Venture Capitalist at Theory

About / Categories / Subscribe / Twitter

3 minute read / May 28, 2013 /

Startup Pricing - How to Manage Channel Conflict

You have just launched your new software start up. The last webpage to go up on the website is the pricing page. Like many other SaaS startups, you decide to employ some version the three pane pricing plan: first the free version, second a paid upgrade costing between $5-$40 per month, and third an enterprise tier with a “Call for Quote” in place of the price.

A few days after you launch, an enterprise customer contacts you asking for a quote. You respond with an offer that significantly higher per seat than the paid plan. Let’s test the waters, you think. Having seen your pricing page, the enterprise customer asks why the enterprise tier is so much more expensive than the paid tier. After all, the cost to deliver the service for each kind of user, whether individual or enterprise, is the same.

Serving Two Customers at the Same Time

This dilemma is called channel conflict. The pricing page is trying to serve two contrasting customer segments: the individual who wants to upgrade and the enterprise looking for a companywide or team-wide plan.

Each of these customers perceive the value of your service differently and each has a wildly varying willingness to pay.

Typically, the individual user is on a budget. They might be paying for the service out of pocket and are generally price sensitive. As the founder, your strategy might be to maximize the number of individuals on the service in order to drive bottoms up adoption. So instead of maximizing revenue from this segment, price the paid tier to generate profit after paying the cost to acquire the customer and cost to serve the customer. This is cost-based pricing - charging the customer your cost to deliver the service plus some mark-up.

On the other hand, the enterprise customer will derive significantly more value from the use of your service than the individual [1]. Additionally, this customer segment has the capacity to pay orders of magnitude more than an individual who upgrades to a paid tier. So quite naturally you want to capture some fraction of that value. This is called value-based pricing.

Rationalizing Channel Price

It’s hard to convince one customer segments to pay based on cost-based pricing and another to pay on value-based pricing on the same page for nearly the same service. So, you have two choices.

First you can distinguish the paid and enterprise products by offering enterprise-level support, service-level agreements, and IT management features that aren’t available in the paid-tier in order to justify the value based pricing to the enterprise customer. Many startups pursue this route like Yammer.

Second, you can create different websites or even brands for different segments. Within each website, one segment is prioritized and the marketing copy and pricing page reflect this. In retail, brand name drugs and generics serve different customer segments the same products at different prices (value vs cost-based pricing). This strategy can be harder for start ups because of the complexities managing two or more customer types at the same time.

Whichever route you decide for your startup, the most important thing is to determine which customer segments you’ll be charging on a cost basis and which you’ll be charging on a value basis. Clearly separating the value proposition either with feature disparity or by creating different brands will be critical to supporting the pricing differences between the two segments.

Do you have other strategies for mitigating channel conflict? Let me know on this Branch.


[1]: According the US Census, a 5k person organization pays more than 50% more in payroll than a 10 person company. So at the very least, in larger organizations, an employee’s time is worth 50% more to an employer.

Read More:

A Startup’s Guide to Maximizing Last Mover Advantage