Pricing is a topic that can make or break any company at any level, however, it is not talked about enough. The reason for that is, pricing is seen as an art rather than science, this might be true but there are available data points that the ultimate decision can rely on.
According to a survey done by Simon Kucher (which is done on 1,650 companies across major industries in over 30 countries);
The two main goals of the setting a price are;
The graph above explains the economic surplus which many executives are familiar with. The ultimate goal is to find that sweet spot, the equilibrium point that would maximize the company’s profits by having a low enough price to convince customers however the highest price to convince the customers to make more money in the meantime. Easier said than done.
Before going into how to do that, we need to look at what is being done in most companies now;
Every company starts with a problem and build a product to solve the problem and when the product is ready, build a Go-to-Market Strategy and grow. In this scheme, pricing is just a minor step in the go-to-market strategy. This is broken because this does not include the customer in the process.
“People get caught up behind the computer screen trying to figure pricing out, or doing a ton of benchmarking and research. Instead, they should be having conversations. All the answers are in your customers’ heads. Founders must get out of their boxes — computer screen, office, city block — and meet with customers. The best I’ve seen do 3–5 daily customer meetings.”
Building the right pricing strategy begins by changing the pricing’s position within the company and its product strategy.
We illustrate the process as linear to paint the picture clearer, however, all 5 are dynamic and could be considered as a continuous circular flow.
Pricing should be considered and talked with the customer even before the product started to be built. This is counterintuitive but if you think it through as; we found a problem that people/companies are facing and we are going to build a product to solve that problem and in the end sell it to those people/companies for $X. Finding a problem to solve is the first step, but validating a viable business opportunity and figuring out the pricing is the second.
“Porsche knew it was taking a tremendous risk by building an SUV, veering from its traditional wheelhouse of sports cars. So the company focused on benefits customers were willing to pay for. The result was a car perfectly designed around features customers wanted, like larger cup holders, at a price they were willing to pay. All the items customers weren’t willing to pay for, like Porsche’s famous six-speed racing transmission, were thrown out, even if their engineers loved them.”
You might be saying, “OK, we understand the need to talk with the customer before building the actual product. But what are we going to say/ask them?” During the interview with the customer, pitch them the problem, the proposed product and also how this product will solve their problem and then ask these 3 questions;
Patrick Campbell (Price Intelligently’s Co-founder and CEO) explains that the results should be interpreted as, “acceptable price” being the lowest price you should consider, otherwise, people may question the quality of the product/service, “expensive price” being the actual price you should use for your pricing and “way too expensive price” being the highest price you can put on the product but would decrease the conversion rate significantly.
Tyler Gaffney believes that 5–10 customer interviews are enough to be a base point for your pricing. Tyler also emphasizes the importance of defining the go-to-market strategy before deciding the pricing, because this also helps with maximizing the effect of customer interviews.
While setting pricing for your product and service you need to provide tiers for different customer segments to select and directed to their specific needs. However, Madhavan Ramanujam says to keep the number of tiers low; “Fewer is more. Start with 3–4 segments, then expand gradually until you reach the optimal number.”
Sheena Iyengar from Columbia University and Mark Lepper from Stanford University conducted research with shoppers. When shoppers presented with six jam flavors, 30% of tasters made a purchase. When 24 options were on the table, only 3% opted to buy.
Rafi Mohammed, Ph.D. (Founder of Pricing for Profit) suggests that 3 tiers should be available, Good, Better and Best. “I strongly advise against setting a Good price that’s more than 25% below Better, and I recommend that the Best price should not exceed Better by more than 50%.”
Tyler Gaffney explains that setting prices in stone and not in motion is the #2 mistake of founders.
“Founders pick what should be a pricing starting point, but stick to it as if it’s a permanent solution, even though their businesses are growing and changing. Eventually, that approach breaks down.”
In their book; Monetizing Innovation: How Smart Companies Design the Product Around the Price authors Madhavan Ramanujam and Georg Tacke mentions that “Sometimes the best product innovation is the monetization model itself.” The best example for that would be Michelin’s pricing strategy in the early 2000s;
“Michelin’s new monetization model allowed the firm to fully capitalize on its new invention — that is, to monetize a tire that lasted much longer than the previous generation did.
Setting price by distance traveled delivered benefits to both Michelin and its trucking customers…Michelin took on the customer’s cost of product problems; if a tire fails early, Michelin bears the risk. On the flip side, when tires exceed quality expectations — say, when they last 20 percent longer than before — Michelin generates 20 percent more revenue per tire.
Michelin simply changed its monetization model. It was a brilliant move. Michelin soon boasted the biggest profits in the industry; by 2011, its earnings before interest and taxes were 25 percent higher than Bridgestone’s and more than three times Goodyear’s.”
Delivering the pricing to the customer is also a sensitive topic, especially for B2B companies. Price Intelligently’s CEO Patrick Campbell says that;
“Early on, many startups don’t want to show prices — and that’s okay. Most don’t really know what they should charge, so they prefer to get intel by asking inbound customers some pricing questions. However, when you reach a point where you either want a touchless sale, then you need to show your pricing. If it’s not a clear number, such as in Wistia’s case, give a range. It doesn’t mean your pricing is negotiable — just that it varies depending on the customer. On the Price Intelligently pricing page, we give direction, not a figure. We’ll use a range, such as $20–30K, or a starting point, such as ‘packages begin at 45K.’ That allows people to self-filter and qualify themselves so no one’s time is wasted and opens a conversation to finalize the price.”
However in the early days while discussing pricing with a lead, which also can be treated as a customer interview, deliver the price in person or over the phone to keep the feedback loop open says Tyler Gaffney. He adds;
“Never deliver pricing over email. When I hear a founder complain about a prospect who went dark, I ask how the price was delivered. I’d say nine out of then startups have initial conversations and demos over the phone, but when it comes to price, they deliver it over email. That’s mistake.”
Further Reading Material: