Back in 2015 I published this post “Your 3 Pricing Strategy Choices: Grow, Skim, or Follow.” This post has been consistently popular, but six years is a long time in the Internet world. You can build a billion dollar company in six years. Whole new categories can be created. And existing industries can see growth fade away and begin to shrink.
Is the advice from 2015 still relevant? In this post, I update the key ideas and introduce a few new ones based on the importance of goal setting and new approaches to pricing and value.
Pricing is a critical choice
The hardest part of startups is making choices. Not decisions but choices. A choice is a decision between alternatives, whereby deciding to do one thing you are also deciding not to do another. Pricing strategy selection is a choice. Or at least it should be.
Compared to the other work you need to do on pricing, however, choosing a pricing strategy is actually pretty easy.
- Set goals and make sure the pricing goals align with the larger business strategy.
- Understand how you create value for different market segments (consider economic, emotional and community value)
- Figure out your value metric and find a pricing metric that tracks value
Value metric: the unit of consumption by which your users get value
Pricing metric: the unit of consumption that your buyers pay for
Designing your pricing architecture and pricing optimization? That’s technical work that needs a lot of experience and expertise.You will want to align your three tier architecture (Good Better Best) with the shape of market demand and consider a pricing model that includes usage-based pricing.
But choosing a pricing strategy? That is actually pretty simple. The hard thing is the discipline to stick to your choice.
What Are The 3 Pricing Strategies?
The three pricing strategies are growing, skimming, and following.
- Grow: Setting a low price, leaving most of the value in the hands of your customers, shutting off margin from your competitors.
- Skim: Initially setting a relatively high price to reinforce your value and capture the profit you need to invest in more innovation.
- Follow: Setting price based on your largest competitor or a dominant input so that you track changing market conditions.
More on the Follow Strategy
The Follow strategy needs a bit more explanation. This used to mean finding a dominant competitor and setting prices at a premium or discount to their price (in practice usually the latter).
Recently, more sophisticated Market Following Pricing strategies have started to appear. In some industries there is a dominant input that has a big impact on value propositions. The price of oil is one example. As the price of oil goes down, the value of energy-saving technologies can also decline.
In others it is the interest rate—pricing strategies for solutions for financial services companies are very dependent on interest rates. The price that makes sense in a low interest rate environment can be very different from what works in a high interest rate environment.
For companies that serve heavy industry, one could even price based on utilization ratios. When utilization ratios are low you would price based on how much you decrease input or process costs. But when utilization rates are high, you price based on how much you increase the capacity of existing facilities, thereby helping companies avoid or defer capital investments.
Pricing Strategies for Startups
For start-ups there are some simple rules to decide which pricing strategy to follow:
- Adopt a grow pricing strategy when market share (first mover advantage) is the most important thing about your market. Keep in mind you will need to raise a lot of money to win.
- Adopt a skim or premium strategy when you have a compelling value differentiation and have identified a well-defined and relatively small market entry segment.
- Adopt a market following strategy when there is a dominant incumbent that you are going to be compared to, or if there is some input that determines the value of your offer.
Constraints on Pricing Strategy
- Your price makes a statement about your brand. You cannot claim a premium brand and pursue a grow pricing strategy. And a discount brand cannot pursue a skimming strategy.
- Market Following strategies are the most difficult to execute. You have to be in close touch with the market, be able to change prices quickly, and be able to communicate the logic of the price change, and why the price change is in the customer’s interest. That’s not easy. Only adopt a Market Following strategy if there is so much volatility in the market that any other strategy would rapidly leave you with pricing that did not make sense.
- You can only have one pricing strategy per segment. Even if you have multiple segments you can probably only afford to have one strategy. Your pricing strategy cascades into your marketing communication strategy and your sales execution. Change it drastically or too often and you will confuse your customers and your team.
The Evolution of Your Pricing Strategy
Pricing strategy can change as you move across Geoffrey Moore’s technology adoption cycle (see B2B Pricing Black Magic). As you move from Early Adopters to Bowling Alley to Tornado you may want to change your pricing strategy at each phase.
Image courtesy of the General Physics Corporation and Chasm Institute
Companies buy for different reasons at each phase and pricing strategy needs to reflect this. Innovators are looking at things because they are cool. They are not real buyers. They are important, as Early Adopters tend to follow innovators and are influenced by them.
Early Adopters buy because the solution gives them a competitive advantage. They expect to pay a premium and are not persuaded by discounts. In the Bowling Alley, people are buying because their peers are buying. This is a critical phase as it is when the market gets framed and anchor prices are set. Be very careful about using a grow strategy here (low prices) as you can do long term damage.
When (if) you enter a tornado market you are in a land grab. Everyone understands what the solution is, why they need it, and expects to buy one (customer success applications are still in a tornado). Here, a grow strategy can make good sense. Once the market is in Main Street, growth slows and differentiation becomes important. At this point, a shift back to skimming or Premium pricing can have a big impact on gross margin. Each change needs to be a conscious choice and needs careful planning.
Pricing Strategy Checklist
- I have aligned pricing goals with the overall strategy
- I have a focused target segment and am setting a pricing strategy specifically for that segment
- I understand what factors determine profit and loss in my target segment
- I understand the pricing metrics used by the alternatives (competitors or other options customers have)
- I have chosen a pricing metric that tracks value for the segment I am targeting
- I have checked to see if my pricing metrics are obsolete and no longer track value
- I know what my brand represents (a premium brand, a discount brand, a customer service brand, an innovation brand, etc.) and my pricing strategy aligns with my brand promise
- I have a Grow, Skim, or Market Following strategy and have communicated this clearly to everyone in the company
- My pricing strategy is aligned with the phase of the technology adoption cycle