As entrepreneurs, we’re constantly seeking ways we can improve our product or service.
Isn’t that what most of us are driven by? To make something that wows our customers?
We’re constantly iterating, testing, and making tweaks in the hopes that our project will take off.
But what if some of that effort was unnecessary?
Instead of adding a new feature, what if you just needed to change your pricing structure?
Now, don’t get me wrong, I’m all for making improvements to create a better experience for the customers. But, I’d like to share with you how changing our pricing structure transformed a side-project into a real business.
You’re probably wondering: can changing the pricing actually change my business?
My answer: Yes. Absolutely.
First, what should we consider to be a real business?
I’m sure there are plenty of different opinions on this. Some might argue that a real business must be funded by VCs or have some insane multi-million or billion dollar valuation.
Obviously there are exceptions, but for this post, let’s assume that a real business is any venture that generates enough revenue to support the expenses of the business and the team running the business.
When you’re working on a side-project you’re likely doing additional work to support yourself. With a real business, that’s no longer necessary.
The Starting Point
I help run a cheap flights service where we send out killer international flight deals departing from the USA and Canada. There are currently two subscription levels: Free and Premium.
The Free Subscribers are mostly testing the waters and getting a feel for the quality of deals that Scott (my business partner) sends out. They get one third of the deals that are sent out.
The Premium Subscribers pay a few dollars per month and get all the deals that are sent out.
We originally charged $2 per month to be on the premium list. At two bucks a month, it takes a lot of customers for it to be considered a real business.
If we wanted to make $10,000 in a month, we would need 5,000 customers. This isn’t impossible, but it would take awhile to get there.
The Pricing Change
When the new year rolled around, we decided to try something new because there were a couple of issues with our 2015 pricing:
- Stripe was gobbling up 18% of all the revenue. 30 cents per transaction doesn’t sound like a lot, but it’s fairly sizable when you run such a low-priced service.
- People wanted to pay for yearly subscriptions. Some subscribers simply didn’t like the idea of paying $2 per month. They’d rather pay one lump sum and get access to the flight deals for the entire year.
On top of that, some customers were asking us to raise the price. I know this sounds crazy — I never thought a customer would actually ask to pay more money!
Even after we did raise the price, we still get comments like this from our premium subscribers:
“I’d pay more for the annual subscription – $50 to $100. It’s that valuable.”
So we went for it. On January 1st, we shifted the pricing to these three tiers:
- Quarterly – $9 / 3 months
- Semi-Annual – $15 / 6 months
- Annual – $29 / 12 months
Remember those Stripe fees that were killing our margins? This pricing change fixed that overnight. Stripe fees went from eating up 18% of the revenue to less than 5% on average.
By eliminating the monthly option we also increased the lifetime value of the customer (LTV). Rather than having one month as the minimum subscription time, we now have customers on board for a minimum of 3 months.
If you’ve dabbled in finance, you’re probably aware of the whole present value of money thing. If you aren’t versed in this subject, let me sum up one of the takeaways for you: money now is better than money later.
By getting at least 3 months worth of revenue up front it allows us to invest money back into the business to grow even faster.
Discounts vs. Price Increases
In addition to the obvious benefits from the price increase, we also learned that increasing the price is actually very similar to running a sale — except better.
When you run a sale you’re typically lowering the price on your product or service in hopes of attracting more paying customers. This is great! You create a sense of urgency, get people to act, and get more customers in the door.
However, there is a big problem with offering a discount: you train your potential customers to expect a discount in the future. Rather than paying full price, they’ll just wait for the next sale to come around.
A price increase creates a similar sense of urgency since you tell your subscribers the exact date the prices will be going increase. This gets your future customers to take action, but it doesn’t train them to wait for another sale to roll around.
As I stated above, if we were to make $10,000 in any given month, we would need 5,000 customers. Let’s see how the tweaks we made to our pricing structure changed this.
Since we created the pricing tiers, the split between the different plans has been fairly consistent: 25% of customers choose the quarterly plan, 25% choose the semi-annual plan, and 50% choose the annual plan.
If you do the math, this means that when the average customer signs up, we bring in $20.50. Now, instead of 5,000 customers, we’d need 488 new customers in a month to make $10,000. Challenging, yes. But, not nearly as difficult as getting 5,000 total customers.
I’ve had a similar experience with pricing changes in other recurring service businesses as well. The multi-month plans tend to do way better than we expect them to.
Consider offering plans that let customers sign up for multiple months at a time. You may be surprised at how many customers take advantage of this option.