Key Moments
How To Price For B2B | Startup School
Y CombinatorKey Moments
B2B startups can price by calculating the value delivered to a customer (cost savings, time savings, revenue increase) and charging one-third of that value, ensuring customers retain two-thirds. Overpricing risks losing customers, while underpricing leaves money on the table.
Key Insights
Pricing should be based on the value equation, with startups typically charging 25-50% of the value they deliver, ensuring the customer retains the majority.
Startup costs should only serve as a floor for pricing, never the starting point; aim for gross margins of 80-90% to ensure sustainability.
Competing solely on price in a commodity market is a race to the bottom; differentiation through functionality or unique value is crucial.
Recurring revenue (MRR/ARR) is preferable to usage-based pricing due to its stability, especially during economic downturns.
For enterprise sales, gating core functionalities like SSO, audit logs, and compliance reports behind a 'contact sales' option allows for significantly higher pricing (up to 10x) compared to smaller plans.
Sales compensation should ideally follow a 5:1 ratio of new signed ARR to total salesperson compensation.
The value equation: a customer-centric approach to pricing
The most critical element in B2B pricing is the 'value equation.' This involves sitting down with a key contact (the 'champion') at the prospective customer's company to quantify the tangible benefits your product will deliver. These benefits typically fall into three categories: cost savings (e.g., reducing operational expenses), time savings (e.g., automating tasks), or increased revenue. For example, a customer service tool that reduces query handling time for a 100-person support team, each costing $100,000 fully loaded, could save $2 million annually if it eliminates 20% of queries. Once this potential value is collaboratively established and validated with the customer, startups should price their product at 25-50% of this total value. Using the $2 million savings example, charging around $700,000 would mean the customer retains $1.3 million, a clear win for them and a profitable deal for the startup. This process also naturally defines success metrics for pilot projects, allowing for data-driven pricing adjustments.
Cost considerations: establishing a pricing floor
While the value equation dictates the potential price, a startup's costs must be considered to ensure profitability. Costs should only act as a floor, meaning the price must always exceed the cost of delivering the service. A common, but flawed, approach is 'cost-plus' pricing, which often leads to undercharging. A healthy gross margin for software companies is typically between 80-90%. If, after applying the value equation and taking one-third of the value, the resulting price is lower than the cost (e.g., value-derived price is $150,000 but costs are $200,000), the business model is unsustainable. This indicates a need to either demonstrate greater value to the customer or re-evaluate the product offering. Founders should treat free credits from cloud providers (like AWS, OpenAI) as a cash cost, as they are not guaranteed indefinitely and can skew margin calculations.
Navigating competition without a price war
When competitors enter the market, a natural instinct for Founders is to engage in a price war, undercutting rivals to win deals. However, this is a destructive strategy that leads to a 'race to the bottom,' eroding profits for everyone involved. Instead of directly competing on price, startups should focus on differentiating their product based on functionality, unique features, or superior value proposition. If a product is a commodity and thus indistinguishable from competitors', all margin will likely be driven out, as seen in industries like airlines which average a mere 2.7% net profit margin due to intense competition and lack of differentiation. The goal is to ensure the comparison is not 'apples to apples,' compelling customers to choose based on unique benefits rather than just cost.
Structuring pricing for customer familiarity and revenue stability
Understanding how customers typically pay for similar software is essential. Founders should explore industry norms regarding payment structures, such as monthly flat fees, per-seat pricing, usage-based tiers, or credits. Mirroring these established payment methods can ease customer adoption. It's generally advisable to favor committed recurring revenue (MRR or ARR) over pure usage-based pricing. Recurring revenue provides a more predictable income stream, protecting against revenue cliffs during economic downturns, which is particularly attractive to investors. If usage-based pricing is initiated, it's often beneficial to transition customers to a minimum monthly commitment with volume discounts after a trial period, offering them a fixed fee (e.g., $12,000/month for usage averaging $15,000/month) if they commit to an annual contract.
Using champion insights for pricing tiers
A practical technique for setting price points is to ask the champion about the maximum amount they can personally approve without requiring additional sign-off from senior management like a CFO or legal department. If a champion has a personal sign-off limit of $15,000, it's a strong indicator that pricing should be kept just below this threshold, perhaps at $14,999, to facilitate quicker deal closures. This insight helps in structuring pricing that aligns with internal approval processes, reducing friction and accelerating sales cycles.
Website pricing: transparency vs. enterprise value
Deciding whether to publish prices on a website or use a 'Contact Sales' model for enterprise plans involves a trade-off. While many software users prefer immediate price visibility, enterprise deals are complex. The value equation often differs significantly between enterprise customers, making a static listed price inefficient. Publishing a single enterprise price risks alienating customers who derive less value (by overpricing them) or significantly underpricing those who gain immense benefit. A common strategy is to offer lower-priced, self-serve plans for individuals and small teams that include basic functionality, while gating core enterprise features—such as SOC 2 reports, SSO, audit logs, or specific data residency options—behind a 'Contact Sales' tier. These features are vital for enterprises and can justify significantly higher pricing, sometimes up to ten times that of smaller plans.
Sales channel alignment with pricing strategy
A startup's pricing strategy inherently dictates its sales channels. A key consideration is whether the contract value is sufficient to compensate a dedicated sales team. A general rule of thumb is a 5:1 ratio between new Annual Recurring Revenue (ARR) signed and the total compensation of a salesperson (base salary + commission). For instance, a salesperson earning $100,000 annually might be expected to close $500,000 in new ARR. This $500,000 could be derived from a few large deals (e.g., five $100,000 contracts), a moderate number of mid-sized deals (e.g., twenty $25,000 contracts), or a high volume of smaller deals. Pricing that results in very small contract values (e.g., $1,000 annually) would require an impossibly high number of deals per salesperson, suggesting a need for an inside sales or call center model rather than a true account executive approach focused on larger contracts.
Pilots and trials: brevity with clear success metrics
Offering lengthy free trials or extensive pilot programs can be counterproductive if the customer isn't fully committed. It's more effective to keep these proof-of-concept phases concise, perhaps lasting only a couple of weeks to a month, with clearly defined success criteria. These criteria should ideally stem from the value equation established earlier. A stronger alternative, especially if confident in the product, is to encourage annual contracts from the outset, incorporating a 30- or 60-day money-back guarantee and an opt-out clause. This approach facilitates immediate recurring revenue recognition and encourages commitment while still providing a safety net for the customer if the product fails to deliver as promised.
Startup authenticity over manufactured size
When operating as a small startup, there's a temptation to inflate perceived size by adding more staff to the website or LinkedIn. However, it's generally more effective to play to the startup's strengths. Founders can offer direct access, promising 24/7 availability to resolve problems—a level of personalized attention rarely achievable from large enterprise software vendors like Salesforce or Oracle. Highlighting this agility and direct founder involvement can be a powerful differentiator that resonates with customers seeking responsiveness and dedicated support.
The 'just pick a number' fallback and incremental pricing
If all else fails and the value equation is too uncertain, a pragmatic approach is to pick a price point similar to what customers pay for comparable software, then increase it by 50% for each subsequent pitch. The goal is not to win every deal. Only when a startup starts losing more than 25% of potential deals solely based on price should they reconsider their current figures. Losing deals means being within the right pricing ballpark; closing every deal suggests underpricing. Early customers represent a small fraction of future revenue, making initial sales momentum and learning more important than optimizing early pricing. Prices can be increased later as the product matures, new features are added, and sales processes improve, leveraging validation from early customer logos and product enhancements.
Mentioned in This Episode
●Software & Apps
●Companies
●Organizations
B2B Pricing Cheat Sheet
Practical takeaways from this episode
Do This
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Common Questions
Start with the value equation: quantify the cost savings, time savings, or revenue increase your software provides to the customer. Then, aim to price your product at 25-50% of that delivered value, ensuring it's a good deal for them and profitable for you.
Topics
Mentioned in this video
Mentioned alongside OpenAI as companies that are reducing costs for LLMs, potentially impacting startup pricing strategies.
Mentioned as an example of software that startup founders might use as a pricing reference, leading to underpricing.
Mentioned as a provider of fees that contribute to a startup's costs, influencing pricing strategy.
Organization where the speaker, Tom, is a partner and presents the video content on startup pricing.
Cited as an example of a large company that startups cannot typically compete with on customer service availability, advising startups to play to their strengths instead.
Cited as an example of a large company that startups cannot typically compete with on customer service availability, advising startups to play to their strengths instead.
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