One of the toughest decisions for a startup is how to price their product or service. The alternatives range from giving it away for free, to pricing based on costs, to charging what the market will bear (premium pricing). The implications of the decision you make are huge, defining your brand image, your funding requirements, and your long-term business viability.
- Product or service is free, revenue from ads. This is the most common model touted by Internet startups today, the so-called Facebook model, where the service is free, and the revenue comes from click-through advertising. It’s great for customers, but not for startups, unless you have deep pockets.
- Freemium” model. In this variation on the free model, used by LinkedIn and many other Internet offerings, the basic services are free, but premium services are available for an additional fee. This also requires a huge investment to get to critical mass, and real work to differentiate and sell premium services to “convert” users to paying customers.
- Cost-based model. In this more traditional product pricing model, the price is set at two to five times the product cost. If your product is a commodity, the margin may be as thin as ten percent. Use it when your new technology gives you a tremendous cost improvement. Skip it where there are many competitors.
- Value model. If you can quantify a large value or cost savings to the customer, charge a price commensurate with the value delivered. This doesn’t work well with “nice to have” offerings, like social networks, but does work for new drugs and medical devices that solve critical health problems.
- Subscription model. This is a very popular model today for Internet services, calling for monthly or yearly low payments, in lieu of one value or cost-based price. Startup advantages include a more stable revenue stream, easier customer retention, and increasing customer investment over time. The customer advantage is a lower entry cost.
- Product is free, but you pay for services. In this model, the product is given away for free and the customers are charged for installation, customization, training or other services. This is a good model for getting your foot in the door, but be aware that this is basically a services business with the product as a marketing cost.
- Product line pricing. This model is relevant only if you have multiple products and services, each with a different cost and utility. Here your objective is to make money with the portfolio, with high markup and low markup items, depending on competition, lock-in, value delivered, and loyal customers. This one takes expert management to work.
- Tiered or volume pricing. In certain product environments, where a given enterprise product may have one user or hundreds of thousands, a common approach is to price by user group ranges, or volume usage ranges. Keep the number of tiers small for manageability. This approach doesn’t typically apply to consumer products and services.
- Feature pricing. This approach works if your product can be sold “bare-bones” for a low price, and price increments added for additional features. It can be a very competitive approach, but the product must be designed and built to provide good utility at many levels. This is a very costly development, testing, documentation, and support challenge.
- Razor blade model. In this model, like cheap printers with expensive ink cartridges, the base unit is often sold below cost, with the anticipation of ongoing revenue from expensive supplies. This is another model that requires deep pockets to start, so is normally not an option for startups.