One of the most challenging areas for startups, especially business-to-business companies, is how to price their products or services. Everyone wants to win some early revenues to show investors, but no one wants to leave (too much) money on the table. There is no magic formula for pricing. I have though discovered some principles that can guide the process.
No pricing strategy completely survives the first contact with enterprise customers. There will always be surprises. Price has to make sense to both sides. It is usually best practice to take the winding path to arriving at a price, rather than putting a price on the table right up front. It can help to do trial closes with different pricing elements, such as asking “if we did this deal do you have a view on what quantity you would purchase in the first year?” or “does your organization prefer to do long-term contracts with ceilings for annual price increases, or do you prefer to renegotiate annual contracts?”
Pricing involves much more than the dollar amount the customer pays. Unlike for consumer goods enterprise sales usually have many more variables to work with, including: volumes, minimum quantities, annual price escalations, level of service provided, customization, integration, payment terms, quality or performance guarantees, and many more. It is always important to be specific about what is included in the deal before stating a price, as the price makes sense only in context.
Beware the Ratchet Effect. If some customers hear a specific price early in the discussions, regardless of the context, that price often gets locked in as an expectation and it is difficult to move the customer off it. This is particularly problematic if the customer sees a price for a no-frills version of the product or service, but wants the advanced features. It becomes difficult to move them to a higher price, and the simpler version of the product may not meet their needs.
Keep in mind Enterprise’s view of costs is often broader than you might see it. I have worked with founders who were shocked to learn they could not give their product away for free. What they were missing were the other costs the customer sees in the transaction. Sometimes the buyer faces looking foolish or even being fired for making a risky purchase decision. Often there are switching costs to move from their current solution to your new one, which can include data migration, retraining, need to run two systems in parallel, and more. And sometimes there are other ecosystem costs such as integration with other tools, or the need for new equipment. The net is your price is only a portion of the enterprise’s view of the total cost.
Enterprises will usually push for a negotiated discount, sometimes because of their volume and sometimes because they feel they are special. Leave some room in the “starting” price to allow the purchasing department to squeeze the lemon, thus proving their value.
Revenues can be an important source of cash for startups. The more the pricing formula can accelerate revenues or gain fees for other services, the less money the startup needs to raise from investors. NRE for product upgrades, fees for customization or configuration, and prepaid revenues are all sources of cash that can offset the need to raise money from investors. In addition such advance revenues often count as evidence of market traction, so can make it easier to raise investor money.
Best pricing strategies have no room for playing games. They police themselves and adapt to standard workflows. Design them so that you limit or eliminate ways for accounts to cheat, buy from or sell to grey markets, do apply price arbitrage.
Avoid pricing schemes that are difficult to administer and calculate. Design them with administration in mind to keep life simple. Complicated pricing schemes also invite suspicion by buyers that they have been mischarged. In other words, keep it simple for both the company’s and customers’ benefit.
It is wise to link prices roughly to cost of doing business. For example, there are often fixed costs per account so there is not a linear relationship with the volume or number of seats. Costs to renew accounts are usually less than costs for initial setup. Knowing the cost basis helps reduce the risk having unprofitable accounts. In addition, having a cost-based rationale can help in price negotiations.
Plan pricing for the long term, anticipating potential volumes and additional services. It is difficult to do a major reset on pricing structures once a customer is on-board. Think about what the business might look like (product range, volumes, etc.) five years down the road when designing the pricing scheme.
For distributors, match their pricing to the roles they play and thus the costs they save the company (including lead generation, closing sales, account management, billing, customer training, customer service, tech support, configuration, etc.) and allow them enough head-room to make money. The more value they provide in the transaction, and the more they bring incremental customers who might otherwise be unavailable, the more you should be willing to discount to them.
It may seem complicated, but thinking of pricing in context of the entire system will lead to better outcomes for both your company and for the enterprise customers.