Monetization Strategy: Pricing

Question 1

Pricing Metric

Answer 1

A pricing metric is the unit in which prices are charged to the customer. It can aggregate several value metrics important to the buyer.

Question 2

Pricing Metric Criteria

Answer 2

For a pricing metric to provide leverage in growing revenues, it must:

Be easily understandable to the buyer; and
Align closely with their value metrics; and
Grow with their usage

Question 3

5 Pricing Categories

Answer 3

Account based pricing metric: A flat license fee is charged per customer (account). We saw this in Zapier’s example above.

User based pricing metric: A seat-based license fee is charged separately for each user in the customer’s company. Example: Zoom.

Feature based pricing metric: Pricing is based on a tiered pricing plan where a cluster of features is grouped under a single tier. Customers upgrade to a higher priced tier to get access to more features or they pay extra for an add-on. Example: Zapier

Usage based pricing metric: The value metric is aligned with the customer’s usage of the product. A good example is Zapier’s model above that used Tasks/month as part of their pricing metric.

End customer based pricing metric: The value metric is aligned with the usage of the customer’s product by their end customers. The preceding category is about usage of your company’s product whereas this is about usage of the customer’s product. Example: Segment

Question 4

Van Westendorp Price Sensitivity Analysis

Answer 4

Dutch economist Peter Van Westendorp developed this technique for determining customer price preferences. It takes the form of a survey of four questions. The responses are plotted as distributions, one for each question, and analyzed for acceptable price ranges and price points

Question 5

Van Westendorp Price Sensitivity Analysis questions

Answer 5

Too Expensive
At what price would you consider the product to be so expensive that you would not consider buying it?

Too Cheap
At what price would you consider the product to be priced so low that you would doubt its quality?

Expensive
At what price would you consider the product starting to get expensive that you would think twice before buying it?

Cheap
At what price would you consider the product to be a bargain?

Question 6

Point of Marginal Cheapness

PMC

Answer 6

Intersection of Too Cheap
and Expensive

This is the lower end of the range of acceptable prices. Below this price point, more transactions would be lost due to the perception of poor quality than would be gained due to perception of a bargain

Question 7

Point of Marginal Expensiveness

PME

Answer 7

Intersection of Cheap
and Too Expensive

This is the upper end of the range of acceptable prices. Above this point, the price is considered expensive and transactions would be lost due to the perception of not having enough value for money

Question 8

Range of Acceptable Prices

RAP

Answer 8

Any price between these two points (PMC and PME) is acceptable to most customers.

Question 9

Optimal Price Point (OPP)

Answer 9

Intersection between Too Cheap and Too Expensive

At this price, about the same percentage of respondents regard it as not delivering enough value as those who feel it is of questionable quality

Question 10

Indifference Price Point

IPP

Answer 10

Intersection between Cheap
and Expensive

At this price, about the same percentage of respondents regard it as a bargain as those that consider it to be too expensive. Most customers are indifferent to price at this point

Question 11

5 key Van Westerndorp metrics

Answer 11

PME
PMC
RAP
OPP
IPP

Question 12

Price plan

Answer 12

Tiers: Recall from lesson 2 that buyers can be segmented into several different personas. Each persona typically maps to a pricing tier. The persona definitions determine how they are approached, onboarded and charged.
Features: In lesson 4, we learned that different sets of features can appeal to each buyer persona as premium value. The value metrics determine what features go into each pricing tier.
Price: The Van Westendorp survey can be run for a large enough sample of respondents that contains buyers from all personas. The VW metrics are then calculated for each persona separately and used to construct the pricing plan.

Question 13

5 monetization strategies that can be implemented once pricing plans for different personas are in place

Answer 13

Profit
Adopt
Collect
Expand
Retain

Question 14

Adoption Strategy

Answer 14

This is a market share maximization move in which the product is priced at the lower end of the spectrum to win dominant market share. A low price typically accompanied by a free trial or freemium adoption model is part of the land-and-expand sales tactics. It aims to minimize friction to adoption, in order to grow quickly and subsequently move up-market after broad adoption has been secured. Slack and Zoom are good examples of adoption pricing.

Question 15

Collection Strategy

Answer 15

This is a revenue maximization strategy where the aim is to collect a fair market price for the premium value offered by the product. This is typically common with a niche product that targets a new market or vertical. It aims to preserve brand prestige by charging a high enough price to convey a sense of luxury and exclusivity instead of a low price diluting away the perceived value of the product. SaaS companies sometimes offer a “premium” tier that is priced maximally offering every feature and a high touch customer support representative.

Question 16

Expansion Strategy

Answer 16

This strategy maximizes revenue per customer while aiming for increasing expansion revenue. As we saw earlier with Stripe, Twilio, and Netlify, by offering a “core” product for a lower price but charging extra for add-ons that are required to get the most from the product, a company can earn a lot more per customer.

Question 17

Retention Strategy

Answer 17

This strategy aims to enlarge the customer base over time by way of maximizing customer retention. In lesson 1, we demonstrated the impact of a small lift in customer retention on LTV. Retention is crucial not just to maintain current revenues but also to earn expansion revenues from retained customers in the future. Companies often introduce premium features into the most popular tiers of their pricing plans instead of always adding them to the topmost tier by default, in order to increase the value they derive for price paid. This is especially important in competitive markets where multiple players are vying for the same wallet share. Dropbox, as shown below, offers a significant number of features in each tier of their pricing plans and continues to add more premium features in each. The bulk of the differentiation between tiers is based on storage capacity and enterprise/IT management features.

Question 18

Profit strategy

Answer 18

Often known as skimming, this is a profit maximization strategy. This involves setting a high price initially and later offering cheaper alternatives to address more buyer segments at lower price sensitivity. Over time, the company can traverse the entire demand curve in the market. While this strategy is more common among hardware products (e.g., Apple’s iPhone offerings and prices), it can often be observed among SaaS companies as well. For example, back in the day MS Office (now Office 365) used to only be available within a $100-500 price range. In recent years, they have brought down the features per tier as well as corresponding prices to as low as $6.99 per month, owing to market saturation and competitive pressures

Question 19

Goals of a Customer Accounting Model

Answer 19

A customer accounting model informs about the growth of customer base

How many customers will there be after N months/years?

What retention rate is needed to achieve growth targets?

How many new customers are needed to achieve growth targets?

Question 20

Customer Accounting Model: Inputs

Answer 20

The inputs to a customer accounting model are the time series of the following transactions across several accounting periods. An accounting period is typically a cycle over which a customer is charged. Often, it’s simply a recurring time period such as a day, week, month or year.

Transactions by new customers.
Transactions by existing customers.
All cancellation transactions.
Separately we also record if a customer restarts their subscription after a previous cancellation.

Question 21

Customer Accounting Model: Transformations

Answer 21

1. Churn rate

2. Growth Accounting

Question 22

Customer Accounting Model: Transformations

Answer 22

New Customers: These customers start paying in the current accounting period.
Returning Customers: These customers were paying customers in the previous period and continue paying in the current accounting period.
Reactivated Customers: These customers became paying customers in some prior period, were not paying customers in the previous period, but did restart their subscription in the current accounting period.
Total Customers: The sum of the above three for each accounting period.

Question 23

Churn rate formula

Answer 23

Churn rate = (Number of customers at the start of period - Number of customers at the end of period) / Number of customers at the start of period

Question 24

Total Customers formula

Answer 24

Total Customers (this period) = New + Returning + Reactivated

Question 25

Revenue Accounting Model: Goals

Answer 25

A revenue accounting model informs about revenue growth.

What is the revenue forecast after N months/years?
What revenue retention rate is needed to meet the growth forecast?
What expansion rate is needed to meet the growth forecast?
How much revenue from new customers is needed to meet the growth forecast?

Question 26

Difference between contraction revenue and churn revenue?

Answer 26

Contraction revenue is due to customer decreasing their spend.

Churn revenue is the loss of revenue from customer churning

Question 27

Revenue Accounting Model: inputs

Answer 27

Transactions by new customers.
Transactions by existing customers for same plan as previous period.
Plan upgrade and downgrade transaction.
All cancellation transactions.
Separately we also record if a customer restarts their subscription after a previous cancellation.

Question 28

Revenue Accounting Model: Transformations

Answer 28

Contraction Revenue (T) = Amount of revenue lost due to paying customers in period T-1 reducing their spend in period T

Expansion Revenue (T) = Amount of revenue gained due to paying customers in period T-1 increasing their spend in period T

Question 29

Revenue Accounting Model:

Outputs

Answer 29

New Revenue: Revenue that started accruing in the current accounting period.
Continuing Revenue: Revenue from existing customers that were paying in the previous period and continue to pay in the current one without any changes to their plan.
Reactivated Revenue: Revenue gained from previously churned customers restarting their payments.
Expansion Revenue: defined above.
Contraction Revenue: defined above.
Churned Revenue: Revenue lost due to paying customers in previous period churning.
Total Revenue:

Question 30

Total Revenue Formula:

Answer 30

Total Revenue (this period) = New + Continuing + Expansion + Reactivated

Question 31

What is the Revenue Accounting Model used for?

Answer 31

to determine impact of expansion and contraction revenue

to build a product and marketing roadmap to meet revenue targets

Decide billing policies

Question 32

Growth Ratios: Goals

Answer 32

This model answers the following key questions about the growth trajectory of market share and revenue.

What will be the trendline for growth of customer base going forward? I.e., how fast will it grow?
What will be the future trend in the growth of revenue? I.e., how fast will it grow?

Question 33

Which two KPIs are used in the Growth Ration Score Card

Answer 33

Quick Ratio and Net Dollar Retention

Question 34

What is Quick Ratio?

Answer 34

Quick Ratio
Quick Ratio, or QR, informs about the pace of growth in customer base

Quick Ratio = (new + reactivated)/churned

Interpretation
A ratio greater than 1 implies the base is growing, i.e., for every customer that churns, a new customer is added to the base.
A ratio less than 1 implies churn is overwhelming new additions. At this rate all customers will eventually churn.

Question 35

NDR

Answer 35

Net Dollar Retention
Net Dollar Retention, or NDR, is the percentage of revenue retained from existing customers after accounting for customer churn, contraction and expansion.

Formula
NDR (T) = (Revenue (T-1) + Expansion Revenue (T) - Contraction Revenue (T) - Revenue lost due to Customer Churn (T)) / Revenue (T-1)

Interpretation
An NDR of 1.0 or 100% implies that all revenue lost to churn and contraction is made up for by expansion of existing customers’ accounts. At that point, all revenue from new customers is net growth for the business.
An NDR > 1.0 accelerates the growth rate, essentially achieving exponential growth.
An NDR < 1.0 slows down the growth rate, leading to a tapering growth curve.