Let’s talk about pricing, shall we? 🤓 With over 8 years of enterprise software/Saas pricing wisdom under my belt, I’ve learned that as Product Managers (PMs), understanding pricing is like having the keys to the treasure chest of your company’s revenue. 💰 But hey, who said it can’t be fun?
Why Pricing Matters:
Pricing can be as complicated as deciphering ancient hieroglyphics, yet as impactful as a meteor strike on the revenue of your company. 🌠 In fact, many large companies have entire teams dedicated to mastering the art of pricing – that’s how crucial it is!
So, welcome to the first installment of my multi-part series, the ultimate Pricing 101 crash course! 📚 Think of it as the prerequisite you wish you had before diving headfirst into the pricing pool.
Basic Pricing Terms: The ABCs of Pricing
Now, let’s break down the basics, but I promise, there won’t be any pop quizzes (unless you count your next meeting with the CFO). 😄
In the Apple App Store, “ProductivityPro” starts at a list price of $9.99. During a limited-time promotion, the developer offers a 30% discount, reducing the net price to $6.99. Customers can purchase the app at this discounted rate. Over a month, the app’s Average Selling Price (ASP) is calculated at $6.99 per copy, reflecting the average price at which it was sold during that period.
1. List Price: This is the initial, standard price at which a product or service is offered for sale by a seller or manufacturer. It is often the highest price before any discounts or negotiations.
2. Net Price: The net price is the actual price a customer pays after all applicable discounts, rebates, or additional charges have been taken into account. It reflects the final cost of the product or service to the buyer.
3. Discount: A discount is a reduction from the list price or the regular price of a product or service. Discounts can be offered for various reasons, such as trade discounts, promotional purposes, bulk purchases, or loyalty programs.
4. Average Selling Price (ASP): ASP is the average price at which a company sells its products or services over a specific period. It is calculated by dividing the total revenue generated by the total number of units sold.
Value-Related Terms: The Holy Grail of Pricing
Congrats, you’ve made it to the treasure room! 🏆
An airline ticket priced at $400 offers economic value for passengers seeking timely travel from location A to location B. Customer segmentation tailors offerings to business travelers seeking flexibility and budget-conscious tourists. Wallet size considerations result in fare options like Basic Economy (ticket price – $400) for affordability and Business Class (ticket price – $1,100) for premium travelers. Budget travelers can be highly price sensitive and can switch between airlines if a suitable but cheaper flying option is available.
1. Economic Value: Economic value is the perceived benefit or utility that a product or service provides to customers relative to its price. It reflects the worth of a product or service in meeting customers’ needs and solving their problems.
2. Customer Segmentation: Customer segmentation is the process of dividing a market or customer base into distinct groups based on shared characteristics or behaviors. This helps us tailor our marketing and pricing strategies to specific customer segments.
3. Wallet Size: Wallet size refers to the potential spending capacity or budget that a customer or market segment has for a particular product or service. It helps us estimate the revenue potential of a target audience.
4. Price Sensitivity: Price sensitivity indicates how responsive customers are to changes in price. Some customers are highly price-sensitive, meaning they are strongly influenced by price changes, while others are less affected by price fluctuations. Understanding price sensitivity helps in pricing decisions.
Cost-Related Terms: The Price of Doing Business
Behind every price tag, there’s a cost tag. 🏷️
In a bicycle manufacturing company, the Cost of Goods Sold (COGS) includes the variable expenses directly linked to producing each bicycle, such as raw materials, labor, and manufacturing overhead. If the company produces 1,000 bicycles, and the total direct costs are $100,000, the COGS is $100 per bicycle. Conversely, Fixed Costs remain constant regardless of production levels and include expenses like annual insurance premiums, administrative salaries, and equipment depreciation. Suppose annual fixed costs amount to $50,000; these costs do not change with production volume. In essence, COGS fluctuates with production, while Fixed Costs remain steady, illustrating a fundamental difference in cost structures.
1. Cost of Goods Sold (COGS): COGS represents the direct costs associated with producing or purchasing the goods that a company sells during a specific period. It includes expenses such as materials, labor, and manufacturing overhead.
2. Fixed Cost: Fixed costs are expenses that remain constant regardless of the level of production or sales. These include rent, salaries, insurance, and depreciation.
Profit and Revenue-Related Terms: Show Me the Money!
Now, let’s follow the money trail. 💸
In a SaaS company, annual revenue is $1,000,000 from subscription-based software. The Annual Recurring Revenue (ARR) stands at $750,000, representing the total value of recurring subscription contracts. After deducting costs associated with delivering services, the company’s gross margin is 70%, resulting in $700,000 available to cover expenses and contribute to profit. ARR reflects the subscription-based revenue stream, while gross margin measures profitability after accounting for direct service costs.
1. Revenue: Revenue is the total income generated from the sale of goods or services before any expenses are deducted. It’s a crucial metric for assessing a company’s financial performance.
2. Annual Recurring Revenue (ARR): ARR is a metric commonly used in subscription-based businesses. It represents the total expected annual revenue from all active subscribers or customers, taking into account subscription fees.
3. Gross Margin: Gross margin calculates the profitability of a company’s core product or service by subtracting the cost of goods sold (COGS) from total revenue. It represents the percentage of revenue that remains after accounting for the direct costs associated with producing or delivering the product. Gross margin does not consider other operating expenses such as sales and marketing or administrative costs.
Stay tuned for more pricing adventures in my next newsletter! 🚀
Further Reading Recommendations: