Capturing Value Through Pricing in the Hold Period
Why is it important to have a pricing strategy?
Pricing is the most powerful financial lever at your disposal – a 10% increase (or improvement) in price has a greater impact on 5-year revenue and EBITDA than a 10% improvement in variable costs, fixed costs, new customers, or customer retention. Failing to optimize your pricing leaves fiscally significant potential on the table.
Business models are intertwined with pricing – companies can be largely defined by two questions: “What value do you provide?” and “How do you capture that value?”. A viable pricing strategy can make or break your business model. It also informs how others in the market perceive your brand and product.
Strong pricing strategies usually indicate a robust understanding of your customer base and cost structure – optimized pricing strategies drive increased revenue, improved profit margins, better market positioning, and more effective customer segmentation. A poor pricing strategy might indicate that a business doesn’t fundamentally understand its customer and/or unique value proposition.
How do you identify when your company has a pricing opportunity or needs to undergo a pricing project?
| Qualitative indicators | Quantitative indicators | ||
| • Management team feedback (“We haven’t had a price increase in a long time…”) • Sales team feedback (“pricing is too complicated”, “it’s hard to sell”, “our pricing isn’t flexible enough”, etc.) • Market changes (e.g., the emergence of new competitors or technological advancements) • Macroeconomic changes (e.g., inflation, new regulation, etc. ) | • Customer engagement is high but net dollar retention is poor • ACV (average contract value) hasn’t risen over time • Customer interviews and/or surveys indicate higher willingness to pay | ||
Pricing Opportunities
What are the common pricing projects you can undertake?
Pricing projects usually address multiple factors at once – occasionally, you might increase your price without making other changes to your pricing strategy. However, most pricing projects address the 3 major components of pricing strategy to some extent.
| Project type | What happens in this type of project? | Example key questions to answer | |||
| Price increases (or decreases) | What you charge goes up (99% of the time) or down | • For which customers does the price change apply? • For which products does the price change? • How much does it change? | |||
| Repackaging | What you sell (and how you sell it) changes | • Do you have tiers of features (bronze, silver, gold)? • Are features sold a la carte or in the tiers? • Do your bundles make sense? • Are your volume tiers wide enough? | |||
| Business model transformation | A shift in your monetization strategy experiences | • Do you need to switch to a subscription, usage-based, or outcome-based model? • Do you want to monetize both sides of a market? | |||
A common business model transition is from a license to a subscription model – because it enables you to increase revenue from providing the same (or nearly the same service). Businesses with strong product or feature pipelines often benefit from pursuing repackaging projects, which expose customers to new features that they will eventually need to pay for.
Pricing Models
What are the 7 components of all pricing models?
There are infinite variations of pricing models, but they are all composed of the same key elements – think of pricing models as recipes. There isn’t a finite number of recipes in the world, but there is a finite number of ingredients or techniques that go into those recipes. In the same way, every business’ pricing model has the potential to be unique, but we use a simple framework to map how that pricing model needs to work at each level.
| 1. Metric | ||
| Definition | The unit that a customer pays for when using your product or service | |
| Key Considerations | Pricing metrics are the most important component—and the hardest component to change. Reeducating customers on new metrics is difficult, and metrics are often hardcoded into software. Metrics must meet 4 requirements: • Feasible – you can track and enforce it • Communicable – the customer can understand it and perceive it as fair • Segmentable – customers differ in their utilization of the metric, so not all customers will pay the same price • Predictive of willingness to pay – the more you use it, the more value you get, and the more you are willing to pay | |
| Research methods | Qualitative/ Internal analysis – evaluate potential metrics from a theoretical standpoint (this is how 1-person start-ups often determine their pricing) | Quantitative/ Internal analysis – if you have data, run regression analyses to determine which metric is most predictable of willingness to pay |
| Qualitative/ External analysis – interview customers to understand their willingness to pay, how much they use each potential metric, and how they think they’re getting value out of a product | Quantitative/ External analysis – conduct a survey asking about willingness to pay and how many of each metric they need | |
Tips on establishing pricing metric:
During interviews, ask customers if they plan to get more value out of your product in the future – Dig into how they expect that to happen to identify a strong potential metric. For example, if a customer says they plan to increase how much they use a product but don’t expect to hire any new employees who will use it, a usage metric can better predict willingness to pay than a per-user metric.
| 2. Structure | ||||
| Definition | How the pricing metric relates to time and volume | |||
| Key considerations | Structure is where you might introduce volume tiers (and determine how wide they are), consider whether your tiers have maximums and minimums, and decide if you have overages. Different structures can help modify the customer experience as it pertains to the 4 elements below. Structure is assessed by 4 elements: • Consistency – how stable pricing is over time • Predictability – how well customers can forecast their costs • Flexibility – how much control customers have over their costs • Timing – how frequently you bill | |||
| Research methods | Competitive analysis – understand industry norms. Customers might be more open to pricing structures they are already familiar with. Customer interviews – gauge whether customers prefer predictability or flexibility, and if your current pricing structure is a pain point or an advantage. Financial modeling – explore the impact of different structures on revenue before committing to a pricing structure. Also, consider how working capital needs play into your billing schedule, as well as your company’s strategic needs for recurring vs. non-recurring revenue. | |||
Tips on establishing pricing structure:
Determine which structure you want by triangulating on consistency, flexibility, and predictability – different common structures have different strengths. For example, a subscription pricing structure is highly consistent but not flexible. While a usage-based pricing structure is less consistent but more flexible.
| 3. Level | ||||
| Definition | The actual price point you charge within your structure | |||
| Key considerations | Level is the easiest to change and experiment with but has a lower long-term impact than metric and structure. | |||
| Research methods | Unaided pricing questions (e.g. the Van Westendorp price sensitivity questions) – these can help identify your price range and are especially useful if you have no idea how to price your product or service. It can also handle price points at different orders of magnitude, allowing you to measure how pricing might change based on volume or other metrics. Aided pricing questions (e.g. the Gabor-Granger method) – lets you hone in on optimal price points if you already have a general sense of the price range. However, you must identify 5 price points to include before conducting the survey, Gabor-Granger cannot handle orders of magnitude price differences, and it’s impossible to use during an interview. | |||
Tips on setting pricing level:
Understand the limits of different pricing research methods – and identify your priorities before conducting surveys or interviews.
| 4. Packaging | ||
| Definition | How your value is organized into offerings | |
| Key Considerations | Packaging is the theoretical framework that determines how value is organized – e.g. the decision to have feature tiers or sell everything a la carte. There is a wide spectrum of packaging archetypes (which are compared to menu styles below), and companies should use customer insights to determine which option makes the most sense. Any one of these styles can exist as a “hybrid” packaging too – e.g. a Good-Better-Best set of tiers with a few add-ons. Packaging archetypes: • Buffet – everyone has the same product experience and gets access to everything • Prix fixe (Feature Tiers) – tiers determine whether a customer chooses a Good, Better, or Best-style package • Dim sum – every item is custom negotiated in your bill Nuanced packaging options: • Add-on packaging – when 90% of your customers have one product experience and 10% have a different product experience (e.g., open source), you standardize your offerings for most customers and provide the option to add on specific features • Use case packaging – offerings are organized by use case or user type, not in tiers of increasing value (e.g., Microsoft Office bundle vs Microsoft Student or Microsoft Home) • Platform packaging – you offer a common set of features to every customer, along with the ability to turn add-on features on and off. • Usage-based packaging – instead of being able to turn add-on features on and off, those features exist on a spectrum, allowing you to use 75% of a certain add-on Note: “Buffet” packaging prioritizes revenue growth over profit, while “dim sum” and platform packaging prioritize profit over revenue growth. Feature Tiers are a balanced approach which is one reason why they are so common. | |
| Research Methods | BYO interviews/surveys – ask customers to build their own package and price their own package to understand how they think about the value they’re deriving from your product. Conjoint analysis – combine level and packaging research to conduct in-depth pricing analysis on different levels of value. | |
Tips on setting packaging:
Understand the structure of customer desires for features in your market – if most of your customers share 1 set of feature needs, you should probably do add-on or buffet packaging. If your customers have diverse needs, you’d probably benefit from platform or usage-based packaging. If feature preferences correlate with willingness to pay, you should probably use tiers.
| 5. Bundling | |||
| Definition | How specific features or products in your offering are grouped together | ||
| Key considerations | Bundling determines which features should go into the tiers identified through packaging. Through bundling, you decide if specific features should be offered a la carte or put into specific tiers. There are 4 types of features, and they can be compared to the contents of a Happy Meal: • Leaders – high adoption, high value (the burger, toy, and/or chicken nuggets). They carry the bundle. • Fillers – high adoption, lower value (soft drink, fries). Lots of people want them, but they inspire a lower willingness to pay. • Killers – low adoption, high value for adopters (coffee, McFlurry). If they were part of the bundle, they’d kill it because most people don’t want it. However, those who really want it are willing to pay for it separately. • Duds – low adoption, low value (pickles). • (Sometimes) table stakes – this is like ketchup: you must have it, or the bundle doesn’t work. | ||
Tips on bundling:
A common type of bundling is nested – where the bundles build on each other to offer more value to the customer at higher bundles. In this arrangement, leaders go in Bronze, fillers go in Silver, and killers go in Gold or are sold a la carte.
| 6. Promotion and discounting | ||||
| Definition | How you get customers to try your product (promotion) and how you bend the price curve to account for noise in customer willingness to pay | |||
| Key considerations | Pricing models can’t account for every component that factors into a customer’s willingness to pay. Discounting solves this issue by offering a flexible, uncomplicated way to meet certain customer types where they are. Make sure that there are clear rules that explain exactly what sales reps can offer in terms of discounting. Promotion strategy helps to accurately price a customer’s risk at trying a new product and encourage them to purchase. There are 4 types of promotion strategies: • Freemium: use when value grows slowly over time, e.g. Dropbox • Free Trial: use when value pops early on and remains flat, e.g. Netflix • Deep Discount: use when value is delayed or negative, e.g. Verizon Reverse Trial: use when value can be accelerated in the initial period of product adoption to improve stickiness, e.g. Comcast. A common error for self-service businesses is mixing up freemium and free trial. Undoing a freemium later in a company’s life can be extremely difficult. The most common error in sales-led businesses is not using a deep discount, but instead charging “implementation fees” – the opposite of a deep discount! See below for more driving adoption through land and expand strategies | |||
Tips on promotions and discounting:
Discounting can improve value-capture efficiency where the pricing model itself cannot – for example, it’s acceptable to have a senior discount at the movie theater. However, it’s unacceptable for the price of your ticket to be based on age.
| 7. Monetization Strategy | ||||
| Definition | The overarching approach that ties all other components together | |||
| Key considerations | The first 6 components help businesses maximize revenue. Monetization strategy determines whether you want to maximize revenue at all, or whether another objective is more important to your business. There are 3 main monetization strategies: – Revenue maximization (default and most common strategy) – Penetration (maximize adoption) Skimming (maximize profit) | |||
Tips on monetization strategy:
For example, if your business has strong network effects, your strategy might underprice the product – you’ll lower the price to get new customers into your ecosystem because they create value by growing the network effect of your product.
Your monetization strategy doesn’t have to work for all potential customers – for example, you might decide to price out the bottom segment of the market because it’s in your best interest to focus on serving only the segments that have a higher willingness to pay. Although you’re not designing a pricing strategy that works for all potential customers, focusing on the customers you are serving will make your business more profitable.
Who should own pricing and who should be involved?
Pricing projects should be led by a pricing or growth professional – companies with ARR of $100+ MM might have a Head of Pricing who should own pricing. The Head of Growth—or Chief Revenue Officers who oversee Sales, Marketing, Success, and Product—can lead pricing for medium-sized companies (ARR of $20 – $100 MM). CEOs or GMs usually own pricing for smaller companies (ARR of < $30 MM).
| Participant | Role | |||
| Head of Pricing/ Growth, CRO, or CEO | Lead the pricing project – they head the project and have the final say to mediate important decisions. | |||
| Head of Product | “Voice of Product” – knows the product inside out, understands what features are valuable, and knows what is feasible and trackable from a monetization perspective (for example, “Can we sell this feature?” “Can we break apart these two features?”) | |||
| Head of Sales or Marketing | “Voice of Customer” – represents the voice of the customer, understands customer complaints and priorities, and can ensure the customer will understand the new pricing strategy | |||
| Finance | “Wild card” Fourth perspective – to provide another point of view that mitigates the natural conflict between Product and Marketing/Sales | |||
Implementation
How should you roll out new pricing to customers?
New pricing rollouts should aim to minimize disruption and maximize acceptance – pricing updates are important, but your rollout strategy should depend on how much risk you want to take and how urgently you need to drive incremental revenue. A phased rollout approach mitigates risk by implementing the new pricing in stages by customer segment.
| Phase | Segment description | Reasoning | |||
| 1. New customers | Brand new customers who have no prior pricing expectations | New customers let you test the market’s reaction to your new pricing strategy without risking existing customers. If new customers balk at the updates, this could be a sign to revisit your assumptions | |||
| 2. Upsold customers | Existing customers who are upgrading or expanding their usage or tier | These customers have a higher willingness to pay and are already hoping to expand their relationship with you, creating a natural opportunity to introduce new terms | |||
| 3. Legacy customers | Long-term customers who are still on old pricing plans | Legacy customers are important clients with significant opportunity to improve account profitability, but they’re tricky to negotiate with because they’re used to your old (cheaper) pricing model | |||
| 4. Recent adopters | Customers who’ve purchased in the past year | Talk to recent adopters last because they will be the most frustrated that they just decided to purchase your product, only for your pricing plan to change almost immediately. | |||
How should you roll out new pricing to customers?
New pricing rollouts should aim to minimize disruption and maximize acceptance – pricing updates are important, but your rollout strategy should depend on how much risk you want to take and how urgently you need to drive incremental revenue. A phased rollout approach mitigates risk by implementing the new pricing in stages by customer segment.
How should you handle discounting?
Lower volume, higher value sales cycles have more flexibility – specific benchmarks should depend on your business model, but in general, if you can use discounting to improve adoption on a case-by-case basis without compromising on profitability, you should.
Discounting thresholds should end in a 9 – on a psychological level, we gravitate toward offering “round number” discounts (20% off, 30% off, etc.). If you map the percentage discount given to the number of deals, you will see spikes at numbers ending in 0’s and 5’s. By requiring manager permission to give a 20% discount (but not a 19% discount), sales reps now need to negotiate for every percent and end up transforming your graph from a spikey data set into a curve. At the very least, this threshold will instantly protect that 1% of revenue.
Driving Adoption
How can your pricing strategy support land and expand GTM strategies?
Promotion strategies convince customers to try your product (land) before you fully prove the value – non-buyers can’t understand the full extent of the value of your product because they haven’t yet had a chance to use it. Promotion strategies factor in this customer’s lower willingness to pay so that you can expose potential long-term customers to the benefits of your offerings.
Promotion strategy should be informed by how your product proves value over time – the same promotion strategies don’t work for products whose values accrue differently over time. Competitors in the same industry generally adopt the same promotion strategy as new technologies are adopted—so if you notice that yours is different from everyone else’s, it might indicate that your approach is out of date or has room for improvement.
| Strategy | Description | When it makes sense | Example |
| Freemium | A free, lower-value tier that can be accessed forever | Value to customer starts at zero and increases over time | Dropbox |
| Free trial | Temporary free access to an offering that you will eventually need to pay for | Value to customer remains consistent over time | Music streaming |
| Deep discount | One-time discount to encourage adoption | There is a delay or cost you must incur to use the product/ service | Verizon |
| Intro bundle | Raise the value for the first year instead of lowering the price | When you can accelerate the customer’s time to value | Software products offering free support for the first year Gyms offering free personal training when you join |
After you’ve landed a new customer, expansion depends on your pricing strategy – “land and expand” isn’t a strategy in and of itself because it refers to the process of securing new customers and then growing those accounts. Your ability to “expand” the value of a new customer depends on how well you’ve aligned your pricing to a metric and structure that accurately judges that customer’s willingness to pay and allows them to expand over time.
Overall
What are common pitfalls?
Companies get “tier-happy” instead of focusing on the differences between customer segments – having too many volume tiers makes it confusing for your customers, complicated for your sales reps, and doesn’t effectively encourage customers to expand between levels because there isn’t enough differentiation. If you’re using volume tiers, make sure each tier solves a specific purpose for a specific customer group.
Overestimating the benefits of undercharging for products with important externalities – it’s easy to underestimate the decrease in revenue that will come from valuing the potential of network effects over direct revenue. Leaders can be eager to sacrifice short-term revenue for long-term externalities on a theoretical level, but it’s challenging to do this exercise accurately and not reverse your outlook when you’re hit with the reality of reduced revenue.
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