When introducing products into the market, entrepreneurs think of a lot of things – what is the right product, how to test it, who is the customer, what is my sales cycle and so on.
The one thing entrepreneurs usually do not think about is what is the right price.
This is understandable since founders, especially deeply technical founders, are most comfortable with identifying and solving difficult problems. They are least familiar with pricing. Pricing in such cases becomes an after thought. The underlying belief is that once the product is ready and deployed with the first set of customers, then a price point can be talked about. Besides, one can always start low and then raise the price so why bother with this headache now?
This is potentially a dangerous trap. One of the strongest levers which have a direct impact on the value of the company is pricing.
Even a 20% increase in price can dramatically move the needle on margins and convert a ho-hum business into an attractive one.
And when the company is an innovator and first mover in a new industry or segment, going in too low can have the effect of significantly reducing the total available market for itself as well as for any other company that might enter the market down the road. In other words, mis-pricing can have the impact of driving profitability out of a new industry segment.
What we are discussing here is primarily written with B2B companies in mind though some aspects would be relevant for B2C companies as well. In an existing market, competitive products can provide a good guideline for pricing. For category creating companies, however, this is a more challenging task.
Which of the following activities would provide the best indicative price in a new market:
a) Focus groups
b) Online pricing survey
c) Asking initial pilot customers
d) Starting free and then gradually raising price
Answer: None of the above.
With no comparable price points to benchmark, customer responses in focus groups and pricing surveys can be wildly off the mark. Pilot customers can provide a wide range of prices depending on their initial experience, and their price expectations will usually be low as an early adopter working with a pre-production version. Starting free, instead of resulting in a smoother adoption, can backfire. A customer who does not have enough skin in the game might not invest the required resources in learning and trying out the product. Free can also lock you in a low price band for an extended period of time.
Even when there are no direct competitors, the customer is substituting a set of tasks with the new product and in the process reaping a better/faster/cheaper benefit.
Looking at ‘before and after’ scenarios are helpful in identifying the value creation in the customer deployments.
If the product is underpriced, your business will be forced to under-invest in sales, which can lead to a vicious cycle of stagnant sales that impede further investment in the business resulting in further erosion in sales. If the SaaS product requires an enterprise sales force, the pricing has to be sufficiently high to reflect the higher costs of a dedicated sales force - direct or channel sales - and a longer sales cycle.
Simply put a higher life-time value (LTV) provides the ability to profitably sustain a higher customer acquisition cost (CAC).
Finding the right price range might be the single most impactful thing you can do to increase the value of your business. It is well worth sweating over it.