Why Charge, How Much to Charge, and Pricing
I remember the first time I wrote a checkout system that took money from customers. It was for a paid real-time analytics product that I’d built – a few years before Google made it free with Analytics. I was using the Authorize.net API and was terrified. “What if I screw up the arithmetic and charge a customer too much? What if we get hacked?” but most importantly I struggled with the belief that anyone would actually pay us for software that I had built. It seemed unfathomable.
Like most things, as you mature as a software developer or product creator, you have a much better sense of how little you still know, which manifests as humility, making it hard to charge for your products.
You’ve written your own software or created your own product, and you know all about the various bugs, problems, inefficiencies, glitches and the various warts your baby has. So it is hard to look at it from a customer perspective and see the value, because you see all the things that need fixing or could be improved. You feel like your customer will see those things too and won’t pay until you fix every single one of them, at which point more perceived problems will have emerged, creating a never ending cycle.
You need to overcome these psychological barriers and realize that, as long as your software solves a real customer problem, and as long as solving that problem is worth more to your customer than the money you charge, you will make sales. Customers will buy. And those customers won’t return furious at you for not fixing every single bug, but will actually be happy that your product worked well enough. As Jim Collins once said, “Don’t let Great be the enemy of Good.”
Why charge early?
It’s important that you overcome the psychological barrier to charging for your product or service early on. There are two core reasons for this:
Firstly, it ensures that you are building a business that can generate cash flow. If you make something free and have tremendous growth, it is as meaningless as standing on a street corner handing out $20 dollar bills. You are not validating your business model.
Secondly, everyone loves free stuff, and that love of free will poison your product decisions. You are getting feedback from people who incur no cost to use your product and thus the bar for product success is artificially low. You need feedback from people who incur a cost, so that they can inform your product decisions from a base of having incurred real cost. If your product decisions do not deliver enough value to justify what the product costs, you need to reevaluate and do better.
How much to charge
Pricing is weird. The more you charge, the more perceived value your product has, even before a customer learns about the product and tries it. Slap on an eye-wateringly high price and you will make a handful of sales, even on a brand new product targeting a new market. I’ve seen it happen. Your price won’t be optimal, but the psychology behind perceived value based on price is real and a useful input in your decision making.
The less you charge, the more you will find your customer service load per customer increases. Customers that pay less are more demanding. I’ve seen this pattern remain constant. It doesn’t apply to slight drops in pricing, but to products where prices are extremely low – in the $1 to $7 a month range. We’ve sold SaaS products at various prices with monthly or yearly subscription over the past 15 years and have found this to remain true.
There is a market for every price point. As our business budget has increased into the millions, I’ve discovered that it makes perfect sense for us to pay 6 figures and higher for certain things when the price is far lower than either: the cost of the problem, the revenue that we’ll earn by using the product, or a combination of both.
As a one or two person team, you’ll be sitting in a room, living off your savings and you’re going to have a very hard time believing that an enterprise customer will happily pay thousands or tens of thousands of dollars for your product per year. That is going to make it hard for you to make rational pricing decisions and very difficult for you to talk to customers and rationalize the cost of your product. This is an early stage problem that goes away quickly after your first few sales.
Start out low, but not too low, and increase your pricing. If you’re charging for a subscription product, it is easy to let your existing customers know that you’re increasing the price. Cut them a break e.g. give them their existing pricing for another year, or just grandfather them in at the old pricing on their existing licenses, which is what we did.
Starting higher and lowering prices later on is not a great look unless you provide a very clear and positive rationale. It risks your early adopters feeling like suckers and questioning their buying decision. It creates negative perceived value, as the product may not appear to be “worth” what it was when the price was higher.
At Wordfence, we started out at $17.95 per year, then raised the price to $35 per year, then to $49 per year, then to $99 per year. That shift happened between 2012 when we launched and around 2017. Those price increases seemed insanely high to me. I was sure our customers would revolt, that we’d receive social media pushback and outright incredulity from existing customers. None of those came to pass. In fact these increases created a positive outcome for our existing customers because we were able to grow the product and team, providing significantly more value.
Even when you’re data driven, it’s not crystal clear
Our hacked site cleaning business is interesting because we use a demand based pricing model. When our team gets busy, the price for site cleaning rises to help throttle demand. When they don’t have enough to do, the price automatically drops.
We recently conducted a financial study where we ‘bucketed’ buyers who paid $100 to $200 in one bucket, $200 to $300 in another bucket, all the way up to $2000. We plotted a bar chart showing how many buyers we had for a given pricing bucket for a given time period and separated the time periods into months with high demand and months with low demand.
In other words, we were able to examine our customer resistance to price increases as the pricing changed. Our average price is around $220 for a hacked site clean. When you examine this data, there appears to be no resistance to price increases, but then you have to consider that the price is increasing due to increased demand. So you’re really looking at how customers behaving in the face of increased price, but also increased demand. Price elasticity of demand says that as demand increases people will pay more. Ideally you’d want to see buyers still buying as you increase price and demand stays static.
I would be remiss without mentioning price discrimination. There is a rather unfortunate reality that some customers just want to spend money, some customers think through every purchase in a logical and systematic way, and others just want whatever the cheapest option is. I describe this reality as unfortunate because, if you create three versions of the same product and simply have a perceived differentiation between each product, but with a low, medium and high priced version, you will make more money.
You’ll make more money because customers that simply “want the best” will buy the higher priced version, some customers will just default to the middle tier, and others will make a rational choice to buy the lowest priced option or will default to that. If you had a single middle tier price, you’d exclude the “I want the best” customers and you may not make a sale to the deal shoppers.
In my humble opinion, it is unethical to exploit price discrimination without actually having differentiated products that provide more or less value, and where that value has some relationship to the costs to produce or maintain those products. So be a good person, make good choices, but know that price discrimination is a very real phenomenon and potentially a low friction way to increase cash flow.
We’ve chatted about overcoming your psychological resistance to charging for your creations, that you should charge early to validate and help shape your product and business, the perceived value of higher prices and the customer service load associated with lower prices.
We also covered how it will be challenging for you, living on Ramen and tepid tap water, to charge a lot for a product that you created, and that you need to separate your circumstances from the reality of the market available for your product and what they’ll pay.
We talked about how it is easier to increase prices than decrease them, and I used Wordfence as an example of how radically pricing can change over the years, provided you continue to increase the value that your customers receive. Finally we discussed how taking a data driven approach can help, but may not provide all the answers, and about price discrimination and how it can increase pricing efficiency.