This is the second in a series of four posts on establishing Product/Market fit. This post covers pricing. Other posts cover the Customer Development Process, managing customer demand, and surviving / bootstrapping. Subscribe to this blog to receive other such entrepreneurial growth tips.
Getting the right pricing, for the right customer group, at the right time, in the right channel(s) may seem like wizardry. Either overly complex or overly simplified a.k.a. best guesses. Fortunately, it doesn’t have to be either.
Like many of my previous posts, I strive to aggregate high-level frameworks and tactics to help start-up employees. Broken down into smaller pieces, pricing can be a fairly easy process.
Prior to beginning any pricing exercise, we must deeply understand the ideal customer profile and buyer personas. For a refresher, this previous post may be helpful.
Knowing who you’re pricing for, how they’re motivated, where they buy, etc. focuses the pricing exercise.
With that in mind, here are 5 steps to overcoming the challenge of pricing a product.
- Choose your positioning vector
- Remember the other 3 Ps
- Benchmark across competition, value, & cost
- Price higher
- Remove all friction to buying
1. Choose your positioning vector
According to “The Discipline of Market Leaders” by Treacy and Wiersema, the most successful companies deliver superior customer value by choosing to stand above their competition on one, not more, of these value disciplines: product leadership, customer intimacy, or operational excellence.
Product leadership: offering customers leading-edge products and services that consistently enhance the customer’s use or application of the product, thereby making rivals’ goods obsolete.
Customer intimacy: segmenting and targeting markets precisely and then tailoring offerings to match exactly the demands of those niches.
Operational excellence: providing customers with reliable products or services at competitive prices and delivered with minimal difficulty or inconvenience.
To be viewed as a leader in a particular field, a company must be at competitive parity on two of the vectors and superior at one. The image below illustrates where industry leaders are positioned across value propositions.
For early stage companies making such decisions early on drives the strategy of the company including the operating model, marketing, competitive positioning, support, product design, etc.
Tensions in achieving product / market fit are often blamed on pricing, sales, product, or marketing. However, they usually stem from broader strategy decisions about the company’s overall value proposition. Often start-ups try to have the best product and be the cheapest. Or they seek to service the customer better than anyone while also having the best product in the market. Both examples are exercises in futility. Consumers will be underwhelmed. Management will be frustrated. Company results will fall far short of expectations.
For startups building a long-lasting or high growth company, choose one vector to excel at and then build the executional plan accordingly.
2. Remember the other 3 Ps
In the eagerness to get a product to market, it’s not uncommon to focus mostly, if not exclusively, on price. But all 4 Ps of the marketing mix are crucial.
Products that solve a visceral need and directly appeal to a buyer persona command a higher premium and better loyalty.
Place, or distribution, is another key element to choose pricing and reach product market fit. Leaving room for margin through channel distributors is not only a cost consideration. Where a product is sold has as much to do with the future price. A luxury price at a discount retailer or website stifles sales and positioning.
Promotion also dictates how the pricing is built. If the marketing mix relies heavily on paid channels or sales people, there will be additional costs to build into the price. Conversely, unique marketing strategies with low to no budget channels may give price advantages vs. the competition. Consider what Zappos, Dollar Shave Club, or Atlassian did with little to no paid promotion.
Spend the extra few hours challenging yourself or your team to succinctly define the marketing mix. It makes the next few steps that much easier.
3. Benchmark Competition, Value & Cost
Once the company positioning and marketing mix are firmed up, it’s time to focus on the actual numbers that calculate the price(s) that build the business plan. Don’t worry, it doesn’t have to be as scientific, or complex, as an econometrician’s pricing differential curves (see graph below).
When evaluating a price, consumers will compare it against the competition or the value they receive. Based on which value proposition vector you’ve chosen, you should build pricing ranges accordingly.
If you’re positioned on the Operational Efficiency vector/ i.e. low cost provider, then the customer’s frame of reference is always done vs. the competition. Think Southwest and Geico. Pricing vs competition then becomes how much of a discount is required to motivate customers to adopt. Geico is affixed to 15% or more.
If you’re positioned on the Product Leadership or Customer Intimacy vectors, customers will primarily compare you for value, real or perceived. Think Tesla or Trunk Club. When compared to value, the pricing range becomes more about time saved, convenience, status, productivity gained, etc.
Once the value proposition’s frame of reference is complete, then account for your costs and build gross margin estimates based on the chosen value proposition vector. Between the costs and customer frame of reference, you’ll have determined an acceptable price range.
Starting from the customer’s point of view first may seem taxing. Which explains why too many start-ups price on a cost-plus basis or by competition. However, not knowing the true value proposition and its frame of references has several drawbacks. Delays in achieving customer density and frequently discounting the product to demonstrate adoption are just a few side effects of shortcuts in the pricing process.
4. Price higher
Start-ups interested in demonstrating product/ market fit tend to price low. They’ve uncovered a cost-advantage that allows easy market entry and they seek to maximize customer adoption by making price a “no-brainer”. The challenge is that without doing the previous exercises, the price is far too low to scale.
Assume that your company will be wildly successful and your pricing strategy moves from customer adoption to revenue growth and then to profit growth. Convincing your initial discount-focused customers to pay more is extremely challenging. Remember, freemium conversions are usually in the single digits.
Also as your business grows, bigger volume opportunities will arise. Larger customers deserve larger discounts. Wholesalers and resellers will bring droves of customers to your door, but will want 10-50% revenue share. Not building that margin in may mean losing money or walking away from marquee clients.
The take away is that it’s easier to start with a higher price and discount accordingly than the converse.
Some helpful tactics to accelerate customer adoption without diminishing product value include:
- Offering “free” upgraded features to a basic offering for a period of time
- Discounting product for a time period or certain segments
- Limiting access to the product or support team (hence increasing perceived value)
- Adding early premium adopters to customer steering committee, early release committees, etc.
- Referral bonuses greater than the direct Cost of Customer Acquisition. Organic referrals of premium customers are more valuable than direct CAC.
- Selling premium product first then releasing “cheaper” products over time. Think Apple or Tesla.
- Providing cashless gifts that are important to a customer segment like social media recognition, sneak peeks of customer facilities, featured case studies or white papers, etc.
In general, start high and come down low if needed. Have a higher degree of confidence in your value proposition and communicate it accordingly. Usually, the best long-term customers are willing to pay a bit more than your initial estimates.
Note: Future posts will cover how to grow into pricing post-product market fit . Price elasticity considerations and how to appropriately move pricing strategy from customer adoption to maximizing revenue and then profit. Subscribe to this blog to see more.
5. Remove all friction to buying
Making products easy to adopt, engage with, demonstrate utility, etc. all decrease price elasticity. If you find yourself struggling to increase conversions on your website or reach scale, chances are something in the positioning or marketing mix is broken. Like discussed in the Customer Development Process, use the pricing strategy framework above as a way to test and refine results.
At every stage of the customer journey (see images below), seek ways to remove friction. Make it simple for consumers to be aware of who you are and what you do. Make it simple for them to consider, test, and convert. Minor reductions in customer friction significantly reduce price sensitivity.
For example, being as close to the consideration point (“Place” in the 4ps of marketing) has massive implications on the price elasticity of a consumer and/or time to order. At an outdoor music festival, consider your own product substitution preferences for Coke vs. Pepsi when only one is sold there.
Well designed user experiences (UX) that make it easier to understand value first decrease friction for price sensitivity. This is a basic tenant of most B2C freemium models but can work well in an enterprise format as well. Yammer’s consumerization of enterprise tech is one such example. By providing a seamless way of collaborating with co-workers, Yammer successfully penetrated hundreds of large enterprises. Yammer salespeople then had qualified leads and product utility statistics to show a CIO or CFO. Justifying an upsell to premium packages was simplified. Again, minor tweaks to the UX, made customer adoption seamless and significantly reduced SG&A costs.
Done right, pricing innovative products can be quite simple. Recognizing what type of company you want to be and whom you’re serving make the numerical and tactical part of pricing straight forward. No more pricing crystal balls or complex demand curves needed.
Be sure to stay tuned for the next posts on Product/Market fit: managing customer demand and surviving / bootstrapping. Subscribe to this blog to receive other such entrepreneurial growth tips.
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