Building a pricing strategy at your startup? In this three-part series, we discuss what not to do (i.e., cost-plus pricing), what to do (i.e., experiment), and which tactics work best.
Let’s look at some specific pricing tactics and a few other tricks of the trade I have learned over the years (mostly from failure points).
Businesses of all types eventually end up selling through a “channel.” You have probably started out by selling directly to your end customer. Maybe your own sales team deals personally with businesses or you sell to customers through your own website. This is a great start and direct selling is the most profitable channel.
Keep in mind that when you sell through a channel, the price to the end customer doesn’t change, so the margin at each stage of the channel is coming off your own profit. A consumer hardware product is perhaps the most extreme example. If you are selling to your customer directly on your website for $100, watch how quickly the channel eats into this.
Let’s consider a model in which you sell to a large retailer. They will typically expect to make 20 to 30 points of margin. And they only buy from resellers because that makes their life easier, and they want 15 to 20 points. And those resellers buy from distributors, who want to make eight to 10 points. Your selling price has quickly dropped from $100 to $60. Then you need to give the retailer market development funds to do co-advertising and marketing. So if you were enjoying 40 points of margin at $100, now you are selling below cost. And all this is before you pay sales commissions or sales performance incentive funds. This isn’t the best time to be realizing you need to rethink the design and costing of your solution—better to think about this upfront!
When you are starting out, it may seem that the channel is a fantastic way to multiply your sales force without investing and training your own team. Don’t be fooled. The channel needs to be sold to as well, and nurtured. Getting listed in their catalogue will do nothing for you—that’s an administrative hurdle to facilitate order processing. You need to figure out how to get and stay on their sales reps’ radar. And when there is a transaction, especially if it is large, recognize that no-one cares about closing that deal more than you do, so you’re going to want to engage in those opportunities and your channel reps will want you there.
You want to avoid your channel partner selling your solution at a higher price, because that will hurt your sales and risk inconsistency in similar markets. Competition is the key to an efficient channel price. If you give a distributor or reseller exclusivity to a market, they will charge as much as they can. They may often bundle the price—either visibly or invisibly—with other parts of the solution they are selling. Channel competition levels the playing field.
These tactics are most common in B2B sales situations. The key thing here is that people value what they pay for. So don’t give your solution away for free. Your customer needs to have some skin in the game, or they won’t likely make the effort to get the value from what you are selling. If your customer is insisting on not paying until they see whether they will use your solution, one tactic is to offer a free-trial period only if you secure a signed purchase order, with a no-penalty termination clause before it starts. While they are receiving what they want (a free-trial period), they do have some investment by having to go through a procurement process, which quite often takes a lot of effort. The downside of offering a free trial without obtaining a future-dated purchase order is that the customer may never get around to using your solution—they will keep asking for extensions with promises of “now I’ll try it.” The other advantage to this approach is that it avoids the free period extending for months beyond what was intended while contracting and purchasing takes place. Despite your customer’s best assurances, no one ever wants to pay for the past.
If you are selling software to consumers, you may need to offer a free-trial period in order to get over the hurdle of customer uncertainty, or maybe the value of your solution requires a network effect, so you need a lot of users. You should assume an extremely low (single-digit) percentage of users will pay to keep using it.
Consumers seem to have quickly accepted that an attractive monthly price is only available when they pay annually. Often the premium to pay monthly is 50% (for example, $10 per month if you pay annually but $15 if you pay monthly). Hook the consumer with the low price and get the funding for your business by receiving customers’ money upfront.
The same approach works for B2B—but you need to stick to your guns. You are excited about landing that big, new customer, so your negotiation power may be weak, but remember, this tactic can be a key source of funding for your business. I have worked with companies where we have taken this even further and sold multiple years in advance. Customers understand that the nice discount you are offering upon signing only means you will increase their price on renewal, so they will try to contract additional years with you. One approach I have taken is not to offer future pricing contracts—if the customer wants to lock in the price for subsequent years, then they need to prepay for those years in advance. This approach could even help you put off raising that next round of financing!
Designing the right sales incentive plan to reward this tactic is essential to getting this prepayment. Salespeople like to discount to close the sale. Offer your sales reps an incentive plan that also rewards them for obtaining prepayment on a subscription. For example, reps get the same commission rate and quota attainment for multi-year prepaid sales. But if the customer renews (and pays) annually, the sales rep only gets paid at the renewal and at a lower rate (since they aren’t having to do as much work to get the renewal.) The sales effort to get a customer to pay for multiple years upfront requires skill and effort. Having them renew each year for something they are already using takes less skill and effort, so alignment of sales efforts is key.
If you have unique customer segments, you should examine whether you can differentiate your product enough to have various prices or even various pricing models. This will allow you to optimize each of your market segments.
Unless you are in the advertising and media business, don’t count on making money from any form of advertising. You need a massive audience before it even remotely becomes economical.
Procurement teams use most-favoured nation clauses to force you to assure them that they are getting the best deal. It’s a shortcut for them and may prevent you discounting the heck out of your price. Avoid most-favoured nation clauses when you can, but be prepared to adjust your price to ongoing, existing customers as you experiment with your pricing.
Don’t “test” your price on your largest potential customer. Not only do big customers have long sales cycles—meaning you won’t get honest pricing feedback in a timely manner—but you also don’t want to blow it on the largest opportunities.
At the early stages, don’t lose a deal on price. Remember, it is an experiment. Maybe you won’t get the price you hoped—but you have learned from the experience and you have the customer to keep learning with.