The 5 Essential Factors to Determine Your Product's Price
Pricing is always something that’s fascinated me. In my economics 101 class, I learned how price affects supply and demand. But in the real world, things aren’t nearly as neat as they appear on that simple two-axis graph.
When you’re launching a new product, especially one where there’s very few competitors in your space, it can be hard to know what to charge. If you pick a number that’s too big, you’ll make it harder to sell and scare away a lot of customers. Pick a number that’s too small and you could find yourself struggling to stay afloat.
Here are the five factors you must consider when choosing a price for your product.
1. At Minimum - Cover Costs
If you’re manufacturing widgets, there is a certain minimum threshold for what you can charge. There is a cost associated with the factors of production for your product – like materials, factories and labor – and the price of your product needs to be at least this high, in order to cover the cost of its production.
With software products and services, these costs are relatively low. Labor is initially high, but once the software is written and the systems are in place, each additional unit is just a few extra entries in a database.
Most funded SaaS companies don’t really consider this when setting their price, but it is an important price point to start from.
Don’t forget to leave some wiggle room to cover the cost of marketing and sales. Sometimes these costs will be more than half of the total costs for your product. Those units aren’t going to sell themselves…
Note: freemium (charging nothing for a minimum version of your product, expecting a percentage of users to upgrade) is another whole issue that I won’t get into here. Techcrunch just ran a good article on freemium here.
2. Charge for the Value You’re Bringing To Customers
This one is highly subjective but very important. To help illustrate, consider these two products:
One is a social media tool with a sophisticated speech-processing algorithm. It helps you write more interesting status updates and tweets in order to get more shares, likes and retweets. It leverages huge databases of specialized linguistics research and was engineered by several PhDs over the course of a few years.
The other product is a simple hack for an iPhone that lets parents find their children if they wander too far away in a mall, arena, or other crowded venue. It took one college kid a weekend to write.
While the first product may be highly sophisticated, it doesn’t really offer a lot of value to its users. It helps you do something that’s already possible, and makes it easier and more convenient.
But the second product is enormously valuable to parents who are worried about losing track of their kids. It brings piece of mind to worried parents, and could potentially aid in stopping kidnappings and abductions. Now that is value.
It’s very important that you consider not only what you think your product is worth, but also what your customers think. After all, they’re the ones who will be opening their wallets for it.
Imagine use cases, find your target market and then go out and ask people what they’d be willing to pay.
3. Leverage What Your Competitors are Charging
If there are already a few competitors in your space, look at each company’s prices and see how those prices compare to their specific offerings. Looking at their prices alone might not tell you much.
If your competitors cater to large enterprise customers, they’ll be expecting long sales cycles and their prices will be relatively high. If your product is similar to theirs, but is geared for everyday users, you might not want to gravitate towards their price point.
It’s always tempting to undercut your competitors by charging slightly less than they are, but this is ultimately an unsustainable solution. If your main sales strategy is to undercut your competition and they decide to lower prices as well, then you’re trapped in a race to the bottom until you are out of business.
Make sure your competitive pricing isn’t the main differentiator you use to describe your product.
4. Consider Economic Signals
Despite the conventional wisdom – setting too low of a price can actually decrease demand for your product. This is because price is often an important economic signal for a product’s value.
I’ve heard of at least two companies where they were struggling to sell at a low price, but then found their target market once they raised their prices substantially.
Think of expensive shoes, clothing and handbags. Sometimes a more expensive product actually is more desirable than a cheaper alternative.
Imagine you’re comparing two services that promise to protect you from identity theft. One is $2.99 per month and one is $129 for the year. The more expensive product just feels like it’ll do a better job. It’s gotta be fancier or something, right?
That feeling could be something that weighs heavily on your customers during their purchase decision. Use it to your advantage.
5. Make the Price Relatable
At the end of the day, the sales process comes down to convincing a customer that your product is worth the price you’re asking. Sometimes all you have to do is put the price in terms the customer will understand.
As a great example, JibJab increased their conversions when they raised their price from $9.99/yr to $12/yr. Why was that? Because now, they could say that their product was only $1 per month! This broke the cost down to something that was much easier for people to comprehend – and now it was much easier for them to realize what a fantastic deal it was!
Put your price in terms people will understand. If you’re offering a product that will help your customers replace another product they’re currently paying for, tell them how long it’ll take before your product “pays for itself!” with the money they’ll save.
Get creative and try things out.
Ultimately, the best price for your product is set by a variety of factors and it’s impossible for anyone to tell you precisely what it should be.
Hopefully, you’re already A/B testing parts of your website and different conversion channels. Test your pricing as well!
Use these five factors to come up with three or four price estimates, and then rotate those prices on your website to see how each of them convert. Make sure you have a large enough sample size to make your results meaningful before you settle on a final price.
Note: you should isolate your existing customer base from any price fluctuations so that you don’t upset anyone. Grandfather all of your existing customers in whenever you raise the price, so that they don’t get hit with a surprise billing increase. And if you lower the price, you could give a matching discount to your existing customers. They already agreed to pay at the higher amount, so their data still counts in you pricing test, and now they’re getting an even better deal!
Pricing is an important decision that shouldn’t be taken lightly. It will have an extremely large impact on your business and should be the result of careful, thoughtful planning.