Going up against an established competitor? A disruptive pricing model can be one of the most effective tools you use to differentiate yourself. But it takes a more sophisticated approach than simply selling your services for less.
We’ve all seen aggressive startups come in and try to undercut the market price. When they go head-to-head with incumbents like this the result is almost always the same — they lose.
A more effective approach is to appeal to a specific segment of the incumbent’s customer base by utilizing an entirely different pricing metric that speaks explicitly to them.
Rather that making an incremental improvement to a value driver that your competitor already supports, find a new value driver that serves some underserved set of customers. And then find a new pricing metric, one the competition won’t want to copy because it undermines their own business model. Before I explain exactly what I mean by that, let’s back up.
The Strategic Role of Pricing
Pricing is where all the parts of your go-to-market strategy come together. It is not your strategic driver, but it is the integration point.
Why? Because pricing does the following:
- Encapsulates your value proposition
- Communicates your value
- Positions you to your customer
- Positions you relative to your competitors
Developing a Disruptive Pricing Strategy: Where to Start
The first step in establishing your pricing strategy is to consider how you can connect your pricing to the value you create. To do that, there are three key questions you need to ask yourself:
1) How do I provide value?
Answering this question will help you determine your value metric — the aspect of your product or service your customer gets value from.
The best value metrics are coded into the product, and actually correspond with the pricing metric (how you charge). Here are a few examples of companies with good pricing metrics:
- Google AdWords: Pay per Click
- Hubspot: Number of Contacts
- Survey Monkey: Number of Questions and Responses (plus some functionality)
- KISSmetrics: Number of Events
Bad pricing metrics, on the other hand, track your costs, irrespective of how much value you are providing. For example, prices based on bandwidth consumed or storage used are often cop outs; they are used as pricing metrics by companies that are focussed on managing their costs. This is the road to commoditization. Big companies can win by driving a service to commoditization. But that is not how startups win.
2) Who do I provide value for?
As a B2B startup you can’t serve the whole market. You will typically want to focus in on a specific segment you know you can create exceptional value for, you can communicate easily with, and that you can reach directly. Ideally, the people in this segment talk to each other and act as references (you want to get an echo chamber reverberating).
How does pricing come into this? Two ways.
- Choose a pricing metric that makes sense to the segment you are targeting. It should connect directly with their business model and use the same words they use. Look at a typical customers profit and loss statement, identify all the variables that feed into a line in the statement. Find the ones you can impact. These are your best candidates for a pricing metric.
- Use pricing to scare away the customers you don’t want. As a startup this may sound counterintuitive, but in fact you don’t want most of the possible customers. You want the ones you can provide extraordinary value for, that are easy to reach, and that help you get additional customers. You need to avoid the ones with a high cost-to-serve, that are difficult to use as reference customers, and that have too many unique requirements.
3) What are their current alternatives?
Your customers always have some alternative. In most cases they are using some other software application or have a manual process (most likely a cobbled together combination of both).
If you have a truly disruptive innovation and are targeting a group of users that cannot use the current solutions (often because they are too expensive and require too many other things to be in place) you may be competing against the toughest of all alternatives – doing nothing.
When your target segment does have a clear alternative, an incumbent so to speak, your best pricing strategy is to find a value metric that the incumbent does not use. Most incumbents have dated pricing metrics anyway, and one of your advantages as an innovator is that you can use a new pricing metric that your competition has trouble following unless it is willing to abandon its current business model (and very few big companies can afford to do that).
Zuora is the dominant player in subscription pricing management (they call their segment Business Relationship Management, but what they do is provide a platform for managing a subscription business).
Zuora keeps its pricing model opaque, but in most cases they have a rather large set-up fee and then charge a percentage of transaction volume. This was a good model when they got started. The set-up fee gave them some initial cashflow and protected them from those companies that set up a subscription model but for whatever reason never executed on it. Without question, this model has worked. They are currently the dominant player in their space, and recently received a $115 million investment from a long list of tier-one investors.
If you were trying to enter Zuora’s market what would you do? You wouldn’t try to challenge them head on. Instead, Chargify distinguishes itself from Zuora using its pricing model (and does this explicitly). First of all, Chargify does not charge a set-up fee. It also charges based on number of customers rather than volume of transactions.
That makes Chargify a more attractive option for smaller, earlier-stage companies that can’t afford Zuora’s set-up fees. These companies may also have more, smaller transactions than more established companies, so they are attractive to Chargify as well.
Some companies that start with Chargify will migrate to Zuora as they scale. But Chargify will try to innovate fast enough to prevent this. If Zuora feels threatened (I haven’t seen any signs of this yet) they are likely to introduce a service with no set-up fees and a higher transaction fee. They will probably avoid competing with Chargify by offering an identical pricing metric (based on number of customers), as that would threaten their core business.
In short, by utilizing a different pricing metric, Chargify has found an effective way to encapsulate and communicate their value proposition, while at the same time positioning themselves as a distinct alternative to their primary competitor.
More Pricing Strategy Tips & Resources from Steven Forth
- You Can’t Price Software Without Focus
Picking a number is actually the last step in a successful pricing process. Steven breaks down what you need to do first. Read more.
- The Secret to Boosting Your Software Pricing Power
Steven explores the surprisingly powerful role emotion plays in setting the right price for your software. Read more.
- B2B Pricing Black Magic: Appealing to Economic AND Emotional Needs
Steven explains how to achieve a potent, irresistible B2B pricing formula by aligning economic and emotional value along the technology adoption lifecycle. Read more.