Pricing is part science, part art, all anxiety. No one wants to leave money on the table by going out too low or get no takers by going out too high.
The good news is that regardless of where you end up, you’ll have opportunities to adjust. And the process itself helps you understand the monetary value of what you are doing, and can generate tools and spot problems that have nothing to do with what you are going to charge.
No process for pricing is perfect, but here is a good general approach that I like to use based on the many mistakes I’ve made . . .
1. Start by determining your Cost-Plus Price. Understand everything that it takes to provide your product or service, and then add in the margin that you need to cover overhead and make the business operate profitably. You probably (hopefully) won’t use this as your price, but this is a very important starting point. Even if you decide to price at a loss temporarily to gain market share, you need to know you are doing it.
2. Now build a Value Model for your customer. You should already have an intimate conceptual understanding of the problem that you are solving, so now your job is to figure out how that solution results in tangible money being made, or money being saved (or sometimes both). What are the value mechanisms in your solution? You have to get this into a spreadsheet, which can be painful but worth it. Key Tip: Build this as if it was something your customer would build to justify buying from you, even show it to them and test it with them. This model has to be realistic, not optimistic.
3. Derive your Value-Based Price from the Value Model. Now that you understand how much value you are creating, what do you think you can charge for that value? In tech I think a good rule of thumb is that your price should be 10% or less of the value because tech investments are risky to buyers, but it depends on what you are selling.
4. Look at Comparables. Now that you have Cost-Plus and Value-Based Pricing, the third key input is to look at other similar solutions. Competitors are obvious comparables, but you should also look at similar solutions in other industries or other contexts. Products that are in the market know things that you don’t, and your cost structure and value model might be wrong. Even if you are right, one terrible thing about startups is that you might have a big competitor who is underpricing, either intentionally or accidentally, and that fact alone can override all of your beautiful spreadsheets.
5. Put One-Offs Aside. You may have that one early customer that wrote a unexpectedly huge check for your tech, or you might have asked a few friendly customers what they would pay. We have a tendency to weigh that information heavily, but those data are fraught with sample size and biases. Ignore them for this exercise.
6. Set the price. More than likely you will be charging more than Cost-Plus and probably less than your highly optimistic Value-Based model.
That’s the science, the rest is art. Your pricing must align with your go-to-market strategy. Are you premium? Your price should be higher than comparables. Are you the low cost provider? Obviously you should be cheaper. Your price sends a message, so make sure it makes sense when taken in combination with the other messages you are sending.
Now test, adapt, and make that money!