When you’re just starting, finding the right pricing model for your young business seems very hard and almost entirely arbitrary. That’s because, at such an early stage of your business, it is impossible to find the “correct” price for several reasons.
At the beginning of your business, revenue serves one purpose before any other: validation. A paying customer is validating multiple things at the same time. They are saying that your product is good enough to solve their problem, they are saying that it provides more value than it costs, and they are saying that their problem is painful enough to pay for a solution. With that one payment, product, value, and problem are validated.
That’s why the price is only secondary. As long as it is not higher than the value of the product, it will be sufficient to allow for business validation. It might not be the perfect price, and you might leave money on the table, but at that stage, it only matters to show that the business works. Early pricing validates your business and initial product. Later pricing optimizes overall revenue.
There are three rules to early pricing: it’s never perfect, it can be changed, and it should be aspirational.
Particularly when you are building a complicated product, you will have to start with a slimmed-down version of your final vision. It will only contain the basic features, the functionality that is needed to show what problem the product solves at its core. But your price should reflect the value of your full vision. That is because you are selling to a particular kind of customer: the early adopter.
The Psychology of Pricing for Early Adopters
Regular customers look at a product, calculate the immediate value they would receive, compare that to the price, and purchase if the benefit significantly outweighs the cost. If a product promises to be better in the future, they dismiss this as a purchase risk. “Majority customers” buy in the here and now, they are customers anchored in the present.
Early adopters or their even more radical peers, the Innovators, don’t think like that. They make purchasing decisions on what things might turn out to become. They will buy an electric car even though the charging infrastructure may not yet be there for it: they trust that the network effect will take care of that if enough people get involved. These customers buy for the future; they are anchored in the hope and trust that the things they purchase will turn out to be great.
And that final state is what they see when they look at the first quirky version of your product. They see it for what it might become, not for what it lacks. And they will pay for what they believe it will be. Of course, there is a lot of nuanced thinking going into such a purchasing decision, but you can be sure that the innovators and early adopters in your market will pay a premium for a product that breaks new ground.
Here’s the catch: you will have to live up to the expectations you set with your price. And you’ll have to do that rather quickly. The early customers might become your biggest supporters and marketing channels if you do it right. If you fail to fulfill your promise, they will soon pack up their things and move to another promising product.
So get used to thinking that your price is a very fluid number with a lot of flexibility. It is not set in stone. What matters is the value you provide to your customers.
Value Metrics: How to Measure the Value You Provide
Your price should reflect what you think the value of using your product is for your customers. This is tricky, as software products are continually evolving, and the value they generate evolves with the product. A good strategy to measure the value you provide to your customers is to determine their central value metric and measuring that.
So what is a value metric? It is the most relevant metric that goes up when your customer’s business is doing well. For an image hosting service, it is the number of images uploaded. For a music streaming business, it’s the number of times their songs were streamed. For a team-building service, it’s the number of team-building exercises successfully finished. If your customers are barbers, it’s the number of beards they can shave in a day.
The point is: if that number goes up, they make more money. And if that number goes up, you should make more money too. If you use tiered pricing, splitting the tiers among certain economically sensible limits of that value metric will make a big difference in your revenue.
Price Acceptance: Purchasing Power and Jobs-to-be-done
Be aware that the acceptance of your price levels also depends on the purchasing power of your audience. Selling to large entreprise companies will allow you to charge much more than when you’re seeling to online teachers who are working two jobs.
What you need to find out is how much it costs them right now to solve this problem. Do they have a solution already? What are they paying for it? If they don’t, how much time does it take them to do it themselves? How much would that be worth?
One approach that always helps with determining this number is the Jobs-to-be-done framework. It states that every product or service replaces something else, but not necessarily the same kind of thing. Imagine a software product that provides AI-generated technical drawings. It might not just replace another software, but make a whole position in the company superfluous: that of the technical draftsman. With one purchase, the company might save $100.000 or more in a year. Now imagine a CRM system that has specific features that automate the work that was usually done by unpaid interns or a half-automated task that is run once a month. How much does that save the company?
For FeedbackPanda, we knew that the purchasing power of our customer base was reasonably low. They didn’t pay for any solution yet, so they didn’t budget for a tool like ours. The resource teachers invested was their free time, which they valued surprisingly little. So we chose to price our product at a point that reflected what online teachers would make by teaching just one more hour per month. That turned out to be a very acceptable term for teachers, and it held true when we increased our prices by 50% one year into the business.
Find out the way the problem is solved now, and figure out what resources are invested in it. That will heavily determine if your price is accepted or not.
The Problem of Underpricing
Significantly underpricing your product will create a few problems down the road. While it will likely get you a lot of customers initially, many of them will be very price-sensitive. In general, bottom-of-the-barrel customers are hard to deal with, as they will want to squeeze the most value out of your customer support and your product for the lowest price.
Once you raise prices later, even a little, those customers might be very vocal about their disappointment. While there are ways to deal with that, like time-limited subscription grandfathering, you’ll be limiting yourself from the beginning, and you will surround yourself with customers you don’t want.
Price always communicates value. By pricing a product surprisingly low, you are saying that it is worth very little. That will scare away customers who are looking for high-quality products. Those are the customers you want because they are invested in making the product better and allowing it to thrive.
The Problem of Overpricing
Overpricing your product, on the other hand, is not as bad. You’re communicating that you think your product is worth it, you indicate that it is a professional tool, something for experts, for the people who know what they are doing.
Don’t underestimate the signaling value of price, particularly in crowded markets. The moment you are substantially cheaper than other products, customers who care about quality will think you’re worse. The moment you’re more expensive, those customers might start paying attention and check out your product.
With a high-price product, you only need a fraction of the number of customers to become sustainable. And you can always lower your prices if customers disagree with your value proposition. Don’t be afraid to charge more, particularly in the beginning. You may think that your product isn’t fully finished yet, but that is no reason not to charge the full value that people are ready to pay. For your customers, the result of using your product is what they pay for.
Another Thing to Try
If you don’t have any customers yet, be bold with your price. Zero customers paying twenty dollars might as well be zero customers paying fifty dollars. See if you can find the early adopters that are looking for a quality product in the future by showing them your sincere attempt to build one through a higher price.
Find a good initial price for your product. If you offer subscriptions, make sure to provide a yearly subscription option, at a slightly reduced price, from the beginning. Those subscriptions are an excellent signal for how much people think your product will be part of their lives. The moment someone commits to a year, you know that you are solving a critical problem well enough.
Don’t forget that ultimately, initial pricing is all about validating your business, product, vision, and what your market is willing to pay. Start with a reasonable price that is not too high to be insulting, not too low to suggest low quality, and shows your ambition to build a world-class product to solve the critical problem of your audience.