A startup must decide how to price its product or service. You can set the price based on costs, give the product away for free, or charge what the market will bear.
The decisions you make today have lasting implications—defining your brand image, funding requirements, and long-term business viability. Clearly, your company’s business model must be grounded in the characteristics of the market and customers you choose to serve, the pricing model of existing competitors, and a strategy you believe is consistent with your future products and direction.
Your business model interacts closely with your marketing model. Marketing is initially required to get visibility into the opportunity and access to it, but your pricing defines how you will make money over the long term.
In general, I’ve found that the “keep it simple (KISS)” principle can be a useful tool for small business owners. Customers are typically wary of complex or artificial pricing, and your challenge is to set the right price to match value perceived by the customer, with a fair return for you. Don’t guess – conduct your research early with real customers, so you know what price will really motivate them to buy your goods or services.
8 Pricing models that startups can use
Product or service is free, revenue from ads and critical mass
This is the most common model for Internet startups today: The service is free, and the revenue comes from advertising. It works fine for customers, but not for startups unless they have deep pockets. If you have real guts, try the new Twitter model of no revenue. Count on the critical mass value from millions of customers.
Product is free, but you pay for services
Give your product away for free and charge for installation, customization, training or other services. This is a good model for getting your foot in the door, but be aware that this is basically a services business with the product as a marketing cost.
With this model, companies like LinkedIn and many others allow their basic services to be free but charge a fee for premium services. It can take a huge investment to get to critical mass and the companies that use this model need to be able to sell their premium services to the free users they acquired.
A product pricing model where the price is two to five times the cost of goods sold. If your product is a commodity, the margin may be as thin as ten percent. Use this model when the cost to produce your new technology gives you a tremendous advantage over competitors. Avoid it in situations where there are many competitors.
Charge a price commensurate with the value delivered. This works well with premium products and services that deliver tangible benefits but does not work for less value-based products, like social networks.
In enterprise products and services, it may be more appropriate to price by user group ranges or volume usage ranges. Create a small number of these tiers to make your pricing strategy manageable.
In highly competitive environments, you need to offer a competitive product—but it can’t be cheap. This approach is often used to drive competitors from the market and later raise prices. Yet this strategy is toxic for startups.
One way to create a feature-rich product is to market it “bare-bones” for a low price and to add features for additional prices. This method can be very competitive, but your product must be designed and built to provide good utility at many levels.
The bottom line is that you will need to figure out what the best pricing model is for your particular startup. But before you do, spend time evaluating each of the eight models and see which one makes the most sense for where your business is right now. After all, as Salesforce said in their article on product pricing, “Asking the right question is more important than getting the right answer.”