Last week, I shared a presentation with an executive team at a large public SaaS company on everything I’ve learned about pricing. Here’s a summary of the frameworks and theory that I’ve aggregated over a decade of investing in startups.
Why do we set prices? Setting aside the important reasons of generating revenue and maintaining solvency for a business, there are many other reasons to set price. Price reinforces brand because price telegraphs whether a product is a premium product or a value product. Price differentiates products in the market and can be used as a go-to-market strategy. Underprice the competition to gain share. There are many others too.
There are four components to pricing: 1. Strategy: what is the goal of the price? 2. Philosophy: how does the company price relative to costs? 3. Structure: what is the pricing rubric? 4. Positioning: how best to communicate the price?
There are two pricing philosophies: cost-based pricing and value-based pricing. Cost-based pricing is common in commodity markets. To price based on cost, you take the cost of the product and then add a margin. If you’re targeting 50% margins, just double your cost and there you are.
Value based pricing means charging the customer what they are willing to pay. This requires understanding their budget and the value of the product to them.
To figure out the right pricing strategy, it’s critical to determine what the buyer cares about. Do they care about cost or value? What is their core unit of their world: people, dollars, gigabytes? How predictable is the pricing plan? And can the buyer clearly articulate the pricing, advocate on your behalf and champion the purchase?
It’s also important to understand the seller’s needs. How does the pricing change the market size? The unit economics and cash flows associated with the sale? The competitive positioning?
Read complete article here: