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As 2020 reminded us, the only thing we can count on is change, and it comes rapidly and unexpectedly, sometimes like a punch to the gut. The pandemic has accelerated the decline in willingness to pay that has been an ongoing trend in software, but there were also many market conditions leading up to 2020 that have caused an increase in volatility of costs, supply chain, demand, driving an increased need for more dynamic pricing.
For example, the trade and tariff wars forced agility in commercial strategy and tactics to cope with cost fluctuation, or companies suffered margin compression. The pandemic has caused supply chain issues, constrained manufacturing capacity, logistics availability and majorly impacted demand in many categories. No one knows how long this will last or how it will all play out.
Many businesses, including startups and technology companies, have realized that business agility and pricing are key in this environment and they did not focus enough on pricing in the past. The last year taught organizations across all verticals that pricing plays a central role in a make-or-break situation. The five following key pricing models can help you adjust your pricing strategies to meet current demands, especially as we hit another year of unpredictability.
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1. Agile Pricing
Agile pricing is the ability to adjust your pricing strategy and tactics in concert with changes in the market, or even ahead of them. This is essential to avoid margin compression in many industries.
In 2021, we still do not know how many industries are going to bounce back so businesses must be willing and ready with smart commercial strategy and tactics, including pricing.
2021 year is the year of pricing agility, which can only come through foresight, preparation, and digitalization of the quote to order process. According to Profitwell research, the number of strategic price moves in subscription driven businesses correlates to an increase in revenue per user, which is an interesting yet somewhat counterintuitive finding.
An example of agile pricing is dynamic competitive pricing in e-commerce, or surge pricing for rideshare companies. But it goes beyond that: for example, we have several customers that price their goods or services in a manner that are tied to their underlying costs and can update their pricing dynamically which their costs change, or sometimes even ahead of this by sensing the market conditions that will drive a cost change.
2. Planful Pricing
What I mean by planful pricing is that pricing must be considered early on in the product development process. Businesses should consider willingness to pay as part of its product development process. There are many value-based pricing techniques that can be implemented and it’s subject to any point of the business and product journey.
For example, conduct a conjoint analysis before a product is developed, which can shape the features of the offer. Getting the right price at the beginning is much easier than trying to raise prices after a company has established a reference price in the market. There’s an even bigger reason to invest in getting that price correct if the product or service is novel and thus has little competition. After that, every time the price needs to be increased, you will lose customers. It depends on the situation, and you should research before you spend R&D money to determine the price, but when in doubt, err on the high side.
I’ve seen a CEO giving pricing advice to another founder that was unsure of willingness to pay but thought there was additional price to be gained by doubling prices and doing it again until you get pushed back. While this is not broadly applicable, the point is that if you enjoy a sizable cost advantage you sometimes have to push to an uncomfortable level to test willingness to pay.
3. Sustainable Pricing
Sustainable pricing is pricing that enables the long term profitable growth of your business.
Many companies price products or services in a startup mode, to acquire customers, below the value the customer perceives, and sometimes even below the cost to provide. This is called “penetration pricing” and it’s only sustainable if the business has a clear path to get to profitability. Many companies believe they can run their business on a model of monetizing the data and their users, but truly don’t and therefore cannot continue to grow once its funding runs dry.
This seems like a simple concept, but there are many companies that have failed because they did not have a clear path to profitable growth. This is especially true in 2021, where consumers are increasingly concerned with data usage and privacy which is challenging the ad-based monetization models that have kept many services free over the years. Think about how you will get to profitability, either via different models, increasing the value you provide to customers, using freemium offers. At the end of the day, if you are not providing enough value for customers to pay a price that results in profitability at some point, you are going down a dead end road.
4. Freemium Pricing
Freemium pricing is a pricing strategy in which a product or service is free but money is charged for additional services. In the challenging economic times that many still face this year, freemium pricing models are more relevant and attractive than ever to bring in new customers and also retain customers rather than having them churn. If done strategically, it can allow for the transition into a sustainable pricing model. Beware and be very thoughtful about how to transition customers from freemium into paying models.
I previously explored this concept in an analysis of Slack and Fortnite and how they have succeeded in the freemium model. This is just one of many examples that have worked but it’s imperative to understand if Freemium is truly a right fit for the business. Slack got it just right by understanding the right break points for their freemium offer that allow customers to scale to the point where they are willing to pay more for the increased value they get, which is a key in freemium pricing strategies.
Also freemium pricing can be a useful retention strategy in tough times to get customers, especially if you have a model where you can generate revenue from user-based data monetization or other streams.
5. Subscription Pricing
In 2011, Marc Andreessen famously said that “software is eating the world.” A decade later, it seems more apropos to say “Subscriptions are eating the world.” In fact, most households have 3-4 video subscriptions, and there are even services credit cards offer to review subscriptions and kill those you don’t like.
As subscription offers have grown, so too has the plethora of subscription pricing models. A few can be considered, but in this new world order of users and consumers wanting choice, it can be a good idea to combine subscription types together. There’s period-based subscription in which a user pays a fee per a designated time period to use a service. There’s options to pay per seat or user, or by how much one consumes the product. Whatever model you consider, it should start with an examination of value and an attempt to align to the metric that best captures that value.
Value metric-based pricing is an interesting strategy and one that I recommend more companies consider, especially if they aim to be a brand that has long staying power. It involves, for example, instead of charging by the lightbulb, provide a service which offers 99% lighting uptime and coverage for $x per month, which I saw at a lighting manufacturer.
I met the CEO of a company selling dirt to construction companies that provides a subscription for waiting in line for less time because they realized that the time spent in line is the thing they value most as it holds up their entire crew and process. MRO companies selling into manufacturing facilities enjoy this same advantage where the cost of the manufacturing line being down can be millions of dollars per hour, which means the willingness to pay for prompt service and repairs is much higher than other clients.
Pricing subscriptions give you the opportunity to go back to the drawing board. It begins with an understanding of segments of customers and their value drivers, then developing offers that are aligned with these. Also, you should always consider how to discourage churn in subscriptions by creating differentiation, creating switching costs, etc.
Traditional Pricing Models to Consider
For those looking into more traditional cost tactics, look into a few terms. Cost plus, which is commonly used and easily understood, often leaves money on the table. A market- based strategy uses market data such as competition and seeks to position your offer in a manner that is consistent with the prices in the market. It is often used in highly transparent and commoditized industries such as retail and e-commerce.
Value- based starts with understanding the unique and differentiated value your offer provides to your customers, with an understanding this can vary by type of customer. And dynamic pricing usually conjures the image of Amazon or other e-commerce companies adjusting prices throughout the day based on a number of factors. However, dynamic pricing has different meanings in varying industries.
Key Takeaways
As pricing becomes a front running strategy in business models and plans, it’s important to remember these key learnings from observations in the last year.
- Freemium is more relevant now than ever for many companies seeing increased competition and decreased willingness to pay in software and services.
- Churn is a killer for SaaS businesses, so pricing strategy and tactics should seek to discourage churn.
- Monetization is often a more effective way of increasing revenue and profit, more than any other process, including attracting new business or reducing costs.
Gabriel Smith is the Chief Evangelist and Vice President of Innovation at Pricefx and has 21 years of experience in Quote to Cash, CPQ, Pricing, Promotions, Consulting, Product Management, Sales, and General Management.
