A lot of startups treat pricing strategies as a math problem. Too often, it's left at the very end of the product launch. As a result, 18% of new businesses failed in 2018 because of pricing or cost issues. Pricing is both an art and a science. It should be a combination of creativity and analytic thinking.
Entrepreneurs should take the time to build out a through pricing plan. Price too high, and you can stall your business right out of the gate. Price too low, and you may begin with unexpected sales volume which could hurt you in the longer term. As an entrepreneur, your challenge is to figure out what you need to charge.
Three Best Pricing Strategies for Start-ups
Madhavan Ramanujam, a pricing expert, argues that there are only three pricing strategies a startup should pursue:
Maximization (Revenue Growth)
Make pricing generate the greatest revenue for the company. Calculate the fixed and variable costs a business will incur, and then figure out how to cut these costs. This maximizes revenue growth in the short term. Startups should pursue maximization under two conditions:
- When there are no clear differences in customer segments’ willingness to pay
- When the optimal short term and long term prices are equal
Many mid-market software companies price with the goal of revenue maximization. They negotiate for the highest possible price in each sale.
Penetration (Market Share)
Attract a high volume of buyers to purchase the product at a low price to win dominant market share. Once a business penetrates the market, grow and expand the brand to meet higher profit requirements. In electing this strategy, you may experience an initial income drop or even a loss that can be difficult to overcome.
Expensify, Netsuite, New Relic, Slack follow this model. Penetration prioritizes market share.
Skimming (Profit Maximization)
Introduce a product to the market at a premium price. Lower the price over time to attract a larger customer base. This works best during the introductory phase of products and services. Consumers are willing to pay top price for the latest and greatest.
Skimming is widespread in consumer hardware. Apple executes the price skimming strategy every year. They sell the latest iPhones at the highest prices. Then repackages older models at lower prices to address different customer segments.
Five Things to Consider Alongside Pricing
Pricing strategies are important, but it’s also important to not lose sight of the price itself. Here are five things to consider, alongside your strategy when pricing your products:
You want to ensure that the price of your product generates enough revenue to cover your costs. You call the percentage that you’d like to make off of each item your gross profit margin target. You can calculate it using this formula:
P = price and C = cost; Gross Profit Margin Target = (P-C)/P
Learning as much as you can about your customers will help you price your products. Conduct market research to outline the demographics and psychographics of your target audience. This data can reveal their purchasing behavior. Surveys and internet research can expose common traits of your customers.
You want your price to be competitive, but also reflect your product’s value. You will need to find out if your competitor's product has the same perceived value as yours. Conduct market research and perform your own internet research. This will provide useful insight into the competition's offerings. Do some digging on review sites, or even as a secret shopper. If you can deliver products with more value than the competition, you may be able to command a higher price point which implies to your audience that it’s a superior product.
Try using a pricing structure that offers “good,” “better,” and “best” options. Applying this strategy can help you capture a larger part of the market. Offer many options for a range of shoppers instead of a "one size fits all" approach.
Odd Number Pricing
A pricing strategy suggests that a product retailing at $39.99 is more appealing than one at $40. The difference may seem arbitrary. But studies have shown that this pricing strategy is successful. In the eyes of a consumer, a few cents can mean the difference between purchasing or passing.
Once you know that your price is covering your costs, test out single-digit strategies. Find which best fits your target audience. Pricing your product integrates the economics of your business and the psychology of your customers. Use simple market research and competitor analysis. This will help you find your pricing sweet spot.