Kevin Hale - Startup Pricing 101

This was a highly requested talk from last year, or lots of people had questions about pricing or were really confused. It's actually was well requested both at YC itself—that's a very, very popular workshop that we run.

We're gonna go over a lot of basic fundamentals for pricing that hopefully will just help you understand how to approach your pricing and monetization from first principles, and then you help yourselves. Same thing with the landing page lock.

So we're gonna go over first principles for pricing. We're gonna go over why is pricing particularly hard for startups, for people making innovative products in new markets—like why is it extra difficult? How do you do price optimization? Like, how do you actually do it? What does that actually look like? Just to kind of demystify that whole process.

When we look at the challenges of pricing, you start recognizing why certain types of customer segments that you're going after are difficult, like SMB. We'll talk a little bit about that. We're gonna talk about how pricing affects your acquisition strategy; it changes what you can do and what you cannot do, and it's extremely important because a lot of companies get caught up doing the wrong positioning strategy or wasting too much money if the price is incorrect.

Then I'm gonna give you some rules of thumb, some pricing tricks just to help make it a lot easier when you're encountering different pricing problems. I call them pricing trick sprinkles.

Okay, there are three levers you can pull to improve growth. So in the last talk, I talked about conversion rate and churn, but monetization is actually the big dog—it's the one that I really like. Now, there was a survey done with over 500 SaaS companies, and they talked about sort of like the amount of effort that they put into each one of these strategies and the returns that they got as a result of it.

Now, acquisition is really fun and exciting; it's the one that everyone kind of understands simply—it's like I get more customers, I get more logos, gives me more growth. Retention, of course, is about keeping customers, and Zatia is about getting more money per customer.

Now, if you increase just your efforts or resources by one percent, your work on acquisition usually gets a return of about three point three two percent. In retention, it's about six point seven. When you're optimizing pricing, that gives you your biggest bang for your buck in terms of impact on your business yet, and it's the one that is most neglected.

I think it's the one that everyone is so afraid to touch because they're so scared that if they get the pricing wrong, they will lose all their customers.

Now, the first principles—the basic idea about pricing—the thing, the concept that really opened up in my head how to think about pricing, how to understand the problems that people are facing, and why startups get it wrong, is to use a concept called the pricing thermometer.

You have to understand that when you price something, there's actually like two other factors at play. There's the cost, there's the price, and then there's the value, and the interplay and relationship between these items affect how growth happens inside of your company.

Now, the gap between price and cost—that is your margin. That is your incentive to sell. So, the bigger that gap is, the more you are driven to want to push your product to your customers, to have your salespeople, etc. This gap here, between price and value, is the incentive to buy, and the larger that gap is, the easier it is to have your customers want to sign up or use your product.

Now, to figure out price, there's really two ways to go about it. You either start with the cost, if you know what it is, and you figure out where your price is based off of that—that is called cost-plus. The other way to do it is to figure out what is the value of your company or product or service, and then you figure out your price from that, and that is called value-based pricing.

In startups, and almost pretty consistently across all businesses, everyone will tell you you should strive for value-based pricing; it allows you to charge a whole lot more. It allows you to manipulate this incentive to buy.

The problem is, because people do not understand their relationships or even understand what their costs are and what the value that their customer is going to think about their product, they put their price in a kind of arbitrary place. They don't know what are the forces at play that drives it, and it results in four different types of mistakes.

The first one is startups will price their products too low. Basically, you consistently undercharge. It is the number one piece of advice we give through most startups to fix their pricing, and I'll talk a little bit about why most companies fall into that trap.

You underestimate your costs. The result is you have a problem where your margins aren't enough to cover sort of acquisition. You don't understand your value; you don't understand how your company thinks about the problem that you're solving for them or how they value it, and either they don't understand your value, or you don't know how to convince them of the value that you think you offer. As a result, you can't get the price that you want.

Lastly, you focus on the wrong customers; you think, "Man, if I built a better product and I charge half the competition, I win." The thing is, that almost never happens, and the reason is because you, as a startup, working on something to create a new market, are working on innovative products; you are focused on the wrong customers. They are not the mainstream people who are going to look at the price and make most of the determination based off of that.

So, this is the sales and profit over a product's life from an Shinto demise; that's what it's called. All you need to know is that these are five different stages of a company, and this is what sales might look like over different stages and what profits might look like over those different stages.

You who are in startup school, you who are getting seed funding, you are in the first two stages: product development stage, introduction—you are not in the growth phase. The thing to keep in mind is that the customers in the first two stages—the ones that you're going after—they don't look like mainstream customers that you find in growth and maturity stages; they're not mature customers; they're early adopters.

And the thing to know about early adopters is you kind of don't really get a lot of momentum and growth until you get past the first two to five percent of potential buyers of your market. These people in that two to five percent—they're called early adopters.

The thing that drives them is very different from mainstream people. There are a couple of things to keep in mind about pricing innovative products. What you are trying to do fundamentally is require users to change their pattern—to stop doing it the old shity spreadsheet way and do it in the new, better your way.

Getting someone to change their pattern is actually difficult, especially if they're a mature person, partly because the average user lacks information needed and the trust in you or whatever it is that you're making to make that change, to take that risk. You are entrepreneurs; you're comfortable taking risks. Your customers are not entrepreneurs for the most part; they're probably less comfortable taking risks.

So in the beginning, you're going after people who are willing to take a risk, and those are early adopters; those are people who care about benefits above all else. The highest value to them is beating their competition, doing something much better, and taking a chance that something new will give them that edge over anybody else.

Those early adopters, therefore, are not price sensitive. If anything, if you've built a better product and you charge less, it looks like you have reputation risk. It's like "Why is it too good to be true? What is the catch?" And what will end up happening is it makes it much longer to get to.

Not understanding this is basically all price optimization. This is the complicated way that you can try to show price optimization; this is a demand yield curve. When you have on this side different prices and on this side, you have sales unit sales, and basically, what you are trying to figure out when you're optimizing the price that you're charging your customers is basically what is the perfect balance between how much I charge and how much sales volume I get.

Your price optimization is basically that—try different prices and then see what the effect is. When I have my companies optimize their prices, they just use a very simple table; you don't need to try to figure that weird-ass graph. Basically, you want to have a column that says, "These are the prices I'm gonna try," and then what is the result in conversion rate? What is the result in sales volume? And then how much revenue did I generate?

That's all it is. So let's say I have prices at these different price points, and I get these different conversion rates, and I get this sales volume; I should immediately be able to see who the winner is. Here we go.

Now, the one thing to keep in mind once we have figured out something like this, what a simple product is that these areas at lower prices, if you can afford them in terms of your margin, are actually lost opportunities. What you want to understand about these is these are what you're going to see if you offer discount pricing or offer tiered pricing at different price points.

Another exercise I like to go with companies when dealing with pricing is how to understand—is like, are you in a danger zone? So what I usually do with my companies that I help is I have them sort of calculate what would their business look like or what does it gonna look like to be a billion-dollar company.

Usually, the rule of thumb there is to be doing a hundred million dollars a year in sales and revenue. So that basically is like what at your price that you give, how many customers do you need to have to make a hundred million dollars in that year? So let's have a bunch of different price points.

Then we know, "Okay, great, I need these number of customers in order to make this formula work." You understand what that looks like at a hundred-dollar price point with a potential about a million users, right? This is consumers; that's what that consumer space looks like.

And you know what this down here looks like—$100,000. Here we call this enterprise. This area here is the part that a lot of companies are in and really, really struggle—they're on the struggle bus, and it tends to be SMB.

These are people who kind of treat their money like consumers, right? But they kind of look like they might be an enterprise, and the reason why this is such a danger zone is because it will tend to fit in the wrong place on my next diagram.

So let's imagine that this vertical axis represents a price you can charge—either high price or a low price for your product—and this represents the complexity of your sales process: low complexity to high complexity. If you are having a product that is two thousand dollars or less and is basically self-serve, then you have something in this quadrant here, and this affects completely what you can do in terms of what drives your business.

What you can spend on to get that sort of growth—that price point here at $2,000 needs to be almost all marketing—be inbound. You can't spend a lot of money outbound or on ads, etc. Your support has to be completely self-serve or very, very minimal. You have no sales team at this price point; you can't afford it, right? But conversions can happen on the same day; it must be in a self-serve model transactional.

So, between two and ten thousand dollars, when you're able to charge this, you're able to have a few new toys up your sleeves. So marketing now can be focused on generating qualified leads. Your customer support can now offer SLAs or you can start paying for training that people get onboarded, and for sales, you can’t hire a dedicated salesperson, but maybe you can have an inside sales rep to sell within companies or within your customers.

You could maybe have an SDR, and you can maybe have someone dedicated to giving product demos. Sales cycle here should not be longer than one to three months.

Enterprise—it’s over twenty-five thousand dollars. Now, for marketing, you can start spending things on branding, on building up trust with customers. Your support is very, very high-touch that you can afford. You can do phone support; you can have a customer success person dedicated to the client.

And for sales, you're going to start thinking about sales managers dividing stuff into territories and having sales engineers that participate in terms of conversion and the sales calls. These will have a sales cycle about six to twelve months.

This is the garbage zone, right? You know if you're potentially in this, and this is the big wake-up call for you. If it's taking you months and months and months to close someone, but you're not making a lot of money to cover it, you have a process where your acquisition costs are just too high for you to be sustainable, and you have to get yourself out of that problem.

All of your work should be towards increasing the perceived value of your product or service.

I'm going to end on a good rule of thumb. So, if you are starting with some kind of price but you don't know how to sort of optimize it or figure it out, then here's a good place to get going. The first thing is I like to have things where the value is 10x the price of whatever it is I'm charging, and I want to have it so that the value is easily understood to be 10x.

So, for example, if I charge for a product that is $10, then it should be, in terms of perceived value by my customer, that it's worth $100 to them. If they do not immediately understand the 10x value of the price, it's going to be hard to get them to move; their incentive to buy might be too low.

Once you have any kind of price—which is particularly important for people who are doing B2B or enterprise sale—you should start practicing raising prices, and I like to just start by raising prices by 5%. If you feel really confident, jump it up by bigger numbers if you want, but this is a pretty safe way to do it.

You want to keep raising prices until you're losing 20% of your customers. That's about a good balance to have in terms of understanding that like I have a good price here; I'm losing 20% of my deals. It's not too high; it's not too low.

In summary for pricing: pricing gives the most bang for your buck. You should work on pricing; if you've never touched the pricing of your product, then you're losing out on lots of potential growth.

Understand the variables: do you really understand your cost? Do you understand why you've placed the price where it is, and do you understand the value? When you go into a sales meeting or call, do you talk to people and you basically say, "It's like I know exactly what this is going to be worth to you." So when I tell you what the price is going to be, you're going to be like, "Damn, that's totally worth it."

Go after early adopters. Remember, as a startup, that is who you're going after. So when you are talking to customers, and they are taking a really long time to make a decision or they're wanting to have a lot more proof that other people are using it, you're not talking to an early adopter—you're wasting a lot of time on non-believers.

Go after them first. Don't take it personally when these people who are much more mature aren't ready for your products; they were never going to be. Your job is to get through that first two to five percent of the market.

Those early adopters care more about benefits than price, so don't underprice your products when you have something that is of value and easily understood to have value.

Get organized. When you're doing proper price optimization, it's really, really easy. Don't overcomplicate things. Figure out a bunch of different price points you want to check, understand sales volume, conversion rate, and the revenue that's involved, and that will help you make the best pricing decision.

Your price will determine your acquisition strategy. If you realize that your sales cycle or all the things that you're spending on are way too much for the amount of money that you're charging, you either need to increase the price or completely reduce your acquisition strategy costs.

Use the 10-520 rule. Set a price that is 10x, that is a tenth of the value. Increase prices by five percent until you are losing twenty percent of the deals.

Thank you very much, guys. [Applause]