As part of my work, I talk to many seed-stage SaaS founders. At the seed, most of these founders are thinking about how to get to product-market fit. The one in zero to one. They’re launching their product with a select few companies to really nail their pain points. And often times, pricing and the business model take a backseat when they offer their customers the product for free or at an extreme discount. While investors don’t expect founders to nail pricing at the seed, it’s useful to start thinking about your revenue model early on. After all, pricing is both an art and a science. And with the right pricing structure, it can also be your proxy for assessing product-market fit. Here’s how.
As a quick roadmap:
- How to use the pricing thermometer to understand value-based pricing
- The difference between buyers and customers
- What is your value metric? And why does it matter?
- How pricing influences positioning
- How to approach building a tiered plan, with a mini case study on Pulley
- Net dollar retention, what product-market fit looks like in dollars
- The SaaS version of engagement metrics
The pricing thermometer
Every product manager out there knows that customers don’t always know what they want, so asking them for a solution rarely nets valuable feedback. Rather, start with the problem. What are their frustrations? What sucks? What’s the last product they bought to attempt to alleviate their problem? Subsequently, what’d they like about that product? What didn’t they like?
There are two perspectives you can use to approach pricing: cost-plus and value-based. Cost-plus pricing is pricing based on selling the product at a given markup from its unit cost. The biggest mistake founders often make here is underestimating how much it costs to produce a product.
On the other hand, there’s value-based pricing. An approach where you determine the economic value of the service you are providing and give it to your customers for a bargain. Superhuman, for instance, prices the fastest email experience at $30/month. Or in a different light, a dollar a day. If you are saving more than a dollar of economic value a day by responding to emails faster than ever, then the product is worth it. The biggest pitfall here is that founders often don’t fully understand the value they’re bringing to their customers, which is a result of:
- They don’t understand your value,
- Or you can’t convince them of the value you think you offer.
To visualize both of these approaches better, let’s use the pricing thermometer, as YC calls it.
The greater the gap between two nodes (i.e. value and price, or price and cost), the greater the incentive. If you’re selling at a price far greater than its unit cost, you are far more motivated to sell your product. On the flip side, if your product is priced far below the value and benefits you provide, a customer is more motivated to purchase your product.
Buyers vs Customers
To take it a step further, if you’re planning to scale your startup, what you’re looking for our customers, not buyers. Buyers are people who purchase your product once, and never again. They learned from their mistake. Your product either didn’t deliver the value you promised or the value they thought you would deliver. Customers are repeat purchasers. Why? Because they love your product. It addresses your customers’ needs (and ideally more) again and again. Your customers’ satisfaction is evergreen, rather than ephemeral.
When you only have buyers, you have to push your product to others. It’s the epitome of a door-to-door salesperson. Think Yellow Pages.
When you have customers, you feel the pull. Customers are drawn to you. They come back willingly on their own two feet. As Calvin French-Owen, co-founder of Segment, once said: “The biggest difference between our ideas pre-PMF vs. when we found it was this feeling of pull. Before we had any sort of fit, it always felt like we had to push our ideas on other people. We had to nag people to use the product.”
Value-based pricing is playing to win. Cost-plus pricing is playing to not lose. While the latter is convenient strategy when you’re a local business not looking to scale (i.e. coffee shop, local diner, local auto parts store, etc.), it’s incredibly difficult to scale with, especially as customer needs evolve. As you scale, your customers might include anyone from Microsoft who wants you to bring a sales engineer to integrate your product to a 5-person startup team who’s just testing your product out. With cost-plus pricing, you’ll be forced to determine price points on a case-by-case scenario. With value-based pricing, you can systemize dynamic pricing based on evolving customer needs. As their value received goes up, the price does too.
As the name suggests, to generate pull, we have to start from value. In this case, your value metric.
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