The 3 Steps of Pricing: Strategy, Setting, Execution
The 3 Steps of Pricing: Strategy, Setting, Execution
Part 1 of 3 of My Deep Dive on Pricing Strategy, Setting and Execution
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Can you believe it? 2024 has arrived!
If you’re like me in Product, you’ll be busy recovering from a wild 2023 full of ups and downs, whether the growth of AI, the onslaught of layoffs, or just simply a roller coaster ride of the stock market. Personally, I’m looking for a far smoother 2024 with a clear head space to take on new challenged for the year!
In my previous posts, I walked through The Key Elements of Product Strategy, and how to link Product Strategy to Roadmap through Themes & Initiatives. It’s now time to dig in deeper into execution: how we convert product strategy into actual outcomes and action across various dimensions.
In this post, I will be walking through a guide on Pricing, potentially one of the most important topics for 2024 for SaaS business.
Why Pricing? Why Now?
Recall that revenue is always a function of two main inputs:
Price: how much you pay per unit consumed; and
Quantity: how many units you consume. Note that this can be simply one (e.g., a service fee to access a product or service), or multiple (e.g., access fee, API call, transaction based model)
If SaaS companies cannot be grow quantity (sales) organically through new business (customer acquisition), then we default to monetising through existing customers, either to:
convince them to up-sell / cross-sell to another offering, or
simply to pay for what they already pay for, via re-pricing.
In fact, in 2023, we saw this happen all across the board from early to late stage companies vying to reach profitability, as soon as possible.
According to ChartMogul, for companies with $1-30m Annual Recurring Revenue (ARR), median ARR growth rates have slowed from 42.5% in 2020 to just 27% in 2023. Looking at the bottom quartile, and we see even flat growth rates of just over 6% for 2023. Ouch.
Kyle Poyar, from Growth Unhinged also wrote about slowing growth and the shift from new business towards expansion via existing customers. He surveyed more than 700 private SaaS companies and found that as companies grew from small (<$1M ARR) to enterprise (>$20M and beyond), their median ARR from new business decreases rapidly relative to Expansion revenue from existing customers.
While new business was important for newer companies, later stage companies needed to take a different approach.
He found that those companies with the most powerful expansion motions centred around a few success factors, related mostly to pricing:
Multiple pricing levers for expanding customers: providing optionality when pressure against seats (declining headcount) or usage (cost optimizations) exists; and
Prioritised product roadmaps based primarily on willingness-to-pay.
So, yes: pricing strategy and execution is perhaps the most important topic to pay attention to as you start your new year.
However there are some very common misconceptions of pricing that we should debunk very early before we move on. Let’s dig in!
Note: Expanding revenue from your existing accounts can be very challenging, deserving an entirely separate post on all the different types of Expansion Strategies available. For the purposes of this deep dive, we are solely focusing on Pricing changes: that is, how we set, change or introduce new pricing to your customers.
Pricing Misconceptions
Many people think that Pricing is solely the activity of just setting a new price for the product. Reduce the price, get more demand - it can’t be that difficult to implement, surely?
Unfortunately, you need much more thinking and much more well planned execution once you’ve decided the pricing you want to implement. Let’s address some common Myths.
Myth #1: Lowering prices always results in increased sales
Lower your price, and a flood of customers will come. Simple equation right?
Well, there are many scenarios where lowering prices may actually result in fewer sales, typically for those markets where competitors have similar offerings, switching costs are low, and brand loyalty is not as high. Competitors can simply lower their prices in reaction, leading to a pricing-war.
We’ve seen this time and time again, and often resulting in unfavourable outcomes for all players in the same market. For example:
Russia and Saudia Arabia Oil Price Reduction: In March 2020, when Russia and Saudi Arabia couldn't agree on production cuts to support oil prices amid a drop in global demand due to the COVID-19 pandemic, a price war broke out. Both countries flooded the market with oil, driving prices down, leading to an oversupply and a massive drop in oil prices of approximately 65% plunge.
Commission price war among ETF brokerages: In 2018-2019, Charles Schwab, TD Ameritrade, and E*TRADE engaged in a fee-cutting competition, ultimately leading to the elimination of commissions for online stock and ETF trades as they raced to the bottom. Investors emerged as the winners in this pricing battle, at the expense of lost revenue to brokerages.
Before lowering prices, careful analysis needs to be done. We dig deeper into this topic in Part 2 of our post, Price Setting.
Myth #2: Increasing prices means I will lose my business
On the flipside, many think that price increases will result in major losses to clients who would churn to alternative products.
But this is not always the case, especially for premium products or those that are embedded in ecosystems where the total value of the products purchased are greater than the sum of each individual part!
Take for example Apple’s product pricing for iPhones, Macs and iPads. Each successive year is a new launch of a brand new device in each category, often increasing in price each time, with no adverse impact to sales quantity / volume.
Here, premium products are being promoted to the consumer, and increases in prices have not resulted in reduced demand due to price inelasticity, a topic we will cover in part two of this deep dive.
Another example of effective price increases is when a company succeeds at adopting a value-based pricing approach, rather than cost-plus pricing (see below).
For example, a consumer may value and pay for a fine art painting, or even perhaps digital art NFTs, for hundreds of thousands of Euros, the cost of creating the art is miniscule relative to the sale price. Both value and price is derived from artist prestige.
We investigate value-based pricing in Part two of this post, Price Setting.
Myth #3: Cost-Plus pricing is the best to stay profitable
Cost-plus pricing is the concept of taking a unit price, then applying a premium on top of it, to arrive at the final price for buyers. It aims to ensure a favourable gross profit per sale, but this strategy has many drawbacks.
One of the biggest problems with Cost-plus pricing is that it does not consider market variability, which was rife between 2022 and 2023, most notably inflation and the general increase in consumer prices. Such inconsistency in production costs can result in variable profit margins, creating challenges for sustained profitability.
Adopting a Cost-plus pricing mindset also fails to consider customer perceptions of value, willingness to pay, and ignores competitors' prices, potentially leading to missed revenue opportunities.
It also limits innovation and creativity in product design due to the emphasis on maintaining low costs. Products can then become more and more commoditised, lacking in differentiation, making it easy for customers to shift to alternative solutions that solve their needs.
Myth #4: Our pricing strategy is too complex or too old to change
Maintaining a status quo on your pricing is like writing your own obituary. While adjusting pricing can be complex to execute, the potential for higher profits can be far more beneficial and worth the spend in effort or time. Fail to adapt, and you’ll be dead in the water.
Let’s say, hypothetically, your business charges high upfront costs for your product. A major competitor of yours changes their pricing model, offering a ‘pay later’ or subscription model that simplifies the billing for the customer and outright investment needed. By staying still, you will lose market share within a matter of days, not months.
To navigate these challenges, organizations must adapt their pricing strategies to ensure ongoing profitability and growth. While it may seem daunting, there are many modern pricing solutions available now, including dynamic pricing models (and even SaaS!), make it easier to navigate complexities and implement changes.
In Part 2 and 3, we’ll explore some ways you can mitigate the downsides of costs and negative business performance while you optimise your pricing strategy for your individual circumstance.
The 3 Steps to Pricing: Strategy, Setting, and Execution
In all of my product and market strategy projects, whether as consultant or as a product leader, I follow a simple model for Pricing across three phases:
Pricing Strategy: Setting the context on our customer, customer segments, market and product landscape, and our choices on the type of pricing we want to implement (versus those we will not);
Price Setting: The actual calculations of the most optimal pricing to set on our product, the metrics to watch to ensure we have set the right price for ROI, and messaging the price to our customers through the correct channel and frequency; and
Pricing Execution: How to implement the pricing both internally and externally, based on a pragmatic plan and the longer-term capabilities, governance and enablers (e.g. tools, support teams, processes) to ensure pricing is implemented and sustained.
In this post, we deep dive into the first pillar of Pricing Strategy, and the components within. You’ll also be given access to our Lean Pricing Canvas, a Miro board that allows you to craft, set and implement pricing in your company, with ease!
Strategy Pillar 1: The Customer
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