When is the best time to start your pricing strategy? Some say wait until you have product-market fit. Others question the concept of pricing strategy, as they think the market determines prices. In reality, many people fly by the seat of their pants until they crash into a mountain.
At Ibbaka, we see pricing as part of a natural flow from market segmentation to customer targeting to positioning. Pricing is based on the differentiated value you provide to your customers. Pricing helps communicate and position the value. Pricing helps you capture enough of that value to cover your costs, provide a return on investment and have a surplus to reinvest in continuous innovation.
Think of pricing not as price setting but as part of your product or service design. As we like to say, 'don't set prices, design pricing.' What does it mean to design pricing? The principles of design thinking can help us here.
Design thinking can mean many things. The most common use of design thinking is as a process where one moves from understanding and empathy through an investigation of root causes, to an exploration of design options, to testing with users. Stanford University's D-School has many good introductory materials.
Here are two simple approaches to design thinking you can get started with today. One is for new products and services, the other is for products and services already in the market.
pricing new products and services
- Ask your potential buyers and users about their pain and aspirations (fears and hopes). Really listen to what they have to say.
- See what they are doing today. If you can, spend time with and observe your potential buyers and users. Note how they are solving their problems today and what else they are doing just before and after. Remember, your offer will exist inside the other rhythms of their life.
- Explore multiple value metrics. Think about all of the different ways people get value from your offer. Think about how they get value from the alternatives. Are there any differences? If there are, that could be a key to your differentiation. This is one key to pricing power.
- Try out different ways of connecting your value metrics to pricing metrics.
- Choose a pricing metric by applying the following filters. The pricing metric should:
- Track value - the value metric and pricing metric can be connected
- Discriminate segments - it is designed for your target customers
- Make it easy to buy - aligns your pricing with your customer's business model, avoid excessive complexity
- Be enforceable - you and your customer both need to be able to calculate how much is owed
- Be simple - this is increasingly important these days
Pricing Existing Products and Services
If you are already in the market there are some simple checks you can do today to make sure your pricing is well designed. If you fail any of these tests, you can begin by applying the five step plan set out above.
- Does your pricing metric (how you set prices) align with your value metric (how your customers get value)? This is the central principle of value-based pricing. You need to start here.
- Do you clearly communicate the value of your offer before you talk about price? Look at your pricing page, but also look at your sales process. Establish value before you talk about price.
- If you have a tiered pricing architecture, is each tier fulfilling its designed role? There are a couple of things to check here.
- If you have assumed that lower tiers (especially the Free or Trial tier) will lead to conversions to higher tiers, is this actually happening?
- What percentage of your units and revenues come from your highest tier? In general it should be 5% to 30%. If it is higher than 30% you are almost certainly leaving money on the table.
- What are the renewal rates across tiers? Are they higher for one tier than another? If so, why? Renewals have a big impact on Customer Lifetime Value.
- Do you know which of your customers are getting the most value from your offer? What is the price/value ratio for each of your customers? Map these in a value map with price on the Y-Axis and value on the X-Axis. Do all the customers fall close to the line (good) or are they widely scattered (bad)? Take a quick first pass at this using rough estimates, then go deeper over time and validate your pricing.
Pricing is not Once and Done
You should be investigating some part of your pricing every day. Markets are always changing. Your competitors change their prices and positioning. Your customers' needs change. How your customers use your offer changes. All of these impact your pricing. Good market intelligence and customer intimacy are critical to pricing work.