The secret to app pricing
Make user value greater than 10x price
Pricing is hard to get right. We may fear looking foolish or upsetting users. What’s the secret to doing it the right way? Here’s a framework I use to think about pricing, based on some principles and practical rules of thumb.
The importance of pricing
On the road to sustainability, our startup must grow. To do this, we acquire users, keep and monetise them (increase income per user). While each of these growth levers is important, return on effort is likely to be greatest on monetisation. Crafting Our Business Plan considers the importance of monetisation in the context of financial viability. Directly charging for app usage is not the only way to monetise; other App Monetisation options include affiliate marketing and ads.
The price per user needs to be pitched between our cost and the value our user perceives.
Cost < Price < Value
Price - Cost = Our incentive to sell
Value - Price = A user’s incentive to buy
The main ways to price are:
Cost Plus Pricing: Price = Cost * (1 + m%), where m% is our profit margin. This is appropriate when selling commodity (low margin) products.
Value Based Pricing: Price = Value * (1- d%), where d% is a discount.
For apps, we should use Value Based Pricing. It is important that potential users clearly understand the value to them and, secondly, this value is at least 10x price.
Short term revenue maximisation should not be our prime objective. However, understanding how price influences revenues helps test our business plan financial assumptions.
Revenue = Sales units * Price
Sales units vary with Price.
Sales units increase as prices reduce; and vice versa.
At a certain price, revenue will be maximised.
Let’s take some hypothetical prices (£5, £10, £15, £20) and respective unit sales (40, 25, 20, 5). The resulting revenues would be: £200 (40 * £5), £250 (25 * £10), £300 (20 * £15) and £100 (5 * £20). Hence, the maximum revenue of £300 is achieved when the price is £15.
The way that demand (unit sales) vary with price is known as the Price Elasticity of Demand. A little time after we have launched and have a reasonable number of users, we should raise our prices by 5% to see how customers react. We keep raising the price until we lose 20% of our users. At this point, our price will be near optimal.
Aligning price to target users
Pricing needs to align with our target users. Asking a consumer to pay £10k to use our app will not work. Scenario planning can help. If we wanted a £1m turnover business that could be achieved with:
£100 (price) * 10k (users) => Consumer market
£1k (price) * 1k (users) => SME (Small/Medium Enterprises) market
£10k (price) * 100 (users) => Enterprise market
The three price points above relate to different markets (or user types), e.g. £100 per year relates to a Consumer market.
Our business plan needs to align with our target market (and associated price point):
Consumer: Light touch user engagement, including self serve sales and support.
SME: Some marketing plus SLAs. Sales cycle less than 3 months.
Enterprise: High touch user engagement, sales and support. Up to 12 months sales cycle.
If there is a mismatch between our target price, market and operational setup then we need to revise our plan.
Predictably Irrational talk by Daniel Ariely
Pricing for Calm SaaS Businesses talk by Arvid Kahl
3 Influencing Tactics for App Designers post by Phil Martin
This post proposes using Value Based Pricing where the user value is at least 10x price. Until next Sunday, consider how you would communicate the value of your app to potential users.