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 (like Twitter), 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.
The revenue model you select is basically the implementation of your business strategy, and the key to attaining your financial objectives.
Obviously, it must be grounded by the characteristics of the market and customers you choose to serve, the pricing model of existing competitors, and a strategy you believe is consistent with your future products and direction.
Your business model interacts closely with your marketing model, but don’t get them confused. Marketing is initially required to get visibility and access to the opportunity, but pricing defines how you will actually make money over the long term.
Overall, I’m a huge fan of the “keep it simple (KISS)” principle – customers are typically wary of complex or artificial pricing. Your challenge is to set the right price to match value perceived by the customer, with a fair return for you. It’s not a game show, so don’t guess – do your research early with real customers.
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. If you have real guts, try the Twitter model of no revenue, counting on the critical mass value from millions of customers
In this model, the product is given away for free and the customers are charged for installation, customisation, 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.
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 users locked-in as free.
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 10 per cent. Use it when your new technology gives you a tremendous cost improvement. Skip it where there are many competitors.
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, some with high markups and some with low, depending on competition, lock-in, value delivered, and loyal customers. This one takes expert management to work.
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.
In heavily competitive environments, the price has to be competitive, no matter what the cost or volume. This model is often a euphemism for pricing low in certain areas to drive competitors out, and high where competition is low. Competing on price alone is a good way to kill your startup.
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.
NOW WATCH: Ideas videos
Business Insider Emails & Alerts
Site highlights each day to your inbox.