Pricing Strategy 101: How Low Can You Go?
You’ve seen it, and it probably boggles your mind. How do web hosts do it? How do they charge such a low monthly rate and survive? The answer: they don’t.
The web hosts that survive with low prices are most likely the ones who are established and have been doing business long enough that they can afford to charge lower prices. The simple explanation for this is volume. Companies doing a high volume business can afford to charge a lower price for web hosting because their costs are effectively lower for each new account. But to figure the exact numbers out, you’d have to do the math and take many other factors into consideration.
Startups, on the other hand, have a higher cost to get into the business and a higher investment into a marketing strategy to acquire its first few customers. These operating costs would prove it challenging to jump into the market with extremely low prices and slim profit margins. Unless you have the financial resources to cover your costs of operation while being satisfied with making very little profit, you really have to do a lot of calculating before coming up with your pricing structure.
Don’t Be a Copycat
As a web host startup, the biggest mistake you can make is copying the pricing scheme of a competing web host who is charging a ridiculously low price for their web hosting plans. This is not an effective strategy because the most important thing about figuring out what to charge your customers is how much it will cost you to deliver that service. Simply copying your competitor does not take into account your costs of operation.
You must also remember that the company you are basing your own prices on might not even be your competitor. It is too easy to find another web host and compare your prices with them, but do an extensive search and all of a sudden prices seem to be pegged all over the map. It is a gruesome task to come up with a market rate for web hosting because the costs of operation vary between one web host and another.
Many web hosts entering the business are under the false assumption that charging low prices will instantly generate a boom of customers. While low prices do attract potential customers, price is not the single factor to be considered. There is also the argument of “you get what you pay for” and many consumers have this philosophy in mind. Just because you charge a low price, it doesn’t mean customers will jump on the bandwagon and host their web site with you. Their perception of the quality of service they expect for the price they pay comes to mind, so instead of copying low prices, give customers a reason why they should pay what you charge them.
It’s About the Margins
Now that we’ve agreed on not charging low prices just because other web hosts are, how do you go about creating a price structure that ensures your profitability, while being competitive enough that customers aren’t scared away?
The first step is taking out your calculator, or working with your spreadsheet program, and making a few calculations. Identify all of your costs. Costs are everything you spend money on to run your web hosting business including your reseller plan or dedicated server, what you pay employees or contractors, software leases and so forth. These are your fixed expenses – expenses that remain at the same cost every month you do business and does not vary based on your sales. Do not forget to include your own salary!
Once you have all of your costs factored in all of your costs, determine how many customers you intend to provide your service to factoring the resources you have available, and determine how long it will take you to reach that number of customers.
Once you have your target number of customers and your total cost of operation, divide the total cost with the number of customers to arrive at your total cost per customer.
(A variation of this is to calculate number of accounts, considering the fact that one customer may set up multiple accounts or web sites.)
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Visit the URL above and download a neat Excel file where you can plug in figures to help determine your costs and profits. Source: http://www.inndev.net
Now that you have your total cost per customer, or total cost per account, you must factor variable costs including merchant account or payment processor fees, commissions paid to affiliates or sales representatives, discounts and so forth. Variable costs are directly related to sales and vary as your sales increase or decrease each month.
Don’t Forget the Profits
The figure you are looking at right now, if you have factored all fixed and variable expenses, is your breakeven cost. If you included your salary, you will get paid, but now it is time to factor in another figure: profit. Essentially, profit is the amount of money your company makes in excess of the costs it incurs to deliver your web hosting service. It is important because it will drive your company’s growth.
After you have determined your fixed and variable expenses, add a percentage to it as your profit margin. This figure will vary and will rely on a comparison based on market prices for comparable hosting plans. This is one point of your pricing strategy where you will have to carefully identify direct competitors and compare your hosting plans with theirs. After you have factored in a profit percentage (say 5% or 10%) above your cost of providing the service, how do you prices look in comparison?
Low Cost vs. High Cost
Now that you have arrived at a raw figure with all costs and profit factored in, you must explore the psychological aspects of pricing. Charging too low, while it may stimulate sales, means that you will be earning less profit or making less per account so you need to achieve a higher volume of sales in order to achieve your desired sales level. Charging a higher price means that you will make a healthier profit per account with less volume.
Let us say your sales goal, hypothetically speaking, is $10,000 per month. With all factors considered, if you are selling a hosting plan at $5 per month, you would need to sell 2,000 accounts in order to achieve that goal. Now, if you sold the same plan for $20 per month, you would only need to sell 500 accounts.
Of course, the example above is a drastic one but is not far from reality. Depending on your hosting plans and what you offer, you could charge as low or as high as you want, but keep in mind that it is the market for web hosting services that will determine the demand for your service plan, so pricing your plans extremely high may deter the majority of informed purchasers, and this is not a wise thing to do.
What About Perception?
The way you price your hosting service plans play a part in the perception of your service by prospective customers. If your prices are too low, some prospects may think your service is too good to be true, or there might be a catch, or a sacrifice in terms of the quality of your service. If your price is too high, you simply won’t get any sales.
Keep in mind that customers still have the notion of “you get what you pay for” and price does play a big factor in their decision making. So not only should you be concerned about how well you have priced your services in comparison with competitors, but how your service offerings justify the customer’s perception of your services as being worth what you’re asking for.
How do you do this?
The pricing should realistically reflect what is being offered with each plan, as well as the perceived brand experience the customer should expect when they purchase from your company instead of your competitors. A sloppy web site from a web host charging ridiculously high prices is unjustifiable, but a neatly designed web site from a company that communicates itself as an established host (who is capable of delivering exceptional service) with the same prices would be justifiable.
It really is a matter of finding that certain pricing point where your prices are comparable to the market price. Once you have a price figure defined, work on the other aspects of your business that will enforce that price on your prospective customer’s decision making process. Do you offer unique services not offered by your competitors? Do you provide 24/7 customer service and technical support while your competitors do not? Do you have a customer satisfaction guarantee to ease the customer’s purchase decision?
As you can see, after coming up with the magical price figure, there are so many other considerations that help make the price concrete, and once you factor those into pricing your services, customers visiting your web site and seeing the information you present or “pitch” to them will be able to discern between a quality web host providing a quality service, and a web host scrambling to grab clients from competitors by charging cheap prices.
Is That All There Is?
There are a lot of factors that should be taken into consideration when choosing your pricing strategy, and if after reading this article you still decide to charge cheap, best of luck to you. For web hosts who realize that price is only one factor and are confident enough to demand a reasonable price while securing a healthy profit margin, you will be rewarded with a healthy cash flow and you’ll definitely have a better chance of surviving in the long run.
Copyright © 2004 Johnder Perez