This XSeed blog was written by Venture Partner, Jeff Thermond, and originally appeared on Forbes.
Somewhere in every entrepreneur’s pitch deck is a slide on pricing. Even when a pitch is going well, as a venture capitalist, I often find the pricing slide to be the weakest of the entire deck.
I’d like to offer three recommendations as to how entrepreneurs should approach this admittedly tricky issue. For discussion purposes, I’m going to assume the startup idea is a SaaS opportunity targeting the enterprise, although some of what I’m going to say would be true if you were selling a physical product to a large company.
1. Simple But Not Simplistic Is The Way To Go
I’ve seen the same slide many times in SaaS pitches. After explaining that there are three different modules to the company roadmap once the product is fully developed, the deck will show each module as a column, and then there are three prices per user for say a five-seat, 100-seat, and 500-seat deployment for each module. The price point for each module at each level of volume deployment is exactly the same and there often isn’t much variation in price per seat between five users and 500. When asked about deployments at scale, the entrepreneur shrugs and says that will be negotiated on an individual basis.
That approach has the virtue of being simple, but to the point of being overly simplistic. That concerns me on two fronts. The first is that if you make a mistake on initial pricing of your product, you can recover faster and with much higher confidence in a good outcome from having priced too high rather than too low – but the opposite is rarely true. The second concern is that entrepreneurs need to be scrappy about getting every bit of value they can extract from their customers. When I see vanilla pricing plans like the above, it worries me that the entrepreneur does not appreciate just how important getting pricing correct can be.
How would I improve the schema above?
First of all, if there was additive value in using two out of three or all three modules, I might price the first module low and the next two higher to capture the incremental utility to the prospect of a two or three module combination. There is no good reason to price the per seat costs of different modules identically.
Secondly, I would introduce more range into the price per seat for the five, 100 and 500 seat deployments. Some of that increase will be explained in my next observation, but some of it is meant to discourage signing up a bunch of small accounts that can never grow bigger than for what they first sign up. It is a lot less expensive to sell to large potential customers because the Cost of Sales as calculated by Sales Expense divided by First Year Revenue goes down rapidly as the number of seats shoots up. Generally speaking, a lot of the problems our entrepreneurs are addressing cause their prospects much more pain at scale than any SMB prospect is going to experience. Target the potentially large scale deployments and make sure pricing reflects that.
2. Start At The High End When Setting Your Price Per Seat And Then Walk Backwards
A decade ago my team was selling a wireless communications chip which was going to be deployed across the entire product line of both smart and feature-phones of a major handset manufacturer. The purchasing team asked for pricing on engineering samples. My organization was about to quote a number a few dollars above what we expected to get for the chipset in high volume thinking the consequences of this price for engineering samples would be immaterial. Then the purchasing guys said something I’ve never forgotten:
They told us that they got their bonuses predicated on showing that they had reduced the ASP of any component by 85% from first purchase to full on volume. My team got the consequences of that immediately. They estimated their price at volume for ~50% gross margin, multiplied by 7, and quoted that number to the purchasing guys. We were all a bit nervous because the price seemed absurdly high to us, but since the volume at that price was going to be a few hundred units, the total dollars involved was less than $30,000. Rather than being indignant about an initial price which seemed exorbitant, the purchasing guys were delighted.
The point of this story is to start determining price per seat (or per chip in this example) at the point of maximum volume, not minimal trial volumes. The last thing you want to do in your IPO road show several years down the road is to have to explain to bankers why your price per seat is lower than you wanted because you never expected the negotiating pressure on the price of volume deployments. If you figure out first the lowest price you’ll ever accept, and then increment the per seat pricing back upwards as the number of seats ratchets back to 0, you’ll never find yourself in a bad price spot. In fact, you’ll be in a sweet spot.
Almost no one does it this way; I wouldn’t do it any other way.
3. Never Give A Low Price To First Customers; Give Them A Higher Discount Instead
This point is courtesy of my colleague, Robert Siegel, who learned as an executive at both Intel and GE that protecting your price point is paramount at all times, but especially at new product introduction. It is true that initial prospects know they’re going to add critical value in terms of product feedback. And to make matters worse, beta releases and even 1.0 releases can have a set of adoption costs for your customer which won’t be nearly as high when the product is more mature. It’s natural for prospects to ask for some price consideration for their extra costs and effort.
But don’t give them consideration on price. Give it to them on discount level instead. Then when they’re acting as a happy reference for future prospects, they won’t say the price you quoted them as an initial customer is way below what you’re now trying to charge in the market. They’ll say the price is the same, but that they got discount consideration because they were on the steep part of the learning curve.
It is always preferable to vary your discounts rather than your pricing. Protect your price points at all costs by adjusting the discount factor, not your price point.
When you take all this on board and show these approaches in your pricing slide, you’ll be pitching a better business and you’ll really differentiate yourself from the crowd. Both of those results are what you want when you’re raising money from the venture community.