Monetization Strategy: Pricing Flashcards
Pricing Metric
A pricing metric is the unit in which prices are charged to the customer. It can aggregate several value metrics important to the buyer.
Pricing Metric Criteria
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
5 Pricing Categories
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
Van Westendorp Price Sensitivity Analysis
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
Van Westendorp Price Sensitivity Analysis questions
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?
Point of Marginal Cheapness
PMC
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
Point of Marginal Expensiveness
PME
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
Range of Acceptable Prices
RAP
Any price between these two points (PMC and PME) is acceptable to most customers.
Optimal Price Point (OPP)
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
Indifference Price Point
IPP
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
5 key Van Westerndorp metrics
PME PMC RAP OPP IPP
Price plan
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.
5 monetization strategies that can be implemented once pricing plans for different personas are in place
Profit Adopt Collect Expand Retain
Adoption Strategy
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.
Collection Strategy
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.
Expansion Strategy
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.
Retention Strategy
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.
Profit strategy
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
Goals of a Customer Accounting Model
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?
Customer Accounting Model: Inputs
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.
Customer Accounting Model: Transformations
- Churn rate
2. Growth Accounting
Customer Accounting Model: Transformations
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.
Churn rate formula
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
Total Customers formula
Total Customers (this period) = New + Returning + Reactivated
Revenue Accounting Model: Goals
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?
Difference between contraction revenue and churn revenue?
Contraction revenue is due to customer decreasing their spend.
Churn revenue is the loss of revenue from customer churning
Revenue Accounting Model: inputs
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.
Revenue Accounting Model: Transformations
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
Revenue Accounting Model:
Outputs
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:
Total Revenue Formula:
Total Revenue (this period) = New + Continuing + Expansion + Reactivated
What is the Revenue Accounting Model used for?
to determine impact of expansion and contraction revenue
to build a product and marketing roadmap to meet revenue targets
Decide billing policies
Growth Ratios: Goals
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?
Which two KPIs are used in the Growth Ration Score Card
Quick Ratio and Net Dollar Retention
What is Quick Ratio?
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.
NDR
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.
