New product pricing strategies: 3 essential tactics for startups

The first method of pricing new products or services is the most mathematical of the three pricing strategies we cover. It takes the costs your business generates as the starting point, then calculates the direct costs and indirect costs generated per sale, and then adds a profit margin to get to your selling price.

Direct costs (or Cost of Goods Sold/COGS) include all costs that are directly allocable to the production of the goods sold (or services performed) by a company. For a producer of 3D printers, direct costs could include the costs of purchasing raw materials used in producing the printers. For a SaaS company, direct costs could include hosting and online payment fees. For a service company, COGS could include the personnel costs of the employees who deliver the services. The similarity among all three examples is that without incurring these costs, sales literally cannot take place; therefore, they all concern direct costs.

Indirect costs or overhead costs are all remaining costs that are not related to the production of the goods sold by a company (or generated to perform services). Examples include event costs, office supply costs, online marketing costs or office rent. These costs are not necessarily required to produce a good or to deliver a service and are therefore called indirect costs. Also, without these costs, a sale can take place.

Example

Below, we present a simple example of how your costs can help you define selling prices. Note: Direct costs and indirect costs per sale presented in the example below are calculated by dividing the expected total direct and indirect costs by the expected total number of sales.

This example shows that a selling price of $125 is required to cover all costs and to secure a profit margin of 25% per sale. This specific pricing strategy works well for business models in which costs are easy to allocate to the unit in which you define a sale. Think of, for instance, selling 3D printers where one sales unit is equal to one printer or delivering legal services where one sales unit is equal to one hour.

You can also apply this method for small businesses and freelancers that experience organic growth: if the selling price for such a business does not cover all costs and does not deliver a certain profit margin, a small business owner is simply not able to provide income for his livelihood. Moreover, for small business owners, external financing is often not abundant, meaning growth has to be financed from the businesses’ income.

Inside-out

This method also has its drawbacks. First of all, it takes a strong inside-out view on things: it mainly takes the perspective of the company and does not really take into account the needs of the market or the customer.

Moreover, it is a strongly mathematical exercise: if the calculated costs per sale are not correct (this can easily happen, for instance, when you have just started your company, which makes it hard to exactly forecast the expected costs and sales), you run the risk of making your prices too high or worse, too low, meaning you might take losses on your sales.

As your sales begin, it is advisable to check the realization of your expected costs. Are the actual direct and indirect costs per sale as you estimated, or are they perhaps higher (or lower)? Based on this exercise, you can then adjust selling prices again.

There are also good reasons to (temporarily) sell without profit margins or even below the cost price. This happens often among startups: in order to grow fast, frequently, it is strategically decided that high expenses are needed (for instance, for sales and marketing around a product launch) that cannot (yet) be financed from income resulting from sales. If these costs were to be included in the calculation of the desired selling price, they would probably turn out to be way too high.

On the other hand, it goes without saying that in the long term, selling prices must cover all costs to create a sustainable business.

A second way to determine pricing strategy is based on the positioning of your product or service in the market. This method is less focused on company internal factors, such as costs, but has a more outside-in approach by means of positioning against competitors.

If you have competitors offering a similar product or service, then you can use their pricing as inspiration for yours. Do they, for instance, sell 3D printers with similar features as the 3D printer you offer for a price of $1,500? If so, then you can take that price as a starting point and adjust up or down, depending on how you position your company or brand against the competition.

Would you like to position your product or service as a low-budget option? Then you probably need to go for price breakers. Can you benefit from the name recognition of a strong and qualitatively recognized brand, while your competitors are primarily startups? Then your prices will likely be higher. Do you want to position your brand as luxurious or high-end? In that case, your prices will most likely have to be higher than the competitors’.

Take into account that marketing and brand awareness are crucial though. If you want to position your company or brand in a certain way, you also have to make sure that customers will start recognizing and acknowledging you in this way.

A pricing strategy based on positioning is very useful when your product or service is not for sale yet, but when you already have to define your prices, for example, if you want to build a financial plan when setting up a new company. You also need a thought-out financial forecast if you want to convince the bank or an investor to raise funding.

If you do not yet possess any historical data that validates your selling prices, but if you can rely on the price validation of your competitors, then you can use your competitors’ pricing as substantiation of your own pricing toward potential investors.

The third and final way of determining pricing strategy that we discuss takes the client as the starting point. This is the method you could call the most outside-in of the three strategies we discuss in this article.

The purpose of this method is to define your customers (segments) as accurately as possible and to generate data about them that validates your pricing. Subsequently, you should match your pricing (page) to the different customer segments as good as possible.

This method is frequently used by software-as-a-service (SaaS) startups, as they often work in a very data-driven manner, by definition, already. Also tehy can easily test through web and software analytics, and can quickly implement new pricing models. For companies offering more “traditional” products or services, this approach is also very useful because it puts the customer first.

This is crucial because a mathematical exercise may show you the selling price of your 3D printer should, for instance, be $1,500 to cover your costs, but if a customer is not willing to pay more than $1,000 … well, your company will have a hard time.

How does this method work in practice?

Step 1: Define your customer (profiles)

The first step is to define clear customer profiles. These are also called “buyer personas.” Buyer personas are (preferably data-driven) role models that represent a customer segment. A well-written buyer persona vividly describes, among other things, the demographic background of a potential customer, the way he/she searches for information, which social media channels this person uses, the motives he/she has and the buying behavior that this person exhibits.

Usually, buyer personas get a catchy name (for example, “Startup Sarah” or “Scale-up Simon”). This naming convention forces you to recognize differences between the different types of customers you serve and ensures that everyone within an organization understands what each customer profile means.

The next step is to assess what value your product or service provides to the different buyer personas or customer profiles that you have identified. Your product or service probably has different features or benefits that, individually or collectively, solve a customer’s problem.

Startup Sarah may have different problems and needs than Scale-up Simon, and the features or benefits that offer value to Startup Sarah might not necessarily result in value for Scale-up Simon as well. Features and corresponding benefits should therefore be fine-tuned to the different customer profiles. The trick is to then adjust prices accordingly.

Let’s take the example of an email marketing software company. Startup Sarah might use software to share nicely designed weekly newsletters with a limited number of followers. Startup Sarah does not have any revenues yet and has not raised any funding either. Therefore, Startup Sarah does not have too much to spend.

The email marketing company thus offers a free version of its online platform to buyer persona Startup Sarah, hoping that when her company and email marketing efforts grow, she will switch to a paid account.

Scale-up Simon, on the other hand, already has several thousands email followers, which makes managing his email marketing efforts more time-consuming. Therefore, Scale-up Simon would like to automate his online marketing efforts and manage all important email marketing activities from one place.

Scale-up Simon is therefore interested in the software’s marketing automation features, the integration with social media advertising and his CRM system, and availability of dashoards with important steering information visible at a glance. Scale-up Simon has a sustainable and profitable business and is therefore willing to pay more than Startup Sarah.

For this reason, the email marketing software company offers a paid version that includes the abovementioned features to customers such as Scale-up Simon. The actual costs for Scale-up Simon depend on the number of email subscribers he manages using the software.

A benefit of working with buyer personas is that it not only helps you define current pricing but that it is also useful for forecasting prices. The reason for this is that buyer personas force you to think about how to grow your product with its users, even if you are still in development and only have a prototype or minimum viable product (MVP) available.

If you have succeeded in validating the pricing for the first version of your product (even if it is a prototype), then this also provides insights for a logical price for a more “advanced” product that offers new features for the more advanced user.

Step 2: Validate the pricing per customer profile

After you have clearly defined your buyer personas, the next step is to validate the pricing for each buyer persona. There are many ways in which you can validate pricing. Below we present several suggestions, but for more inspiration, definitely check out this article as well.

The ultimate form of price validation is of course a paying customer. But what if you do not have a product or service to offer yet? How do you validate your pricing in that case? As mentioned before, it is advisable to check out competitor pricing to start with. Which features do they offer for which prices? Which needs of which buyer personas do they seem to address? The answers to these questions already give you a great starting point.

To validate pricing, online businesses can set up a landing page with a clear call to action. Have your website visitors sign up for different plans offering different features and prices that match with your expected buyer personas.

Try to experiment with both the prices and features and track the conversion from website visitors to subscribers. To attract visitors to your website, you could perhaps invest a bit in paid social media or search engine advertising.

Is your product already in a phase where you have designs, a prototype or an MVP available? Then reach out to your potential buyers and try to convert them into pilot customers! Pitch your proposition, demonstrate your prototype or MVP and have them fill out a questionnaire.

With the questionnaire, try to validate your buyer personas and test your prices. At the end of the questionnaire, you could ask, for example, what the potential customer would pay for your product as soon as it is live.

Does the customer indicate that he/she is prepared to pay X amount? Then pull a pilot order form out of your bag and ask the customer to sign up. Signing the pilot form could commit the person, for instance, to provide you with product feedback on an occasional basis and/or to pay a certain amount that he/she is willing to pay for your product as soon as it is live. This gives you insight not only in a possible selling price but also in the actual “willingness to pay” of this person.

Is your product or service ready for sale? If so, again, engage with (potential) clients, whether online or in real life! Introduce them to your product (for example, by providing a demo or free trial account) and make sure you collect data. Present the customer with a number of different price ranges to pick from and ask the following questions:

• At what price level is my product or service so expensive that you would never consider purchasing it?
• At what price level is my product or service on the expensive side, but you would still consider buying it?
• At what price level is my product or service a fantastic deal, and you would buy it immediately?
• At what price level is my product or service so cheap that you would question the quality of it?

The answers to these questions provide a great deal of insight into what the customer is willing to pay for your product.

Do you want a sneak preview as well of the selling prices that you might be able to ask as soon as you have added new features to your product? Show the customer a list of new features that you are considering to build and have him/her choose five features from this list that would add the most value to him/her if they were included. Thereafter, ask the four pricing validation questions again, mentioned above, but assume that the five features that were selected by the customer have been built already and added to the current product. This not only gives you some first insights in a potential price level for a more advanced product, it also tells you which features are most relevant to the user.

No matter what phase your company is in, it is crucial to collect data that validates your buyer personas. This allows you to address the right customer profile with the right combination of features, proposition and price.

You may also find out that a certain buyer persona is not worth investing in, for example, because this persona does not want to pay for your product or service. Such a customer is called a “negative buyer persona” and is a client you deliberately do not invest time, money and effort in.

Step 3: Apply the pricing strategy and optimize

Now that you have defined your buyer personas and have validated the pricing per persona, it is key to apply your pricing in a way that clearly demonstrates on which axes your selling prices are based. For example, the email marketing software company we mentioned earlier might have a pricing page that shows prices are determined using three different axes: 1) per month, 2) per email sent and 3) per feature. It is important that your selling price reflects the research you have performed under steps 1 and 2 above. The features, proposition and prices you offer are thus specifically adjusted for each buyer persona.

Does this mean you are done now? Definitely not! Client needs, buyer personas and buying behavior change continuously. Moreover, your product or service will change as well, as it is likely that you will keep improving it. Therefore, keep testing and optimizing your pricing strategy, keep collecting data and keep in close touch with your customers.

When determining your pricing, do not forget to take into account your costs and your positioning against competitors as well. Will you continue to apply these pricing strategies consistently? Eventually, you will find the right pricing for any product or service you offer, whether it is a new or an existing one.