A founder called me recently, upset about how a “small” detail had upended an important client deal. After extensive discussions and a long sales cycle, she sent in her proposal outlining the terms and price range already agreed to.
Instead of the signed contract she expected, she got a call back asking for bigger discounts, more freebies. Her proposal had inadvertently prompted the client to find loopholes in how she had priced her product packages. They had no qualms using her own terms against her. She had to agree to more discounts to save the deal.
She’s not the only founder who gets blindsided by this lurking danger: pricing is the X factor that gets the least attention but has enormous influence on your revenue, growth and even fundraising prospects.
What Makes Pricing Hard
In talking with dozens of founders, I’ve found four big drivers for pricing missteps:
The Fear of the Ask
As a founder, it’s natural to struggle with asking a customer to pay what your product is truly worth. Maybe you don’t truly understand the value you’re giving your customer, and are anchored to your production cost instead of to value. More often, it’s because you know the value but are terrified of putting a number that might scare the customer away. When it’s taken months to even get to the negotiating table, it’s hard to do anything that might risk losing the deal.
Baseless Assumptions
Founders often default to setting prices the way everyone else in the industry does – it’s easy and it’s proven. How you charge must make sense to your customers, but sometimes it can pay off handsomely to “think different” with your pricing.
For example, airplane engines had been sold for decades on a unit basis. Customers paid for the engines and entered into separate maintenance contracts for their upkeep. Then Pratt & Whitney came along and completely disrupted the market with their “Power By The Hour” (TM) program, based on price-per-mile-flown basis, to great success.
The Poker Factor
Pricing is to strategy what poker is to games – winning requires a delicate blend of math and psychology. On the math side, you must cover costs and make enough profit to thrive and grow (and make investors happy). On the other, customers, even business buyers, can be irrational and demanding creatures, and behave in ways that aren’t logical. Your price must walk this tightrope between math and psychology, not to mention the competition. Not easy.
The Knowledge Gap
There’s also a practical barrier: good pricing know-how is often hidden in the minds of industry veterans and pricing experts, who you may not know or be able to afford. Pricing models can get complex quickly, so it’s easier to just default to the lowest common denominator for your product.
The Keys to the Pricing Kingdom
There’s the story of a consultant who, when asked for a quote, replied: “Well, there’s a three day answer and a three month answer. What’s your budget?”. The answer to the pricing question is likewise elastic, depending on the resources you have. But even at the earliest stages, there are keys you can use to unlock the power of pricing:
Category Selection: Position Your Product for Success
Many founders miss the fact that the category they choose for their solution is completely in their control and is a major driver of pricing. Say your startup has developed a groundbreaking technology to decarbonize chemical manufacturing. You could sell this in three different product categories:
- Equipment: Sell the technology as standalone equipment, allowing manufacturers to integrate it into their factories, for a one-time purchase.
- Service: Offer the technology as a managed service, charging for implementation, maintenance, and process optimization for your clients – essentially offering decarbonization as a service. You could charge a flat subscription fee, a usage based fee, or a flat fee plus usage combinations
- Outputs: You could also sell the outputs of your process, for example, sustainable raw materials. Depending on which market you’re selling to, you could justify very different price points and plans.
Category selection and pricing are intimately interconnected.
Framing: Or The Gentle Art of Mind Bending
If you’ve ever bought a computer, you’ve probably experienced price framing. Apple, for example, is the master at getting you to buy more expensive models simply by featuring an extremely high priced “decoy” model alongside two lower priced, but still highly priced versions. Works like a charm, and I’ve fallen for it more than once!
Similarly, framing a more expensive option relative to the base price will increase the number of people selecting it, versus just stating it as a flat price. For example, “For just $x more, you can have…”.
Just showing fake discounts from an inflated price can increase sales, and…you get the picture. There’s no end to the ways in which framing can impact customers’ price receptivity!
Become well-versed in the most common psychological pricing techniques and see the cash flow in!
Pricing Design: The Architecture of Value
Costco has become a huge hit for its rock-bottom prices. Yet it makes a killing on the annual fee members pay before they ever buy a single product. The magic is in pricing design: how it breaks up the money you pay to shop there.
As a founder, you have control over three big building blocks of how your customers pay for your product:
- Pricing unit – for example, are they buying pieces of equipment or the hours of service it provides?
- Pricing structure – what are the puzzle pieces that make up your price? For example, cars are priced on a “base model plus options” structure.
- Price mechanism – the method for determining how much your customer pays. For example, Priceline upended the travel market by bringing high art pricing (auctions) to low-ticket airline tickets and hotel stays.
Steps to Smart Pricing
Regardless of where you are in your go-to-market journey, there’s always money left on the table to tap with pricing. Here are four practical steps to get you started:
Understand Value
Before you think about numbers, take a step back and understand what your customers care most about. It’s said that insurers sell policies and customers buy peace of mind. You may sell equipment maintenance, but customers buy uninterrupted service. What is the one thing that’s foremost on your customers’ minds when buying? What is that worth to them?
Explore the Category-Price Relationship
Brainstorm at least two possible categories that could work for your solution. How would it change who you sell to? What do the categories imply for pricing? If you can guesstimate sales and revenue for these options, you’ll get immediate insights about which way to go. For example, you may realize that while your offering-as-a-service has greater long term revenue, selling your technology as equipment can ease immediate cash flow pressures, and reduce the need for external funding.
Develop New Frames
Flip through any basic book on pricing psychology and identify at least three possible frames for your specific product. For example
- Bundling – combining different products / features into packages
- Relative pricing – “get the upgrade for only $x more”
- Disassembling cost – “less than the price of a cup of coffee per day”
Extra credit if you keep a running list of pricing tactics and strategies to test.
Practice High Watermark Pricing
Regardless of anything else, there’s one simple step that’s almost guaranteed to up your revenue: high watermark pricing. Take whatever method of pricing you’ve chosen for now, and quote the highest number you can say without either fainting from fear or bursting out in laughter. You’d be surprised how often customers will say yes without a blink.
I remember the instructive story a terrific healthcare founder told me recently. When her first customer calmly accepted what she thought was an outrageous price, she quickly added “per quarter” to her original annual quote. Quadrupled her revenue in 10 seconds!
Now it’s your turn: Where do you see the biggest upside in your pricing? What step can you take to test its potential?
#financialstorytelling #pricing #financialmodeling #businessmodel
