Startup Pricing Facts You Won't Learn in Business School
The subjects of startup pricing and monetization are complicated enough to make entrepreneurs lose sleep over it. Overthinking, questioning yourself and changing the enterprise pricing models several times because you’re not confident in the monetization model are usual attributes of being a first-time founder of a new small business.
At 2muchcoffee, we work with a lot of entrepreneurs on the matter of pricing their products. Taking into account growth goals, the scope of the industry and individual approach to each case we help our clients to create an efficient pricing strategy.
So, based on our practical experience we’d like briefly introduce you to the simple facts of startup pricing. It worked for our company and for startups we’ve worked with, so we hope that the content would be relevant to you, too.
Your Foundation is a Key
Costs. The foundation of any pricing effort is getting all of the baseline costs accounted for in your pricing. On top of the direct costs that you’ll spend to make your product, you must also integrate the indirect operating costs to keep the lights on for everything revolving around your product such as marketing budget, your office rent, employee salaries, etc.
Units Sold. Once you think through all of the costs that are needed to keep your production and business-at-large afloat, you need to indicate the units you are going to sell accurately. Note, that there are plenty of startup founders that expect that they’ll sell thousands of units in their first year and rely their pricing model on it. In reality, if you haven’t already sold this kind of volume and you’re starting from zero, make sure that your pricing doesn’t rely on scale for you to turn a profit and that it’s properly inflated.
Profit Margin. Once your base price is created, don’t forget to add a profit margin. Whether it’s 1% or 15%, add a little or a lot to create a fund that you can reinvest back into your startup’s growth.
Always Know Your Bottom. When you crunch your numbers above, remember to always be aware of what your bottom of your pricing is. Maybe this is your price without your profit margin, or with a lower profit margin than your standard margin, but know what this number is and memorize it. This should be the red flag that signifies that the company is losing money on the sale. If you know this number and religiously stay away from it, this is the minimum you have to do to have a pricing strategy that works in favor of your business.
Pricing Thermometer
In order to understand the problems people are facing during pricing and why startups get it wrong you should use the concept called the pricing thermometer. It is suggested that when you price something there are other factors that play a crucial role in the process like the cost and the value. And the relationship between these items affects how growth happens inside of your company.
Therefore, the gap between price and cost is your incentive to sell. And so the bigger that gap is, the more you are driven to push your product to your customer. The gap between price and value is an incentive to buy. And the larger that gap is, the easier it is to have your customers to want to sign up or use your product.
Now to figure out a price, there's really two ways to go about it. You either start with the cost (if you know what it is) and you figure out where your price is based on that. The other way to do it is to figure out what is the value of your company or product/service and then you figure out your price from that. Note, that value-based pricing allows you to charge a lot more and sort of manipulate the incentive to buy.
When people do not understand the relationships between costs and values or they don't know what are the other forces at play that drive price, there is a possibility that they will put their price in a kind of arbitrary place. And usually it will result in a few different types of mistakes. Take a look at these common mistakes, so you could avoid them while building your own startup pricing model:
Startups will price their products too low. It results in constant undercharging. You underestimate your costs, and the result is you have a problem where your margins aren't enough to cover the acquisition.
You don't understand your value. You don’t understand how your company thinks about the problem that you're solving for them or how they value it. And either they don't understand your value or you don't know how to convince them of the value that you think you offer. And as a result, you can't get the price that you want.
You focus on the wrong customers. It’s wrong to think that if you built a better product and charged half the competition means that you win. You, as a startup, work to create a new market and produce innovative products means that customers are not the mainstream people who are going to look at the price and make most of the determination based on that. But rather this is the sales and profit over a product’s life from inception to demise.
More infromation on the subject of pricing and pricing thermometer you can get from the lecture of YCombinator Partner Kevin Hale.
How to Think About Pricing
Once you’ve figured out a desired price and bottom for your products, decide on what pricing you want to put out there and test in the market. Also, take into consideration factors such as competitor pricing, your brand’s value, and target market when deciding on this number.
Testing your pricing and adjusting it according to the ever-elusive customer perception meter is incredibly important. Within the silos of your office, it’s really difficult to understand what pricing your customers will respond to. It is only by trying to sell your product at a specific price that you’ll receive the feedback you need to raise or lower your prices.
Once you’ve figured out a test price, go out and sell it. After selling a product at this price, you can use customer feedback throughout the experience as data points to guide whether to increase or decrease your pricing. If the majority of your customers did not try to negotiate with you on pricing and had an amazing experience with the product, it’s a reflection that you either set the pricing perfectly or that you could potentially raise your price.
Conclusion
Pricing is not all based on concrete math or itemized inputs, which makes it difficult for a startup to navigate how to price a new product. We mentioned the basic fundamentals that every first-time founder should know about startup pricing procedure. Note, that price is directly depended on the cost and the value of your product and startup in general.
We hope that you will find this article useful in your future career endeavours. In case you still have any questions or suggestions feel free to contact us and we gladly assist you in any inquiries.