journey of building a startup, I taught myself, relied on mentors, and winged my way through to us generating revenue.
Here’s a breakdown of how I’ve helped to price early-stage SaaS startup products - to give you a little confidence that we really are just making this up as we go along.
Pricing your product based on value metric
You’ve probably read a ton of articles about charging for value metrics. In its simplest form, it means how much value your buyers get out of your product.
For example, Hubspot charges by the number of marketing contacts. AirBnB charges for nights booked. My local charges by the pint of Pilsner.
Then there are other examples in SaaS that’ll charge by seat, by active user… you get the gist. The idea is all about a metric that reflects the customer and the value they get from it. Or, as Profitwell suggests: “In SaaS, value metrics determine the pricing and subscription terms of a product”.
This is different to a pricing metric.
A pricing metric is a unit of measure. This means if your customer consumes or uses more of your product, they pay you more. And if they consume less, they pay you less.
Therefore, a pricing metric is the priced unit of consumption and a value metric is the unit of consumption that creates value.
Okay, enough of the theory, let’s talk application.
When I worked for a SaaS startup - an online learning provider in this case - we tested two potential pricing models:
1 - Per active user, per product.
2 - Per active user.
Product for us was a library of video content titles. Active was another word for “seat”.
The first option allowed us to scale more effectively for a few reasons. If we’d kept it at active user, we would have hit a ceiling pretty quickly, but by incorporating the different product sets we had - in this case libraries of content - we were able to get more money in.
When I say test, by the way, I literally mean in the sales demos we were conducting we’d try both pitches. Twenty prospects would get option 1 and twenty, option 2. It was some macro-level testing.
What about pre-product market fit startups?
I’m also a shareholder for a care software SaaS provider where we are literally implementing what I’m writing here. We’re at the point of determining what we should charge for, and are currently exploring different options to see what combination works best for our ideal customer. (Who we think they are at least!)
There are a couple of ways this SaaS could determine its value metric:
Number of active contacts
Number of workflows completed - evidence of the service users’ progression
New organisations added
Alerts recorded
These activities are all tied to a customers’ jobs to be done or the progress they want to make with our platform.
What’s really effective about this approach:
We are super early stage which means we don’t have tons of data. A lot of what we are relying on is hunches which we are ready to disprove/validate the more we talk to committed prospects.
However, discussing pricing in such a way that it is linked to customer value means we’re building a product that truly puts the market at the front and centre.
Important bit: discussing pricing in a way that it is linked to customer value means we’re building a product that truly puts the market at the front and centre.
(If this is you and your startup predicament, I offer startup coaching on this - largely supported by the jobs-to-be-done framework - to get the answers you need. You can apply for a seat here or learn more about my SaaS marketing services.)
Choosing your pricing model
I’ve lost count of the number of times I’ve been in a meeting and there’s a heated discussion about what feature needs to sit in which tier. Pricing discussions have this tendency to migrate to what lives in a tier and what doesn’t.
The director will continue to debate the tiers and then they’ll pull someone in from finance - because pricing means numbers, right (?). All the while, the customer doesn’t get a mention.
After much debate, it goes one of two ways:
The person with the loudest voice gets their own way and you just give in to what they think
No real answer is concluded and instead there’s a further hour meeting about what the tiers should be called.
“Basic, Professional and Grow!”
“Penguin, Helicopter, Left-handed Goldfish!”
The good news is when it comes to your pricing model, there are many more models than your tier-based approach.
These are:
Tiered pricing - this is based on the feature set you want the most.
Usage-based pricing - this is consumption-based. You use it more, you pay more.
Fixed rate pricing - everything is included for one price.
Per-user pricing - this is based on the number of users you want to be signed up and using the software.
Variable pricing - this is based on demand. So it can go up and down depending on things like additional bundles, time of year etc.
How we chose a pricing model in the learning platform startup
I wish I could say that we started off with tons of research, but really, what we found was we were often pitching against one main competitor. So we copied their approach which was usage-based pricing.
At this point, can I just say there’s nothing wrong with this approach (at first).
Of course, you want something tied to your customer’s perception of value but… the actual difficult part of all this process really is actually rolling up your sleeves and making a start. People can have opinions, consultants can share best practices, and marketing bros can get all shouty… but they’re not the ones doing the grafting.
Anyway…
After a few months and, after we started to add additional features, we found a hybrid model (variable pricing) worked for us. This was based on the number of users, the number of brands the customer had, and certain reporting capabilities.
It worked at this point for us because we were learning tons about our customers and identifying areas where consumption could be tweaked.
What about that the pre-revenue no-customer startup? What’s the thinking behind the model of choice?
We’re still at the customer development part of building our startup, and so we are considering per-user pricing at this stage. That’s because we are pre-revenue and are collating data and commitment. These are the two ingredients that’ll get us more customers and, therefore, more data.
Of course, there’s an appetite for exploring the tier-based approach but my gut feeling is saying that this may cause a little anxiety/ frustration because we don’t know enough about paying customers yet.
Until then, we’ll continue with our customer interviews to understand what model and what messaging resonates most.
If you’re interested in what model may likely make the most sense for your customers, there’s a framework called Customer-Led Growth. Whilst this is aimed at more companies with product-market fit there are aspects of it that will help to uncover what features should live where and how to link this all to the progress your customer is trying to make.
How much should you charge?
Let’s start this off with a super quick nod to the three pricing methods available.
Cost-plus pricing. This is where you add up all the costs (direct/indirect) to build and market your product, then add a little profit. This is a good way to actually understand things like run rate etc, not necessarily how to price your model.
Competitor-based pricing. Here, you look at what your competitors are charging. I’ll see startups do this, however, it’s based on so many what-ifs, guesses and - more often than not - incorrect hunches.
Value-based pricing. This is based on how much your customers want to pay. This is the long-term play, and requires a ton of data. I find myself using a combination of the first two options with a view to then checking in with value-based and changing as necessary.
How to get value-based pricing to work for a pre-revenue startup
Before you're even tempted to copy your competitors’ pricing, I’d recommend sending a survey to your committed prospects called the Van Westendorp approach.
The Van Westerndorp approach
This set of questions will help you to understand a little more about the price sensitivity of your respondents.
All you need to do is create a quick survey and ask these questions:
At what price would you consider the product to be so expensive that you would not consider buying it?
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?
At what price would you consider the product to be a bargain - a great buy for the money?
At what price would you consider the product to be priced so low that you would feel the quality couldn't be very good?
The data you’ll collect from this will give you an acceptable range of pricing to explore and consider when looking at alternative methods of charging. Get a friend that’s really into spreadsheets and plot the data to see how the numbers stack up.
What you’re doing here is trying to understand, based on the perception of the customer and their pricing sensitivity… do you have a potential repeatable business model? Side note, learn more about using this as part of your startup’s MVP launch.
Only send this to people who are your trial/pilot customers.
They will need to have used your product and have signalled some kind of commitment to being a paying customer. There’s nothing worse than analysing data from surveys completed by people with opinions but no intent on buying.
Signs you need to revisit your startup’s pricing strategy.
Okay, so let’s assume you’ve collated the data from the above recommendations and you’re a few months into it.
When is it time to revisit the pricing strategy you’ve set out?
Here are a few examples:
High churn
Your sales cycle is taking way too long
Your CAC is increasing
Your close-win rate is low
Let’s face it, though. The stage your startup is at means the numbers are going to be a little ugly whilst you validate things. But, these are the numbers you need to keep an eye out for to ensure they’re not decreasing.
Summary
Deciding how much you should charge and what you should charge is always going to be a challenge. Don’t think that established businesses have got it sorted. They have teams of data and pricing analysts who look at this stuff every day.
We’re in the game of pricing for maximum revenue in a high-pressure environment. I think it’s this part that makes the discussion around pricing really stressful. Here are a few resources that helped me out when I started this process:
How to use value metrics to optimize pricing
9 Best Pricing Strategies for SaaS Business Models
