In this series, TechNexus provides insights on growth strategies for startups. Follow along with the entire series here.
Crafting a pricing strategy takes time and discipline to implement effectively. When done correctly, your pricing strategy complements your revenue model and overall growth strategy. When done incorrectly, you will struggle to sell and your business could fail. Fortunately, pricing strategy is something anyone can understand and implement, and I’m here to help you get started.
Revenue model vs. pricing strategy
First, it’s important to understand the difference between a revenue model and a pricing strategy, which are often conflated. Your revenue model is a key component of your overall business model—it defines the core method by which your business generates income. This model should align with the nature of your business and target audience. For instance, if you are a B2B company, your revenue model might involve selling subscriptions, licenses, or service contracts to other businesses. The revenue model provides the structure for how your company makes money and ideally remains consistent throughout the lifecycle of your business, offering stability and a clear path to profitability.
On the other hand, your pricing strategy determines the specific tactics you use to sell your product or service within the framework of your revenue model. It builds upon the revenue model and should evolve as your business grows. Think of it as a one-to-many relationship: For every revenue model, there are multiple possible pricing strategies that can be employed to meet your business objectives and resonate with your target market.
For example, let’s say you own an inventory management software company that targets mid-market logistics companies. Your revenue model might be charging your customers an annual subscription for a software license. The amount you charge for this license and the structure in which it’s delivered is determined by your pricing strategy. We’ll revisit this example after we discuss a few common pricing strategies.
Common pricing strategies
So, what are the different types of pricing strategies you can use, and which strategy is right for your business? There are many, but today we’ll focus on five main types:
- Value-Based Pricing: Aligns prices with customer value. This strategy sets prices based on a customer’s “willingness to pay,” which is determined by their perceived value of your product or service.
- Best for: Established brands with differentiation. For example, Swiffer can charge more for refill pads once a customer owns the mop, reflecting the value of a product that fits perfectly.
- Worst for: Startups. While this strategy maximizes revenue potential, it’s challenging for startups because it requires significant investment in gathering consumer feedback and building brand value.
- Cost-Plus Pricing: Ensuring cost coverage with a standard markup. With this approach, you start by determining your desired net profit margin, then use your costs to back into that margin by adjusting the price.
- Best for: Mature markets, commoditized products, predictable fixed costs, and low variable costs. This strategy is often used by manufacturers or small businesses with a need to simplify pricing decisions.
- Worst for: Highly competitive markets, premium brands, and businesses with high fixed costs but low marginal costs. Cost-plus pricing is often too rigid and simplistic to capture the complexities of pricing such as customer demand and perceived value in these scenarios, leading to missed revenue opportunities.
- Competitive Pricing: Staying ahead in a competitive market. This strategy involves benchmarking competitors’ pricing and adjusting your prices regularly based on competitor data, sales trends, and customer demand.
- Best for: Highly saturated or competitive markets, value-based brands, high volume, and thin margin. For example, airlines, or grocery stores often engage competitive pricing where small price differences can make or break a sale.
- Worst for: Niche businesses, companies with strong brand value, or innovative products. For example, startups or niche businesses may be unable to compete on price due to higher costs.
- Penetration Pricing: Gaining market share with lower prices. This strategy helps you establish a foothold by offering lower prices when you initially go to market. For example, some companies may offer substantial discounts to early adopters.
- Best for: Fragmented markets, new entrants. This strategy is particularly effective in competitive and fragmented markets with many potential alternatives. However, you should have a clear timeline or target market penetration goal in mind, as you’ll need to shift pricing strategies later to achieve financial viability and avoid mutually destructive price wars.
- Worst for: Established market leaders, durable goods with long product life cycles. In general, penetration pricing is more risky, especially for low margin businesses.
- Skimming Pricing: Maximizing early adopter revenue. This strategy is the opposite of penetration pricing—set high prices for new products and lower them as competitors enter the market. The goal is to generate the highest possible profit in the shortest time rather than maximizing sales. This strategy suits startups with early adopters who are willing to pay more for new products. It also allows you to segment customers by willingness to pay, which can help you transition to value-based pricing as brand awareness grows.
- Best for: Innovative companies, early entrants. First-to-market companies or those with little competition should consider this strategy—pharma companies, for example, often use it to recoup development costs before generics enter the market.
- Worst for: Price-sensitive markets, products with short life cycles. This can also backfire in highly competitive markets.
Implementing your pricing strategy
As a startup, you should typically start with Cost-Plus Pricing, Penetration Pricing, or Skimming Pricing based on your market, product type, and other business characteristics. Then, consider how you might need to shift your initial go-to-market strategy over time. Specifically, outline what benchmarks will trigger shifts in your pricing strategy as you grow.
Now, let’s apply what we’ve learned to define a pricing strategy for our B2B inventory software company. Suppose the market for inventory management software is highly saturated with large competitors like SAP and Oracle. You differentiate in the market through real-time analytics, but you don’t yet have the brand awareness to leverage this in a competitive pricing strategy. You decide to go to market with a penetration pricing strategy to gain a foothold in the saturated market. If your competitors charge $49 per employee per month on an annual contract, you might enter the market at break-even, say $19 per employee per month. Once you reach 1% penetration of your obtainable market, you could shift to a competitive pricing strategy at $49 per employee per month.
Remember, the amount you charge a customer for this license and the structure in which it’s delivered is determined by your pricing strategy. Therefore, the price point itself is just one aspect of the pricing strategy, alongside the per-seat license fee. For instance, you might decide in the future to shift the pricing strategy to a single annual licensing fee for organizations with fewer than 1,000 employees. This example highlights how important it is to distinguish between your core revenue model and your pricing strategy, which can dynamically change without impacting other key business operations.
Pricing strategy as your business grows
As your organization scales, your pricing strategies become more complex due to the one-to-many relationship between a revenue model and its pricing strategies. For example, after a business is past its early stages (Series A and later), it may begin to diversify its revenue streams. Each of these revenue streams may, in turn, have different pricing strategies. For this reason, it’s important to be thoughtful about your overall business model, including your revenue model and potential pricing strategies, from the start so that you can remain agile as you scale.