Pricing Strategies for Startups by Tom from Y Combinator

Introduction

Common question from founders: How to price their product?
Founders often freeze when asked for pricing, especially if they lack experience in larger companies.

Concept: Determine the value your product delivers to the customer.
Process:
- Sit down with the customer Champion (interested buyer).
- Document what they expect the product to do for them (cost savings, time savings, revenue increase).
- Challenge assumptions to ensure accuracy, as this will help when justifying the expense to decision-makers (CFO/boss).
Example: Selling a customer service tool to a company with 100 agents:
- Each agent costs $100,000/year (salary + overhead).
- Total cost = $10 million/year.
- Tool saves 20% of queries, resulting in $2 million savings.
Pricing: Charge between 25% and 50% of the value delivered (e.g., charge $700k for a $2M savings).
This equation also provides success metrics for pilot projects.

Cost as a Floor: Never start pricing solely based on cost as it often leads to underpricing.
Ensure costs are significantly below the calculated value.
Aim for 80-90% gross margins.
Caution: Be careful with credits from services (AWS, OpenAI); treat them as cash costs.

Avoid engaging in price wars; it leads to unsustainable pricing.
Differentiate your product based on functionality/value instead of price.
Commodity Product Example: Airline industry has low profit margins due to lack of differentiation.

Understand Industry Norms: What do customers typically pay for similar software? (monthly fees, per-user pricing, etc.)
Keep Pricing Simple: Complicated pricing can hinder sales.
Prefer Recurring Revenue Models: Monthly or annual contracts are better than usage-based pricing, especially during downturns.
Trial Strategies: Offer short pilot programs with clear criteria, or push for annual contracts with a money-back guarantee.

Transparency vs. Sales: While some customers prefer seeing prices online, Enterprise pricing often requires personalized negotiation.
Offer different tiers for small businesses and enterprises, targeting specific functionalities required by larger customers.

Ensure contract values are sufficient to cover sales team compensation (5:1 ARR to compensation ratio).

If unsure about pricing:
- Start with a number similar to what competitors charge, then increase it with each new pitch.
- When losing 25% of deals solely based on price, you’re likely at an appropriate price point.
Key Takeaways:
1. Use the value equation for pricing, aiming for about one-third of the value.
2. Ensure pricing is above cost levels unless you have a plan to lower costs.
3. Differentiate your product in competitive markets to avoid price wars.

The first few sales are often the hardest; focus on closing deals and iterating on pricing as you grow.