Setting the initial price for your product may be the decision that has the single biggest impact on your bottom line profitability. It also conveys signals about brand image, product quality, and even affects whether customers will consider purchasing your product at all.
Unfortunately, setting that initial price is often based on guesses and trial and error.
At thoughtbot we’ve helped our clients design, build, and launch hundreds of products. We’ve also launched some of our own. Here are some of the things we’ve learned along the way about what works, and what doesn’t, when setting the initial pricing of your product.
Pay what you want
When we first launched FormKeep we had no idea what we should charge. FormKeep provides form endpoints that you can use to back web-forms, often on static websites. This lets you accept data on your website without building a backend. We felt that the “value” of each form varied greatly, from a contact form on a personal website, to a company’s sales form that could be worth hundreds of thousands of dollars in revenue.
To attempt to resolve this, we punted on the problem and launched the service with a “pay what you want” model. We provided a slider from $1/month to $99/month and let people make their own decision.
Unfortunately, the vast majority of our customers chose the minimum price (duh). At this lowest price point, a customer would net about 68 cents after credit card processing fees. After a year of providing this person with a quality service and customer support, we’d have about 8 dollars in our bank account.
Clearly this was not the way to build a sustainable business.
Pay per project
With FormKeep, we knew we needed to adjust pricing to fix the profitability of the product, but we still wanted a pricing model that acknowledged the different value of different forms. We decided to switch to per-endpoint pricing, and ask customers to indicate whether a form was for commercial or personal use. Commercial forms were $25 per month, personal forms were $9.
When we launched Hound, a code-style guide checking service, the pricing model seemed more clear to us than with FormKeep. You enable Hound on individual GitHub repositories, so we decided to charge $12-month per private GitHub repository you hooked up to Hound (public, open-source repositories were free).
The problems we ultimately found with this model, which I’m calling “Pay per Project” for both FormKeep and Hound were similar. Paying per project was an instant deal-breaker for companies with lots of forms or GitHub repositories. These people should have been our best customers, but the price ballooned far too quickly to be feasible.
As a result, almost all customers restricted themselves to one form or GitHub repository, even though they had more. Adding a second came with the instant penalty of double the monthly cost.
Tiers of joy
Ultimately, we decided to move both FormKeep and Hound to pricing tiers. The initial pricing tiers for FormKeep looked like this:
- Up to 4 forms: $29 per month ($7.25 per form)
- Up to 10 forms: $59 per month ($5.90 per form)
- Up to 30 forms: $99 per month ($3.30 per form)
- Up to 75 forms: $199 per month ($2.65 per form)
As you can see, the price per form decreases as you go up in number of forms, but the amount of each of the tiers is a sufficient monthly cost for us to operate profitably.
A tiered pricing model makes us attractive to organizations with many forms or GitHub repositories, who are likely to be our Best Customers.
When we rolled our these changes for Hound and FormKeep, our average revenue per user began to steadily rise.
Don’t be clever
This brings us to our first important lesson. We went through a lot of changes for existing customers and our products only to arrive at what is ultimately a fairly industry-standard solution. Nearly all SaaS products you see will have a pricing model that is based on tiered pricing for various levels of usage.
In our attempt to side-step the difficult pricing choices we needed to make, we created more complicated, less efficient pricing models that ultimately customers didn’t respond well to.
Sometimes being boring and doing what everyone else is doing is a good choice. They’ve probably done their research, and it is also what customers have come to expect.
Setting the price
When setting the initial pricing for your product, you have to consider:
- Your costs.
- Competitor’s pricing.
- Other market forces or changes that affect demand.
- How much customers are willing to pay.
So setting the right initial price for your product isn’t easy. Optimizing that price considering all of the factors is complex.
There are quite a few firms out there who will use established methodologies to conduct a formal pricing study for you. However, if you’re not in a position to work with one of these firms, you can do most of it yourself.
This one will contain a lot of guesswork at first, but is very important to consider. If your pricing isn’t setting your business up to operate profitably, it’s just not going to work (unless its specifically part of your funding strategy, which is a topic best saved for another post). A price change of a few percentage points can have a large effect on operating profits.
Make some reasonable predictions about what your major costs of doing business will be, including people, hosting, customer support, operations. Don’t forget credit card processing fees taking a percentage of your revenue. You can use 3.5% as the guide there.
SaaS businesses take some time to ramp up. If you’re launching a SaaS business, it is likely that you’ll go many months operating unprofitably. You’ll want to ask yourself at this point, how long you’re willing or able to operate unprofitably.
Finally, combine all of that information together to get your initial minimum price point needed to operate profitably. For example, if you’re expenses are $10,000 per month, and you can afford to operate unprofitably for six months, and you can reasonably expect that you will have 500 paying customers in six months time, then your minimum average monthly revenue per user is $20.
Like it or not, most customers will consider other options when making a purchasing decision. So you can’t consider your pricing in a complete vacuum. If your ideal pricing is $40/month but all of your competitors are $20/month, what will that do to your sales?
This doesn’t mean you need to match competitors pricing, but rather, you may need to figure out how will you justify this price difference. It may be that this higher price conveys signals about brand image and product quality, and therefore you need to pay particular attention to your brand and product quality, and how you position yourself so customers choose you. It may be that you decide to focus on a specific industry or market segment that that is willing to pay this higher price point.
If there aren’t any direct changes you’ll make to your pricing based on competitors, you’ll still want to keep this information in mind for the final step of determining how much customers are willing to pay, below.
Other market forces
There can be any number of things happening in your market that can affect what customers are willing to pay or what you can charge.
One such factor might be the other non-competitive services your customers are already paying for that will draw comparison. For example, when we launched Hound at $12/month per private repository, we saw several potential customers voicing their concern online about that price because they were comparing it to GitHub, which was about $9/month for the repository itself.
How much customers are willing to pay
Ultimately the price that your customers are willing to pay doesn’t come down to just one factor, but often is a combination of the above considerations plus even more variables.
There are a number of sophisticated tools and analysis methods you can use to determine pricing:
- Conjoint, MaxDiff, and discrete choice methods that measure how consumers trade off price versus other product attributes.
- Demand curve analyses that use pricing surveys to optimize pricing by projecting revenue and demand at different price points.
One common analysis method is the Van Westendorp method, also known as the Price Sensitivity Meter. In this method, potential customers are asked a version of the following four questions:
- At what price would you consider the product to be so expensive that you would not consider buying it?
- At what price would you consider the product to be priced so low that you would feel the quality couldn’t be very good?
- At what price would you consider the product starting to get expensive, so that it is not out of the question, but you would have to give some thought to buying it?
- At what price would you consider the product to be a bargain (a great buy for the money)?
In your survey, you can either have free form value entry or specific values each respondent must choose from. You can total up the number of responses for each value and plot the number of responses for each value all on the same chart. In order to get the lines to intersect, you’ll invert the values the “too cheap” and “cheap” responses.
The result will look like this:
To interpret these results, we look at the intersections of the lines:
- The crossing of “too inexpensive” (in blue) and “getting expensive” (in green) can be the lower bound of an acceptable price range.
- The intersection of the “too expensive” and “bargain” lines is the upper bound of an acceptable price range.
- The point at which the “getting expensive” line crosses the “cheap” line is known as the “indifference price point”, where equal number of customers rate that price point as either a “bargain” or “getting expensive”.
- Finally, the intersection of the “too inexpensive” (in blue) and “too expensive” (in purple) lines represents the “optimal price point”.
The optimal price point represents the point where there is an equal trade-off in extreme sensitivities to the price at both ends of the price spectrum.
There are some great things about the Van Westendorp analysis:
- You’re talking to real customers.
- It’s relatively easy for you to execute on and customers to respond to.
- It feels like science so you can feel good about the choices your making.
However, there are some problems with this analysis as well:
- It assumes that the responding customers are actually capable of envisioning a pricing landscape and responding accurately.
- It does not ask customers to consider other factors like value or utility, only price.
- It doesn’t take into account some of the other factors listed above, like competitive products.
- It assumes that every product has a price below which it is so cheap that you would question its quality. This might be true for some products or services, but not all.
Our client, SPLITFIT, which allows users to book time with personal trainers, conducted a Van Westendorp analysis. The analysis allowed them to identify what reasonable pricing could look like, but in talking with customers further, they learned that the lower they could get the price for personal training, the higher demand could be. That led them change a number of factors in their business, product, and offering to allow people to invite friends, train with strangers, and introduce a robust referral model, all the split the cost with others and lower the total price, to increase demand.
Summing it all up
In my experience, as long as you don’t use the Van Westendorp analysis as the only thing you are considering, it is an excellent complement to considering all of the above and arriving at your final pricing model and values. While other, more sophisticated methods exist, the Van Westendorp analysis, combined with the other considerations outlined here is the right mix for most people who aren’t going to pay for or aren’t more equipped to do a sophisticated pricing study.
- Keep things simple and don’t be clever. If you’re a SaaS business, your customers, competitors, and the market are probably all expecting and offering a tiered pricing model. That’s probably what you should do to.
- Make sure you understand your costs, how long you can operate unprofitably, and ensure that your pricing is set accordingly. Remember that a price difference of only a few percentage points can have a large effect on profits.
- Conduct a Van Westendorp analysis to identify the acceptable price range and optimal price point.
- Compare the acceptable price range and optimal price point to competitors, other market forces, and what you need to charge to cover your costs. Determine what, if anything you will be doing to justify any deviation from what these numbers are telling you, such as brand image and product quality.
With those four points considered, you should be able to arrive at a pricing model and values that will allow you to operate profitably and attract customers.
Finally, even though you should strive to eliminate the guesswork from your initial pricing strategy, you’re probably not going to get it perfect the first time. As we demonstrated in all of the examples above, you can adjust your pricing after launch based on what you learn.