Pricing Series, Part 2: Evaluating Your Pricing Model
Part 2 of 3 of Companyon Ventures' Pricing Series
Written by Brandon Hickie
In part one of Companyon's pricing series, we talked about startup B2B SaaS pricing and how a user-based pricing model, which charges each client $x per user/seat per month, is not always the best fit. Although user-based pricing is simple and transparent, it can often result in non-ideal customers that do not always contribute to long-term success.
We also talked about how a usage-based model, which is charging based on utilization, is gaining more and more traction, despite it being more difficult to explain to customers and operationalize.
Now, we’re going to dive in and look at how to evaluate which pricing model is best for your company. We will look at how to make a decision on whether to keep the current pricing model, make some slight tweaks or switch to a new model altogether.
Pricing’s Role in Your Strategy
You first need to understand the purpose your pricing model plays in your go-to-market strategy and have a clear set of criteria to evaluate your model and alternative options.
The goal of pricing is to align a company's success with that of its customers so they can build a long-lasting, mutually beneficial relationship together. Think about it like setting up the compensation structure for your sales reps: The goal is to create a model that encourages reps to focus on the right opportunities to help your business win. Pricing is similar except the arrangement is with your customer and alternative options are almost always available and outside of your control.
A great pricing model balances the following 6 criteria:
Aligns With Strategy – The model must facilitate a clear path to achieve your business objectives and align with your go-to-market strategy. Your pricing model sets the incentive structure to signal to your customers how they should adopt and deploy your product. This is particularly important with new category and innovation products.
Aligns With Customer Value – The model must align with how customers think about and experience value creation. If not, customers will have a difficult time understanding how pricing works and why. This leads to misaligned expectations.
Fair – The price metric needs to be considered a fair measurement of value. If not, then pricing will deter prospects from using your services and create unneeded friction in the sales process and make expanding deeper into an account more difficult.
Scales With Value – Price needs to align with the value delivered via your products or services so that your incentives are aligned with that of your customers. This enables you to lower the barrier to entry but also allows you to grow with your customer as your partnership deepens over time. This typically comes in the form of a feature growth path via packaging and a scalar variable. This can be the price metric itself or a second variable such as users, data, usage, audience, outcomes, etc.
Predictable – A prospect or customer should be able to reasonably estimate the cost of using your services so they can appropriately budget and plan ahead. This requires a customer to have a clear understanding of the price metric, or what they are charged for whether its users, gigabytes of data, API calls, etc. How pricing is calculated and a way to measure anticipated costs is also important.
Ability/Cost to Operationalize – The pricing model needs to be something you can:
Easily implement into your sales, revenue, provisioning systems and contracting processes.
Deploy sales enablement tools and assets, and customer enablement tools, where relevant.
Easily integrate into your sales compensation model. Don’t forget this one. Reps also need to be brought along in the process and failing to do so often leads to failed business model changes.
You will be using the above criteria later in the process to evaluate your current business model, optimization opportunities, and alternatives.
Step 1: Understand Your Business and How You Create Value
The first part of the process is to ensure that you have a clear understanding of your strategy, how you create customer value, the target customer, the competitive landscape, and the dynamics of your market.
A great way to do this is to set up a workshop with the CEO, COO, heads of product, marketing and sales, and a few investors to discuss the following questions.
How does the product fit into your company’s long-term product and market strategy and what are the implications for how we package and position the product?
Target Customer Definition & Value Structure
Who are the target customers for this product and how does the product/service deliver value to them? And how do they think about return on investment?
What is the perceived value of your product/service and perceived willingness to pay? Is there value differentiation across the customers base and if so can it be explained via feature differentiation and/or pricing differentiation?
Competitive & Market Dynamics
How are customers servicing the pain points and needs your product addresses today, if at all? And how are other competitive products/services in the market whether direct or adjacent, positioned, priced, and sold?
Is there a set-up cost or variable cost structure that must be accounted for in the model design to ensure financial feasibility?
Are there product or service requirements for operationalizing the model?
Do you have relationships with the target customers and buyers already? And if not, are indirect sales models such as value-added resellers in scope?
Why do some customers grow faster with us than others after initial adoption? Why do some customers have more success on our platform than others?
Step 2: Evaluating Your Business Model
Then, have each stakeholder evaluate your pricing model based on these six criteria outlined above using a five-point scale, one being unacceptable/non-starter and then ranging up from not attractive to acceptable to attractive to the top option.
If you are not getting a good score across the board - and typically you don’t at the beginning - that sets the stage for a discussion on why you are scoring lower in specific areas.
Then it is time to look at alternative pricing strategies and build a few alternative pricing models so you can compare them to the current model. This exercise may be good to do even if the model scores well.
Step 3: Build your alternative models
Now you are going to develop a set of alternative models by identifying and evaluating a set of potential price metrics based on what you have learned about customer value from the previous exercises and discussions.
First, ask the group to build a list of 10 to 12 potential price metrics based on the customer value discussions and knowledge of the ecosystem around your company’s products/services. Then have the group evaluate those metrics based on the pricing model criteria from both the company and customer perspectives on a 2x2 to identify the best options.
The following is an illustrative example. Other metrics can be found using a combination of users, volume metrics and features by product edition.
The goal is to find pricing metrics and variants that are in the top right square of the box, where value is high from the company and customer perspectives. Have the group look at the results and agree on the top three to four price metrics to build a few alternative models around.
Now take that set of metrics and design a set of three or four alternative models to compare against the current pricing model (note these can be optimizations to the current model). You can use the following model component guide to guide you through this process.
Obviously, for early-stage companies, simplicity is your friend but remember that a great model needs to scale with value. Now, you are ready to evaluate the options based on total addressable market and revenue projections.
Step 4: Assessing the models
The last step in the process is to project how each pricing model would impact the business financially and to try and get a read on the risks/challenges with the transition to the best alternative.
Sizing & TAM Implications: Does your new model result in more revenue and larger TAM than the old pricing model?
Winners and losers financial scenario analysis: Model customer outcomes using each of the shortlisted models to see where you will win and lose relative to your current model. This will tell you how difficult it may be to operationalize the changes and signal how it impacts your customer acquisition and expansion strategies. Below is an example of how you would do that.
3. Assess Implications for Strategy: Analyze how each model positions your company in the market and how the customer is thinking about it. Here are some questions to ask about this part:
How will customers associate the company with the new pricing model?
Is your company now positioning itself as the more expensive option that is superior or the basic version that wins on price?
Are you locking some customers out that may be ideal customers long term?
Is your pricing so high that customers will leave you at the first sign of a problem?
Are you charging too early or too late, in terms of when the customer starts to see real value?
Is the model simply too difficult to follow?
All of these questions will help you understand the best pricing model long-term and look beyond the numbers. Remember, the goal is to create a long-term, win-win scenario.
The last piece of the process is to run the new model by your customers, and prospective customers. You don’t know how it will work until you get the buyer’s perspectives on the model and actually test it.
Now, this process may be more involved than you imagined. But when building a company, the more work you put into understanding your customer and building your products and services with the customer in mind, the more likely you are to succeed.
Achieving a triumphant economic model is all about aligning customer incentives with your own and making sure they scale together and fit the maturity and competitive dynamics of a given market.
Brandon Hickie is the Director of Monetization Strategy for LinkedIn’s portfolio of Hiring, Learning, Engagement, and API solutions. Brandon is a friend of the fund who helps Companyon’s portfolio companies implement new pricing strategies as they go through their GTM expansion phase. Prior to his current roles, he advised OpenView Venture Partners’ portfolio companies on GTM strategy and setting their businesses up for scale for 5+ years.