How To Price A Product: 5-Step Pricing Strategy + Examples

Your pricing strategy can make or break your product. If you understand what prospective and existing customers value most about your product and pricing that key service or feature accordingly, you’re on the right track. But it can be easy to lose sight of your customer when determining a pricing strategy.

There’s a few common mistakes product teams fall prey to:

• Getting hung up thinking about which features belong in which price tier versus building a customer-first, research-based strategy. Instead, teams wing it or go with whatever the loudest voice in the room has “a good feeling” about.
• Making a decision based on what your competitor is doing instead of letting the market inform your decision. Being influenced by competitive plays ignores the nuance in your product and other practical concerns, like how much it’s going to cost to keep the lights on.
• Letting external factors or the economy guide a knee-jerk reaction to how much you charge.
• Taking too long to react after such a pricing mistake has been made. Going back to customers and reevaluating decisions needs to happen fast following a poor pricing rollout to avoid losing the confidence of your customers forever.

Ultimately, if you act impulsively or fail to go about creating or updating your pricing strategy in a methodical way, there’s a high likelihood that you haven’t figured out your optimal price point. Here, we’ll walk through five steps to creating a sustainable pricing strategy that takes growth and expansion into account.

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How To Price A Product In 5 Steps

There are five essential steps to crafting a strong pricing strategy:

• Step One: Use the most valuable attribute of your product — your value metric — to help define how you scale your price.
• Step Two: Assess your customer’s willingness to pay for the product.
• Step Three: Ensure your pricing and packaging strategy will drive growth and revenue.
• Step Four: Calculate how much you’re bringing in versus how much it costs to drive revenue.
• Step Five: Test and adjust your pricing and packaging strategy as needed.

Let’s get started by looking at what we mean when we say you should let your value metric define how you scale your price in step one of our pricing strategy guide.

Pricing Strategy Step 1: Base your price on your value metric.

The first thing we need to do when we’re determining how to price a product is to put what the customer values at the forefront of that strategy. Identify what the customer values most in the product and use that as the primary driver of how you shape your overall pricing strategy.

We call the single most valuable component of your product the value metric. And we define the value metric as what you charge per user or per unit.

As we consider what customers value most in a product — and what special attribute the product has that they are most willing to pay for — we should concurrently think about the ways to package products. This way we begin to think in terms of what the customer cares about and how the customer should pay for what’s most valuable. There are three ways to package products:

• Package a product by features: When products are feature differentiated, price scales as users add more and more features.
• Package a product by usage value metric: This means that price scales (aka increases) the more a user uses the product.
• Package a product by outcome metric: Pricing scales based on the impact the users see as a result of using the product.

We now know what it means to use our value metric, or, the attribute the customer values most, as the driving force behind our pricing strategy. We also know that there are three ways to package our product. Let’s move on to the second step in the process of determining how much to charge for your product: a customer’s willingness to pay.

Pricing Strategy Step 2: Assess your customer’s willingness to pay.

Once you determine what your users value most and how you will package that in your pricing strategy, you’ll want to answer a crucial question: Is the customer willing to pay for it?

This is the moment when you will begin to understand if the customer’s view of how the product brings them value is similar to what you’ve defined as the value metric and if they are ready to take their wallets out.

When a consumer's willingness to pay is higher than the price you’re charging, they feel like they're getting a good deal. When their willingness to pay is lower than the price you’re charging, they are far less likely to buy the product. Nobody wants to feel like they're paying for something that isn't worth it.

We can research willingness to pay by running a Van Westendorp survey, which is designedto show how much customers are willing to pay for a specific good or service. These surveys are used in pricing research to help inform decisions about what to charge over a specific period of time. The output of a Van Westendorp survey will provide a price range and a recommended price point for each customer segment.

There are three factors that influence willingness to pay for a product.

First is the use case, or, the reason a particular user persona seeks out your product to begin with. For example, the use case of a prospective customer who has malware in their system is probably willing to shell out a good deal of money to remove it. On the other hand, the use case of a person considering purchasing anti-malware as a preventative measure is in a position to do more research. You want to consider who your use cases are and why they should choose to pay for your product over an alternative.

Thesecond factor that influences willingness to pay is the customer’s demographic or firmographic realities. Simply put, different types of customers have different needs, and they vary depending on where they live and what their situations are.

Thethird factor that influences willingness to pay is how often or how much the prospective customer uses the product. These circumstances can change, which would of course affect their willingness to pay.

It’s important to note that while the Van Westendorp survey is a great indicator of how much a prospective customer will and won’t pay, it may or may not realistically reflect the exact price you should charge. We highly recommend performing qualitative and quantitative research to understand if the outcomes the survey suggests make good business sense for the organization. We’ll look into the cost of revenue in the fourth step of the process.

But first, let’s move on to step three, where we take a look at how organizations can be sure they’re creating a pricing and packaging strategy that accounts for all types of customers in their target market.

Pricing Strategy Step 3: Ensure your pricing strategy will drive growth.

At this point, we have an opportunity to consider whether or not our monetization strategy will drive revenue, which we can do by visualizing our customer’s journey into what we call growth loops. It’s enormously useful to hit pause, step back, and walk through the customer journey as we currently have it laid out to ensure our pricing strategy is headed in the right direction.

Increased friction can slow or prevent us from acquiring new customers and retaining existing ones. That is to say, when our growth loops have too much friction, our revenue is affected.

We define growth loops as a closed system of inputs and outputs. New and returning customers move through the loop, going through a series of steps that generate an output. This output can be directly reinvested into the original input, which creates a growth loop.

Pricing Strategy Example: Zoom

Let’s illustrate this process by using Zoom as an example. First, users come to the platform to host a meeting. Then, they invite their friends or colleagues. Once invited, these guests sign up as new users and attend the meeting. Seeing the value of the product, some of the attendees become hosts themselves. Lastly, these new hosts invite another group of guests to a meeting, perpetuating the loop.

Now imagine that Zoom doesn’t have a free plan, which means that customers need to pay in order to create their own accounts. This would create friction between the fourth step and the acquisitional movement back into the first step, where an invited attendee becomes inspired to become a host of their own meeting.

While Zoom would receive payment upfront, this model would decrease the number of attendees who convert to new hosts. As a result, the number of meetings hosted would also decrease, leading to lower exposure to Zoom as a product and fewer new customers.

Instead, Zoom’s free plan removes friction from their growth loop, and enables a viral acquisition and retention channel.

Higher conversion rates yield less friction, while barriers to conversion can severely impact growth. You’ll want to ensure that the monetization model, and in turn your comprehensive pricing and packaging strategy, lends itself to compounding growth.

Once we’ve placed our pricing strategy in the context of our customer’s journey to confirm we’re driving growth and not friction, we want to focus on the cost of revenue.

Pricing Strategy Step 4: Factor in the cost of driving revenue.

The next major consideration when setting your pricing strategy and how much your product should cost is the cost of driving that revenue. You need to think of how much it costs to acquire new customers and how much it costs to serve them a reliable product. This is known as the cost of revenue.

There are two types of costs that revenue has to support, the cost to acquire a customer and the cost to serve the customer.

Cost to Acquire a Customer

This cost usually includes advertising costs, sales costs, referral costs, and marketing team costs.

Cost to Serve the Customer

Included in this cost are product development, storage, customer support, and logistics costs.

If the monetization model you’ve defined is going to yield revenue growth for your company, you need to be sure that the net revenue you’re generating outpaces the cost of revenue.

When we subtract the revenue we’ve generated from the cost to serve, we have a net contribution margin. To put it another way, the net contribution is the revenue you generate from gaining a customer, minus the cost of serving that customer. Organizations can use the net contribution to reinvest in new product development or in acquiring new customers.

In addition, companies should consider how fast and frequently they will get the money back that they put into a customer. This is known as the payback period. The payback period gives companies a sense of what they will have on hand to keep the business going and growing.

The length of your payback period is the minimum time you have to retain a customer to justify the cost to acquire and serve.

For instance, if your payback period is short, say six months, then any revenue you make after the first six months of retaining a customer, is all profit.

But if your payback period is very long, like 3+ years, then it means you will have to retain a customer for that long to make this a viable pricing strategy. If you're not sure your product can do that, then you will struggle to have a profitable business.

The final step in our five-step process on how to price a product is to test and adjust as needed. Let’s dig in.

Pricing Strategy Step 5: Test and adjust your pricing strategy.

Despite the qualitative and quantitative research you do to get pricing right — and despite your best effort to account for how your product will acquire and retain customers — the effectiveness of your pricing strategy cannot be perfectly predicted.

Therefore, it’s important to test your hypotheses with A/B testing. An A/B test compares the current product, or control, with a variation, to see which one performs better.

Before you start crafting a hypothesis you want to test, answer these three questions to help define the scope:

1. What is the change we're testing?
2. What metric do we think the test will move? Will other metrics be impacted?
3. In which direction and by how much will the metric move?

Now there are a few challenges when defining your scope and objectives because pricing is such a sensitive topic. Unlike other smaller A/B tests, there will likely be some unforeseen impact on other parts of the business when testing new pricing strategies.

• First, there are trade-offs associated with monetization decisions, which a single metric doesn't capture.
• Second, it doesn't measure the impact on other growth metrics or the growth loop.
• And third, long-term effects on any of these metrics aren't tracked.

To accurately test how your pricing changes impact the whole of your business, it's important to start from a well-defined hypothesis and scope. When defining the scope of a test, try to focus on more than just the primary success metric. Take the time and space to think through additional outcome metrics, trade-off metrics, secondary success metrics, and leading indicators. All of this data will help your team make the most informed decisions when it comes time to decide on a new pricing strategy.

It’s important to remember that pricing strategy updates are among the most sensitive growth initiatives, which is why they shouldn’t be rushed. It’s extremely hard to win back customers that have been burned by a half-backed pricing change. Bringing people along in as transparent a way as possible can go a long way toward ensuring customers understand why a company makes the decision it makes.

Diving Deeper Into Pricing Strategy & Monetization

We have now provided an overview of how to go about implementing a new pricing strategy and pricing a product. As a reminder, when you price a product, take the following steps:

• Step One: Use the most valuable attribute of your product—your value metric—to help define how you scale your price.
• Step Two: Assess your customer’s willingness to pay for the product.
• Step Three: Ensure your pricing and packaging strategy will drive growth and revenue.
• Step Four: Calculate how much you’re bringing in versus how much it costs to drive revenue.
• Step Five: Test and adjust your pricing and packaging strategy as needed.

The simple truth is that thinking through how your product will turn a profit is a serious undertaking. When we slap a sticker on something just to see how it goes, or when we make a pricing decision based solely on our competitor analysis, we’re failing to think through the nuances of our own organization and what keeps the lights on.

Pricing and growth go hand-in-hand. You want a price that speaks directly to what the prospective customer is willing to pay, but if they’re not willing to pay more than the cost to serve and the cost to acquire, you need to go back to the drawing board.

Ultimately, even when you do your homework, it’s critically important to run pricing tests to ensure that your predictions line up with reality.

If you’re interested in learning how to create a winning price strategy from A to Z, inclusive of robust insight into the analyses you need to run and additional factors you need to consider, Reforge’s Monetization and Pricing program will prove an invaluable investment.

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