- Why failing to invest time and effort in pricing is a wasted opportunity.
- Getting the fundamentals right: pricing, packaging, positioning, understanding who your buyers are, and the unit of measurement that grows with your buyer.
- Understanding willingness to pay and perceived value.
- International pricing localisation is one of the quickest and most powerful pricing strategies.
This article is based on an interview with Peter Zotto, General Manager and Co-Founder of Profitwell, talking about one of the trickiest subjects in tech and startups; pricing and monetisation strategies. It’s a tough challenge but critical to success and anybody that’s run a business knows how hard it is to figure out what to price and how to price it. But what we’ve learned from Profitwell is the profound impact a well thought out monetisation strategy can have on revenue growth, customer retention and revenue expansion. What we’ve also learned is that it’s often overlooked. Their research shows that software companies, on average, change pricing once every three years. But they can also show the opposite, which is that organizations who understand pricing, are talking to their customers, researching their pricing, validating their decisions and making relatively frequent pricing changes, have a much higher growth, better monetization, better retention and better revenue expansion. And that’s why we keep coming back to this topic with Profitwell, as they are the foremost providers of pricing insights and SasS performance metrics on the planet today.
Given the profound importance of pricing, why is it so overlooked?
This is the $64,000 question, but I do think the subscription economy is wising up to spending more time on monetisation. By and large, I think it’s been overlooked because it was never a priority to begin with, especially for companies that were starting out and raising a lot of money.
And what they would do is say, “Okay, the first thing we want to do is we want to get product-market-fit. Cool. We’ve got product market fit. Let’s just acquire as many customers as we can.” And pricing was always an afterthought. And it was, “well let’s just look at what the predecessor did or what our competitors are doing. Or let’s just put a finger in the air and pick something that we think feels right.” There was never any data, rigour or framework behind pricing. And so it was easy to sort of let it go by the wayside. Which is unfortunate because pricing and monetisation at large and pricing, packaging, personas and positioning, have a massive impact not just on the growth of your business, but everything from the way that you think about your unit economics, to the way that you think about profitability, to the way that you can justify hiring more people directly; correlating or translating into how much you’re charging for a product, and then exposing the transparency that comes with it. So it’s just a missed opportunity, unfortunately.
Unpacking the monetisation strategy: pricing, packaging and personas.
Pricing is one piece of the pie. But if you start to peel back the layers of what pricing really means, what you find is that actually it’s more about this concept of monetisation. The way we think about it at Profitwell is that it’s not enough just to put a price point on a product because, ultimately, you can have a perfect product and you can have perhaps a perfect price point. But if you’re not selling to the perfect persona, or if you’re not packaging it in the way that a certain persona wants to buy the product, then they’re never going to consume the product, you’re never going to convert them into paying customers. What a waste.
Perhaps the more intelligent way is to think about pricing as just one lever of the monetisation growth spectrum. So you have packaging, i.e. what features belong? Or what functionality belongs in what package? Then, who are the right personas to sell to? So are you selling to a large business or a small business? Are you selling to a VP or a C level executive? Are you selling to a consumer that has XYZ type of income? Are you selling to a significantly lower income persona? Because ultimately, if you don’t have the right personas then nothing else really matters? So that’s your foundation.
And then on top of that the right value metric. This is another overlooked component of the pricing equation, which is to say, what is the unit of measurement that you’re actually going to charge on? And one of the things that we as technologists and operators and technology companies have always done is we’ve looked at the bellwether SaaS companies and said, “Okay, we know that Salesforce charges by user. We think that’s a good metric. That’s the one we’re going to go with.” But that doesn’t always correlate to what the consumer finds valuable. And so, for example, if you look at Netflix, Netflix is one price point, you can consume all the content you want for as long as you want. If Netflix decided to change that, do you pay on a per show basis or an a la carte manner that would likely wildly change the impact of that value to the customer, to the consumer. And ultimately, they may decide that it’s not nearly worth as much as it was before on all you can eat. And so we want to be particularly mindful what that value metric is, and what the unit of measurement should correlate to for success. And so all of these things just to round that out, bubble up into the right monetisation strategy.
As a recap, it’s pricing, it’s packaging, it’s positioning, it’s understanding who your buyers are, and then ultimately, with that unit of measurement, that grows with your buyer.
How does pricing and monetisation and packaging excellence translate into world class in economics?
The crux of it comes down to getting your pricing right, figuring out that you have the right customers, and selling the right package to them. And doing it in a way that’s positioned exactly to create the value they are going to generate from your product. Then, ultimately, what’s going to happen is that they’re going to stick around for a lot longer on that product, your LTV is going to go up, your churn is going to go down, the acquisition cost will likely be significantly lower, because you’ve identified the perfect persona, you’re going to hit them with the exact functionality that they need, and you’re going to position it for them perfectly. So your acquisition costs are going to be lower.
If you can lower your acquisition costs, the money you spend on sales and marketing goes down so you can take that money and invest it in product.
If you have customers for a lot longer, you know that that LTV goes up and every budding entrepreneur, or existing company founder, knows that that translates into higher multiples and higher valuations.
One of the things that’s really hard to predict for companies when they haven’t figured out their pricing is having churn that’s wildly out of control; one month it’s high, one month it’s low, but they don’t really know why. A lot of the time we can deduce the fact that it’s likely to be because they have a poor packaging strategy. And so you have customers that are coming in, are under the impression that they’re going to get a lot of value from one package. They don’t get nearly enough value as they thought they were going to get and so they churn off the product. And similarly to that, you get customers that feel like they’re getting too little value, and they’re paying far too much. And so they turn off that product and they go to a competitor.
All these things play nicely hand in hand with this sort of concept of having good unit economics. But you can’t achieve this without having some framework for building a better pricing strategy.
How can organizations understand willingness to pay and perceptions of value?
One of the traps people fall into when they’re starting a pricing strategy research process is they’ll go to an existing customer base and ask, “how much would you pay for my product?” The problem with that is that human beings don’t look at value as a specific point. We think about value on a spectrum. And what I mean by that is that I don’t necessarily know how much the computer I’m on now is worth, whether it’s £1500 or £2000 pounds, but I know that it’s more expensive than the cup of coffee that’s sitting next to me. And I know that that cup of coffee is significantly less expensive than the room that I am sitting in. So when it comes down to determining what value is we think about it on this spectrum. It becomes insanely difficult to do this when we’re talking about software because often software, as we all know, is intangible. So it’s not like a really well designed shoe or a piece of clothing or a car, that I can touch, see and smell.
The way we determine value for software is by using a modified version of a Van Westendorp Price Sensitivity Meter. A Dutch economist, Peter Van Westendorp, came up with this concept about asking a range of questions to a particular audience that you think are relevant buyers for your product. And again, I would recommend people do not do this to an existing customer base.
The questions are as follows:-
1) When is the price point for this product, or this potential product, so expensive that no matter how much value you get out of it, you cannot consider purchasing?
Then at the other extreme, 2) when do you think this product is so inexpensive you’re going to question the quality of the product?
And this becomes insanely important for many startups out there because when you’re selling to enterprise businesses, startups have the tendency to undervalue the product or under price the product. And it becomes undervalued in the minds of these enterprises. And of course that messes with unit economics, the LTV numbers and that CAC number we mentioned earlier.
So the way that we combat this is to ask questions around when is this a good deal.
So, 3) when does it start to get a little too expensive, but there’s still enough value that you can make a purchasing decision?
Then 4) when it is a little too cheap and you start questioning quality?
These four range questions give us a really good top, bottom and middle and you add all those up, do some math, and then what you end up with is what we call an optimal price band. The band upon which you can price within; you get something that we call an indifference price point and that’s a sort of intersecting line between all of the four points. And that indifference price point is a good indicator of where you should price.
How does willingness to pay correlate with perceptions of value?
This relies on us introducing the product and where we want people to ascribe value. We don’t necessarily want to ask existing customers. So what we typically do is partner with market panels, who provide you access from anyone from a sort of stay at home mum in London or New York, stay at home dad in Munich or Texas, all the way to CIOs of a fortune 500 company.
You can aggregate all these buyers, run them through a series of videos or audio text or texts that allow you to describe the value, and then they can enter into a survey. And you can ask the range of questions on pricing we described earlier, but we can also ask them questions about their relative preference for the product capabilities.
The easiest way to think about this, and how you might do it on your own, is to remember that no two things are valued exactly the same. But we want to zoom out and look at components for drivers of value, and aggregate. What we don’t do is ask questions like, “Hey, can you rank this feature? Or can you rank this functionality for me on a scale of one to 10?” Because inevitably, and again this is how the human brain works, we want everything to sound good. And we want it right now. So if we give people the option to rank everything on a scale of one to 10, inevitably, what happens is we rank everything between a nine or a 10. We all want amazing things.
So what we do is very simply just ask forced trade off questions. This is known in the survey market research world as conjoint analysis, or max diff, and it allows us to ask what’s most valuable to you, versus what’s least valuable to you. And if you asked a statistically accurate sample size which varies based on confidence intervals, but let’s say you ask a group of 50 people, “Out of the following features, what’s most important and what’s least important, and you can only choose one of each,” what ends up happening is you get a far more interesting look at the value.
What we do then is we take that and we layer on different segments of the market and different components of the product. So it allows us to identify packaging structure and positioning structure for, say, a VP of Sales at a growth stage in the United States versus an established enterprise in the EU; they are buying the exactsame product but might say that they value the product or the functionality of the product actually quite differently.
This is going to inform the way that we go to market both from a marketing manager and content marketing perspective, as well as tactical hand to hand combat when it comes to the actual sales rep themselves. How do they talk about the product to drive value for that enterprise company versus how do they talk about the product and drive value for that Series B startup itself? So these things allow us to get more specific and more tactical with our strategy as it relates to go to market.
How early can and should founders be exploring this willingness to pay and perceptions of value?
It’s too easy to answer, “It’s never too early to work on pricing!”
In reality, though, this is one of the problems of being an entrepreneur because everybody’s telling you what to do: “focus on product market fit”, “focus on monetisation”, ”focus on hiring your first VP of sales”, “focus on getting your SEO in check.” The reality is this; if you don’t have product market fit, then you’re going to be in trouble regardless whether you have the right pricing or not. So it’s not that you should not think about pricing early, I think you should, but first you have to figure out:
1) who your buyers are first,
2) how you’re selling to them, and
3) the outcome of using your product.
If you don’t have that stuff right then you can’t ask a series of pricing questions, because the value is not necessarily correlated to what your product does at this point. So while I would tell you it should be done early and often, as far as exactly when in the life cycle or journey of an entrepreneur, the answer is “it depends.” But as soon as you have product market fit you should definitely focus on this.
Pricing is never “one and done.”
Pricing isn’t a one and done process. In fact, we recommend people change their pricing every six months. That doesn’t mean that they actually change their price points. That might mean they changed their value metric, they changed the packaging strategy. But this is one of those things that like your product, like your sales strategy and your marketing strategy, your monetisation strategy should be considered and discussed in management meetings, in annual board meetings and in annual kickoffs. These are things you want to do on a fairly continual basis, because you invest in the other parts of your product and your business, you should absolutely invest in your monetisation strategy as well.
How important is pricing localization to software companies as they grow?
Localization is one of the easiest rates of pricing optimization you can make when you’re working on a pricing strategy. Different cultures and different parts of the world have different levels of willingness to pay for the exact same product. And so, if you’re not optimizing for price localization, then on one hand you’re leaving money on the table, and doing yourself and your product team a disservice. On the other hand, you are missing out on the ability to acquire more customers.
So how do you do that? It’s not too dissimilar from what we talked about earlier, which is you need to run a bunch of studies to figure out what the actual willingness to pay is in a particular region. But I’ll give you a couple tips here. One is that if nothing else, you should change your currency symbol to reflect the actual location’s currency, sometimes that’s switching it from dollars to euros or from euros to pound sterling. etc, etc.
I would recommend finding a billing system to enable you to do that.
We’ve seen in the data from 16 or 17,000 subscription businesses across the globe that the Nordics region has a much higher willingness to pay in aggregate than any other region in the world. So if you’re selling into the Nordics, or you’re in the Nordics yourself, raise your prices by about 20% compared to North America.
We see that the UK and Western Europe also has a higher willingness to pay than North America, but less so than the Nordics. And we see that North America has a higher willingness to pay than South America.
Then we see Asian countries have a lower willingness to pay than South America.
So you want to keep things like this in mind as you’re starting to think about your pricing strategy around the globe. But to answer your question directly, price localization is incredibly important. It doesn’t take a lot of heavy lifting to do it, but it’s one of the easiest wins that you can get.
Who does monetisation best?
We think the folks at HubSpot do this particularly well. Their value metric is the number of leads or contacts in their database, which is brilliant, because what it does is open their platform to everybody within the organization that uses it. There’s no limit to the amount of licenses or users that you can have. And every client is tasked with the same goal, which is “get more leads!”. Which, of course, goes into the Hubspot platform, which drives value for the customer and value for Hubspot.
Their model is directly correlated to success, so we think they do a particularly great job.
There are some larger businesses out there, like Atlassian, who went public a couple of years ago; they do a particularly great job when it comes to their pricing.
Slack does a fantastic job. People are pretty familiar with Slack at this point, the internal communication platform. What they did was to give you up to five users for free, but one of the thresholds that you pass pretty quickly is the amount of historical texts that you can go back and review. So as soon as you pass the 10,000 line (or something to that effect), you have to start paying. Otherwise, the data, the text, the conversations actually disappear. At some point that becomes a major problem for organizations. They start with small teams and add more people from there, which drives more data and conversations, so again you pay more. So Slack and HubSpot do a particularly great job.
So, in short, pricing and monetisation is critical to success. Companies with good monetisation strategies, making frequent changes, with models aligned to customer success and localised internationally, significantly outperform their peers.