Pricing Questions
Pricing questions assess business model understanding. Pricing determines market segment, quality perception, business viability, and competitive positioning.
Pricing Framework
Analysis Steps
| Step | Questions |
|---|---|
| Understand product and context | Problem solved, target customers, competitive landscape |
| Identify value | Customer value, current alternatives, willingness to pay |
| Consider costs | Delivery costs, unit economics, margin requirements |
| Choose pricing model | One-time vs. subscription, per-user vs. per-usage |
| Set price | Based on value, costs, and positioning |
| Plan iteration | Testing approach, success indicators |
Pricing Models
Freemium
Free basic tier, paid premium tier.
| Condition | Requirement |
|---|---|
| Works when | Strong viral/network effects |
| Free users provide value (content, data, referrals) | |
| Clear upgrade path exists | |
| Low marginal cost per user |
Examples: Spotify, Dropbox, Slack, LinkedIn
Risk: Free users cost money. Low conversion and high marginal costs cause losses.
Subscription
Recurring payment for access.
| Condition | Requirement |
|---|---|
| Works when | Ongoing value delivery |
| High retention achievable | |
| Predictable revenue important | |
| Users prefer lower upfront cost |
Examples: Netflix, Salesforce, Adobe Creative Cloud
Key metric: LTV = ARPU × Average Lifespan
Usage-Based
Pay for consumption.
| Condition | Requirement |
|---|---|
| Works when | Usage varies significantly between customers |
| Value correlates with usage | |
| Customers can predict/control usage | |
| Enterprise customers want to start small |
Examples: AWS, Twilio, Stripe
Trade-off: Less predictable revenue. Good for adoption, harder to forecast.
One-Time Purchase
Single payment for permanent access.
| Condition | Requirement |
|---|---|
| Works when | Product doesn't require ongoing updates |
| Low ongoing costs | |
| Customers prefer ownership | |
| Market expects this model |
Examples: Most mobile apps, traditional software
Challenge: No recurring revenue. Growth requires constant new customers.
Transaction Fee
Percentage of processed transactions.
| Condition | Requirement |
|---|---|
| Works when | Facilitating transactions between parties |
| Transactions are trackable | |
| Value ties to transaction volume |
Examples: Airbnb (host fee + guest fee), Uber, Etsy, Stripe
Typical range: 1-30% depending on industry and value added.
Worked Example: Driverless Car Service Pricing
Question: How would you price Google's driverless car service?
Product Understanding
Autonomous taxi service. Competes with Uber/Lyft and car ownership.
Value Identification
Passenger value:
- Convenience of not driving
- Potential cost savings vs. car ownership
- Productive time during commute
Current alternatives:
| Alternative | Cost |
|---|---|
| Uber/Lyft | ~$2-3/mile |
| Car ownership | ~$0.50/mile (all-in) |
| Taxis | ~$3-4/mile |
Price ceiling: Uber/Lyft pricing. Price floor: delivery cost.
Cost Analysis
| Component | Estimate |
|---|---|
| Vehicle depreciation | $0.10/mile |
| Maintenance | $0.05/mile |
| Energy (electric) | $0.03/mile |
| Insurance/liability | $0.10/mile |
| Remote monitoring/support | $0.02/mile |
| Total | ~$0.30/mile |
Driver cost advantage over Uber: ~$0.70/mile (Uber drivers retain ~70% of fare).
Pricing Model
Per-ride pricing (matches user expectations). Subscription option for frequent users.
Price Setting
| Strategy | Price | Rationale |
|---|---|---|
| Premium positioning | $2/mile | Match Uber, maximize margin |
| Penetration pricing | $1.50/mile | Undercut for share |
| Value pricing | $1/mile | Make car ownership feel expensive |
Recommendation: $1.50/mile (30% below Uber).
- Signals value while maintaining quality perception
- Provides ~75% gross margins
- Drives adoption without price war
- Allows promotional flexibility
Subscription addition: $100/month for 10% discount on rides (captures frequent users, increases predictability).
Testing Plan
- Launch in one city at proposed price
- A/B test $1.25 vs. $1.50 vs. $1.75 in different zones
- Monitor: rides per user, conversion from Uber, value perception feedback
- Adjust based on demand elasticity
Pricing Changes
Price Reduction Analysis
Question: AWS considers 20% price cut across all services. Should they proceed?
Reasons to cut:
- Competitive pressure (Azure, Google Cloud gaining share)
- Demand elasticity (lower price drives volume)
- Cost reductions passed to customers
- Strategic prevention of customer evaluation of alternatives
Risks:
- Revenue decline if volume doesn't compensate
- Price cuts are difficult to reverse
- May trigger price war
- May signal weakness
Analysis:
Current: 100 units at $100 = $10,000 revenue
After 20% cut: Need 125 units to maintain revenue (25% volume increase required).
Question: Is AWS demand that elastic? Existing customers are locked in (low elasticity). New customers may switch from competitors (higher elasticity).
Recommendation: Selective approach rather than blanket cut:
- Selective cuts on commoditized services losing share
- Volume discounts for large customer retention
- New customer promotions (first year 30% off)
- No cuts on differentiated services with strong position
This maintains existing customer revenue while competing for new business.
Price Increase Considerations
| Factor | Guidance |
|---|---|
| When to raise | Pricing power exists, currently underpricing, costs increased, significant value added |
| How to raise | Grandfather existing customers, add features to justify, offer annual lock-in at old rate, communicate value |
Netflix example: Multiple price increases while maintaining growth through simultaneous value increase (more content, better quality).
ROI and Business Case
LTV vs. CAC Framework
| Metric | Calculation |
|---|---|
| LTV (Lifetime Value) | ARPU × Gross Margin × Average Customer Lifespan |
| CAC (Customer Acquisition Cost) | Total Sales & Marketing Cost ÷ New Customers |
Rule: LTV should be at least 3x CAC for healthy business economics.
Acquisition Evaluation Example
Question: Startup wants $50M. They have 100K users paying $10/month. Should we acquire?
Value calculation:
- Revenue: 100K × $10 × 12 = $12M/year
- Gross margin assumption: 70% = $8.4M gross profit
- Churn: 5%/month = ~20 month average lifespan
- LTV per customer: $10 × 0.7 × 20 = $140
- Total customer value: 100K × $140 = $14M
$14M total value < $50M asking price (before acquisition costs, integration costs, risk).
Conclusion: $50M too high unless:
- Significant growth potential unlockable
- Strategic synergies (their technology + your distribution)
- Competitive denial value
Fair value range: $20-25M.
Practice Questions
New Product Pricing
- Tesla autopilot subscription pricing
- New Microsoft productivity app pricing
- Drone delivery service pricing
Pricing Changes
- Netflix $2/month price increase analysis
- Spotify cheaper tier with ads pricing
- Response to competitor 30% price cut
ROI/Business Case
- Apple fitness app acquisition valuation (5M users)
- Uber flying cars investment ($100M) business case
- Feature ROI: $500K cost, expected 2% conversion increase