This is an excerpt from a Pricing Model Webinar at Stone and Chalk. Published as a Stone & Chalk Blog post here:
Pricing is a crucial aspect of your startup's success, although it's often a challenging topic. It significantly impacts your bottom line without requiring significant changes to your product or business.
When introducing innovation to the market, it's essential to understand the adoption lifecycle and how it affects your target customers. Innovations bring about a shift in user behaviour, transitioning from old ways of doing things to new approaches. This shift influences how customers perceive pricing and make purchasing decisions.
In the early stages of your startup, you'll be selling to early adopters and innovators. At this point, your pricing design should focus on maximising revenue rather than optimising profits, as your goal is to convert potential demand into actual sales.
Your pricing strategy and model will also evolve as your startup grows and your product matures. Initially, you may offer pilot projects or services when selling to early adopters. However, as you target the early majority market, your pricing design should focus on maximising customer conversion.
To achieve maximum conversion, consider two external constraints: customer constraint and market constraint.
Customer constraint relates to their budget, which may be limited in the early stages of a new product category.
Market constraint considers price elasticity, the correlation between price changes and demand. It is essential to understand how much your customers' willingness to pay is vital.
Pricing Design
Pricing design involves understanding your product category and target segment and determining whether they are price-sensitive or price-tolerant. Each pricing decision will also impact sales volume, revenue potential, and profitability. Factors such as product type, consumer income, economic conditions, sector performance, competitive pricing, and substitute products can influence the price elasticity of your product.
The price elasticity of your target customers can change. It seldom does, but it can. That's why most startups try to move their product from highly elastic to highly inelastic by differentiating their product so that there is less of a response to changes in price.
These factors will often contribute to the price elasticity of your product:
Product Type
Income/budget of the target consumer
Health of Economy
Sector Performance
Competitors Pricing
Substitute Products
You can offer different price points within your customer's willing-to-pay range to maximise conversion. Offering other price points allows customers with different budgets to choose the option that suits them best. You can increase revenue and conversion rates by providing multiple price points.
Pricing Models
Different pricing models can be applied depending on your product offering and customer behaviour.
Subscription and Membership Model
Common and desirable for recurring revenue, suitable for continuous and regular usage, and to lock in customer.
Value and Usage Model
Aligning pricing with customer usage and value derived from the product. Popular in SaaS and performance-based models. Monetising direct contributions to customer revenue or upside.
Dynamic Pricing Model
Matching demand and supply through time-constrained pricing. Optimising monetisation based on fluctuations in demand or supply. Ideal for scenarios where volume or availability fluctuates.
Market-Based Pricing
Leveraging marketplace dynamics to determine the price.
Utilising auction models and capitalising on demand and supply differences.
Suitable when limited quantities exist on one or both sides.
Freemium Model
Offering free access to attract users and drive adoption
Upselling or monetising through additional features or premium offerings
Three common use cases: user onboarding, platform monetisation, and attention monetisation.
Once you have designed your pricing to maximise revenue for the customer and the market, checking whether your pricing model is commercially viable is crucial. You should evaluate unit economics, contribution margin, fixed costs, and growth constraints.
Unit economics and contribution margin help determine whether your business is profitable. Fixed costs become essential when they are significant, requiring a high sales volume to cover them. Growth constraints relate to the cost of customer acquisition, ensuring it is within the ability to monetise those customers effectively.
Key Definitions:
Price elasticity of demand: A measure of how sensitive the quantity demanded of a product is to changes in its price.
Substitute products: Products that can be used as alternatives or replacements for each other in satisfying a particular need or desire.
Contribution margin: The difference between the selling price of a product and the variable costs associated with producing and selling it.