Recently our team was brainstorming on how to create a business model for for our website DoesAnyone
These are discussions I believe that most start-up co-founders keep having, and the strategies they choose have a long-term effect on the future of the company. In fact the fate of the company’s future lies in successful execution of these strategies.
A common mistake made by first-time entrepreneurs is “cost based pricing” to decide the price by estimating the costs incurred and adding a margin to ensure profitability. Although this sounds reasonable, there are quite a few issues with this approach.
Problems with a cost-based pricing
Hidden costs: People generally under-estimate hidden cost of running a business. This could be in the form of unplanned travel costs, power cuts or employees who are not up to the mark. Basically anything that is not in your control and you didn’t plan for.
Customer retention: Cricket pitches in the sub-continent have a low bounce, where as those in Australia have a higher bounce. So, Australian batsman can adjust to Indian pitches, but sub-continent batsmen find it very difficult to adjust the bounce on Australian pitches.
Similarly, once your customers are used to a low price, it becomes very difficult to retain them after an increase in the price (especially in a price sensitive market like India). If the price increase is too high, they generally stop using the service or start looking for alternatives. So its always better to start from a higher price, and then decrease it until you find your sweet-spot instead of starting small and then trying to increase it.
True Potential: If your product/service is enchanting to (the right) customers will be willing to pay higher based on what it means to them. For example – An iPhone is not just a smartphone, it is a status symbol. The customer here is paying not only for the facilities provided by a phone, but the bragging rights that come along with it. For being a proud owner of an Apple product.
In the world of start-ups, it makes sense to put the extra effort to find and reach out to the right kind of customers who have a higher perceived value of your product (even if they are small in number), than to price it lower and expect to recover the costs by selling a higher volume.
Value based pricing
To arrive at a price for your product, it is essential to think from the customer’s point of view. Talk to a few prospective customers (from various demographics and affluence) and try to answer these.
What is the worth of your solution for a customer?
This helps in determining the Return on Investment from the customer’s point of view, and hence its perceived value. So, you need to understand what your customers are gaining from using your product in a quantifiable manner.
If you are a B2B product, this means having a clear understanding of your customer’s business model.
If you are a B2C product, this means knowing your users in and out. What is the exact difference your product adds to a users life?
Sometimes it may not be possible to quantify this in terms of money. In such cases look for other quantifiable metrics like time or satisfaction.
I recommend the book “Crossing the Chasm” to understand how to create use-cases for your product based on what matters to them.
What are the alternative solutions they use as of today and how much do it cost them?
One assumption first time entrepreneurs tend to make is that if their product is completely unique, then there is no competition. This is a grave mistake.
For example: Say, you just invented the washing machine. It would be a completely new concept in the market of cloth cleaning, but when it comes to adoption, your pricing will be (subconsciously) compared to the cost and availability of a housemaid.
Again, it helps to put on your customer’s shoes and live like them. I’d recommend the book “Selling the Wheel” to learn more about this.
What is missing in these solutions that your solution provides? – differentiating qualities
If you can pin point how your solution is better than the ones already available, this gives you an estimate of how much more it is worth for the customer. This also gives you an insight into market segmentation. You need to target the segment of people who have an urgent need for your differentiating qualities.
What is the effort involved? The cost of switching –
If the customer is already using a solution for his problem, how much effort in terms of time and money would it take to switch to yours.
Once you estimate the perceived value and compute the cost incurred, you’ll have an idea of your margin and if it is worth to make this solution at all.
Hope these suggestions help you in your pricing strategy.
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