Pricing is an important aspect of starting your subscription business. It’s here that you pay for your product, also known as cost of goods sold (COGS), and realize profit to compensate staff. What’s more, it’s in the pricing that you subtly indicate your value proposition and even alienate or attract different types of customers.
Clearly, this shouldn’t be an arbitrary number. Take these lessons and apply them to your business to determine an adequate and marketable price for your product.
In Brief: The Basic Psychology of Pricing (& Billing)
When thinking about pricing, it’s important to give some time and thought to the actual science behind how people decide to purchase something. A number of things come into play, but at the core, cost drives consumption, and pricing drives perceived cost. You likely understand your own thoughts and behaviors as a consumer, and while every one is different, most people are rational: you want to feel like you got a good deal. Preferably, you want to feel like you got a great deal.
Consider these basic assumptions when thinking about pricing: If you’re developing a lower priced box, you don’t want your brand to come off a cheap or misguided – that could mean lack of quality, and surely a bad deal (even $1 can “feel” wasted on a bad product.). Likewise, if you’re developing a higher priced box, understand that you need to demonstrate an experience and value proposition worth investing in.
Now look at your box and your price. What would you need to receive in order to feel like you’re getting a great deal?
While this is a very, very simple way to understand the thought process behind determining how price affects customer behavior, it shouldn’t be overlooked. By misstepping PRICE in relation to perceived COST, you run the risk of devaluing your brand, excessively churning customers, or missing out on potential revenue.
(A Note on Rebilling: Keep in mind that customers are more likely to consume right after they’ve purchased the product (gym members frequent more often after they’ve just made a payment, for example). This is sometimes called a “sunk cost,” and correlates to customer-loyal behavior – like renewing subscriptions. For this reason, it can be wise to place your rebilling dates soon after your products arrives. Your product is fresh in the mind of customers, and if you’ve provided them with a good experience, the customer is more likely to see the billing as something irreversible, and an experience they need to get their money from next month. The perceived cost here now becomes a missed experience next month in the eyes of the happy customer. This is you controlling the psychology behind your product’s value.)
COGS and Conversion Rates & Price Sensitivity
Getting into the true core of the topic, you should look at two big areas when determining a price: cost of goods sold (COGS) and Conversion Rates & Price Sensitivity.
- Cost of Goods Sold: This should be understood as the total cost of the product and service you provide. If it takes you $20 to get your customers their product, you’re dealing with $20 COGS (sometimes you leave shipping out of these factors, but for the purpose of this exercise, include it). Consider these points:
- Work backwards when determining your costs. What types of products do you want to include/what is your value proposition? Figure out the metrics behind your idea to determine what price range you’ve put yourself in.
- If you your COGS = $20, your service needs to cost customers at least $20. That would cover costs, but leave you no room for profit. If you want a gross profit margin that is 50% of your retail, then your box should cost $40: $20 to COGS, and $20 of gross profit.
- This leaves very little room for one big reality: margin of error. It’s suggested you provide yourself with enough profit margin to afford some padding each month, in case shipping, procurement, or some other unforeseen issue gets in the way. Because of this, I recommend building in at least a 50% profit margin.
- Conversion Rates & Price Sensitivity: As mentioned above, price drives perceived cost. To some, that can mean rigid $ values. For example, $19.95 is consider a “hot zone” for impulse buying – it doesn’t feel like a lot of money, but in many ways, it is. Arguably, that should lead to higher conversions. However, it’s difficult to say this is always so black and white. The Association Library does a great job covering some of these notes. In brief, consider these points:
- Your Market: What are competitors pricing their product at? Subscription business range widely, but most are inexpensive. Does this create a biased or higher perceived cost (what if someone could subscribe to two boxes instead of one for the same price?) to the buyer?
- Your Product: Is your product unique and hard to compare to others? How does this benefit or hurt your business? Does your products inherently have a $ value associated with it (ie. “$100 value, guaranteed”)?
- Your Added Value: What have you done to add prestige to your brand? Do you offer benefits outside of the regular delivery? How do customers perceive this?
- Subscription businesses that can confidently answer these questions are more likely to develop a product that is less sensitive to pricing than those that cannot.
(Note: It’s generally advised that you price your subscription boxes around impulse buy zones. These often are associated with nearly whole numbers, like $39.95, $29.95, etc. Because consumers tend to understand theses prices more, while also seeing them as costing “less” than whole numbers, you may be able to increase conversions by hovering in these areas, or applying the same pricing techniques to your business.)
With your costs determined and a blueprint of the factors determining your price sensitivity mapped out, try to pin down an acceptable price. It’s recommended you test this price with others – ask for feedback and try to judge the perceived costs reported by others without directly asking them. Getting lots of people to authentically say “That seems worth it” is a good indicator that you have landed on a good price for your product offering.
You can also check your pricing with the Cratejoy calculator. This tool helps you to consider all the costs (COGs, box materials, transaction fees, etc), and allows you to easily generate suggested pricing using different at various profit margin rates.
Different Types of Pricing: Are Multi-Month Options “Better”?
It may be tempting to offer multi-month subscriptions – that is, for example, subscriptions that renew every 3, 6, or 12-months. Rather than being charged monthly, it offer subscribers the opportunity to prepay for a set of shipments. You may even consider offering slight discounts on these extended options.
So is this better?
The perks are clear:
- Automatically Increased Retention: You’ll automatically, but somewhat artificially, retain those customers.
- Increased Revenue… Sort of: By increasing the dollar amount you make at a sale now, you increase revenue of that given month (because you collect the following 2 month’s of payment in advance). If you offer a discount, remember that you’re actually getting less revenue from that customer if they would have organically stayed on for 3 months.
- More Options May Feel Better for Some: There’s also the argument that providing more options for your customers may increase the likelihood of customers making a purchase.
But there are also downsides:
- Customer Service Implication: What if a customer purchased a year subscription and decided it wasn’t for them 3 months in? What if they requested a refund? This reality, though it would likely represent a small number of people, does equate to hours your agents will spend either solving or explaining your policy.
- Lumpy Revenue (You Should Probably Save): Revisiting revenue, you’ll soon see that by staggering subscribers, your cash flow will become more lumpy, with different sets of subscribers rebilling at different times. For example, if you acquire 50 3-month subscribers in May, but only 5 in June, your August rebilling (from 50 3-month subscribers) will be significantly higher than your September rebilling (only five 3-month subscribers). Keep in mind: this only represents a problem if you do not accurately account for it in your cash planning. If you overspend, for example, that means you’ve likely used past income that will be needed to cover future costs. It’s not a good position to be in.
- More Options Aren’t Always Better: I’m not convinced more options are always better, and neither are all the researchers at Stanford. Though more options can lead to higher perceived quality, that is likely only most true for grocery and retail stores. In the case of a single business or single product type (the study looked at types of jams, for example), more options seemed to actually serve as a drag on buying behavior. While it may vary from business to business, multi-month may lead to unintended thought and calculation in the case of subscription boxes. That may increase the likelihood your customer’s won’t convert.
In the end, neither option is truly “better” than the other. If you find that you can lift overall retention of your customer base by offering multi-month options, while also not risking healthy cash flow and still seeing competitive conversion rates, then by all means multi-month is the better choice. If you find that retention naturally scales past multi-month options, or near it, and you prefer simpler cash planning, then the only having monthly recurring subscriptions may be wiser for you.
(Note: Offering multi-month options may be a great way to market gift subscriptions. Because these will likely represent a much smaller portion of sales, cash flow isn’t as significantly impacted. Likewise, these customers are probably more likely to be the type to cancel (or churn) more quickly that regular subscribers. Multi-month options in this case may be a great way to capture unrealized revenue from a unique type of customer.)
While diligently thinking through pricing can feel like a cumbersome task to tackle, it shouldn’t be ignored. Astutely pricing your product and service directly contributes to the success of your marketing, and to the happiness of your customers, which directly contributes to the success of your business.
If you’ve established a price, but feel something may be wrong with it, don’t hesitate to provide questionnaires or special offers to customers. Try to pry out details – which price points seem to resonate best with your audience? Which offers seem to perform well consistently? When you practice diligence in pricing, you set your business up with a foundation for a strong, sustainable stream of revenue.
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