When getting off the ground, a major decision startups must make is how they plan to price their product or service. The pricing model chosen can have a significant impact on variables and metrics such as how much the company needs to raise, long-term viability, sales and marketing strategies, and more.
There are many different pricing models that a business could use when selling its product or service. Determining which one is likely to be the most effective will depend greatly on the company’s unique position. Here, we will review different common pricing models that startups may use.
What makes an effective pricing model?
For a startup to succeed in its market and generate revenue over the long term, setting the right price for its product or service is key. The right pricing model for a startup will do a few things:
- It will match the value perceived by the customer/market, while also generating revenue, and ideally, profit.
- It will align with the pricing of the competition within the market.
- It will support the product roadmap and future plans of the company.
Now, let’s examine a few different pricing models that startups commonly use.
Freemium model
Under a freemium pricing model, a company’s product or service is typically free to use with the option to upgrade to a paid model for additional features. For businesses, the key to a successful freemium model is understanding the point at which freemium customers are willing to pay for the greater value they can get out of the product or service through the paid version. Freemium pricing models can be a great way to attract initial customers that will hopefully become paying customers later on. Many apps use this type of pricing model, such as Headspace or Slack.
Subscription model
The subscription pricing model has wide applications, from streaming services and wine delivery to SaaS and cybersecurity. Under a subscription-based pricing model, businesses sell consumers products or services on a recurring basis– that could be bi-weekly, monthly, quarterly, etc. In recent years, this pricing model has become highly popular. When utilizing this pricing model, it is crucial that a business has a deep understanding of its customer segments and what drives its value.
Market-based model
A market-based pricing model, also called a competitive pricing model, sets prices of products and services based on the current market conditions. In practice, this means assessing a product’s features against the competition and then setting the price higher or lower accordingly. When going this route, it’s important to take price sensitivity of the target customer into account, otherwise, a business could end up pricing themselves out of their own market. This model can be well suited for companies in markets that are already well saturated.
Value-based model
Under a value-based pricing model, prices are set based on how much the customer believes the product or service is worth. Businesses that are best positioned to utilize this type of pricing model typically offer unique or highly valuable features or services. Examples of businesses using this type of pricing model are luxury goods or clothing, where there is high worth associated with the brand name. For this type of pricing model to be successful, the business must be highly customer-focused.
Dynamic pricing model
Dynamic pricing is a pricing model where businesses can sell products or services at different price points for different customers at different times. The goal of having a dynamic pricing model is maximizing profit based on the consumer’s perceived value of a product or service at a given time. An example of this would be Uber’s surge pricing when there is high demand for rides, or flights and hotel stays. This type of pricing model can be more complex to implement, as it requires real-time market and consumer data.
Key takeaways
Getting pricing right is critical for long-term startup success, and there is no singular recommended approach. The right pricing model for a business depends on its unique products and services, its target market, and its long-term business goals and objectives.
When assessing whether or not a startup’s pricing model is sustainable, it’s helpful to return to those three elements that make up an effective pricing model:
- Does the pricing model match the customer/market’s perceived value?
- Does the pricing model align with the competition?
- Does the pricing model support the company’s future plans?
If the answer to these three questions is yes, then the pricing model may be one that is effective in the long term. If the answer to any of these is no, there is likely a mismatch between the pricing model and the product or service.
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The information presented here is for general informational purposes only and is not intended to be, nor should it be construed or used as, comprehensive offering documentation for any security, investment, tax or legal advice, a recommendation, or an offer to sell, or a solicitation of an offer to buy, an interest, directly or indirectly, in any company. Investing in both early-stage and later-stage companies carries a high degree of risk. A loss of an investor’s entire investment is possible, and no profit may be realized. Investors should be aware that these types of investments are illiquid and should anticipate holding until an exit occurs.
