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TODAY’S STORY
13 Jun
,
2022

Pricing tells a story.

When starting out a new venture, how does one determine the pricing? The mistake amateur entrepreneurs often make is they treat pricing like something that is slapped on the product with an attitude of “Let’s set an arbitrary price based on the market and iterate based on customer feedback.”

Conventional advice (mostly wrong) even tells you to keep your user interviews and customer development interviews centred around their pain points and not talk about price, as price can divert the discussion from behavioural insights to budgets and price comparisons.

But I vehemently disagree with this notion that treats price as some second-class citizen. I think it is as important as any other feature to determine product-market fit. A customer might not buy a product at $10 but they will easily buy it at $100. Yes, that happens, and you will find it easy to believe once you understand how deeply connected price is to product perception.

“The moment you make a mistake in pricing, you're eating into your reputation or your profits.”

— Katharine Paine

The thing that most novices do not often grok is that price is inextricably linked to your brand, perception, product decisions and purchasing decisions — the whom, why, how, what, and when. Price is not about maximizing some simple unit economic calculations on the balance sheet, slapped post-facto onto the product and tweaked only for the sake of optimising numbers. Rather, it fundamentally determines the nature of the product and the structure of the business that produces it.

Pricing spells out product and distribution strategy.

In the 1960s, Morris Chang, then-VP of Texas Instruments, discovered that every semiconductor manufacturing run had a learning period at the start, where they struggled to get yields up for each new process.

Because there was so much capital involved in producing a new process, the prevailing view at the time was to charge a high price for the chips from the start. Chang felt it was silly. He engaged a group of BCG experts and instructed them to look into volume pricing for the chips. They eventually devised a strategy known as 'learning curve pricing,' in which TI would first price the chips low, gaining a large portion of the market and driving volumes to maximum capacity, allowing Chang and TI to expand their business.

Chang is quoted saying,

“We would automatically reduce, and then continually automatically reduce the price every quarter even when the market did not demand it. This was a very successful effort, even though it was somewhat controversial. A lot of people thought we were being foolish. Why would you reduce the price when you didn’t have to? But we did it because we believed in it, and indeed our market share just kept expanding. That, combined with other strategies, made the TI integrated circuits business the biggest IC business in the world, and also the most profitable.”

Pricing tells a story.

$0/month means your goal is to maximise distribution and growth. Your product probably benefits from network effects or has certain natural tripwires to trigger in-app purchases (Freemium). You will probably require venture funding because you will have no income initially. If you're successful, you will need operators and engineers who are good at building products at scale. It also means your product needs time for its value to be evident.

$1/month means your product does something simple: so simple that it doesn't need customer service or tech support. It shouldn't, because at this price point, you can't afford it. In terms of perception, customers will probably think your product is for satisficing basic requirements and will mostly attract individual creators and freelancers. It probably won't be the right fit for using organisation-wide for deep work. You won't be able to spend much on marketing either, so most of your sales will need to come from word-of-mouth.

$10-$100/month means you're a cheap version of a high-end product. Customer expectations will still be high as your product will still be bought mostly by individuals and SMEs, and not large organisations. You will need a small team doing customer support.

$1000/month means only medium to large companies will buy it. Intra-company incentive structures will take centre stage. These companies will have complex buying and approval processes around budgets, demos, and RoI calculations. And the people making purchase decisions will have their own incentives to take care of. You will face long sales cycles. Selling a subscription at this price point will mean you will need a real sales force, sales collateral, impressive logos of other businesses on your collateral, case studies, and referenceable customers. You will need to get on calls and book demo meetings with clients. Inbound marketing won't do.

$10,000-$100,000/month means large companies only. At this price point, it is likely that your tech product will have strong switching costs and consequently, large learning curves that need in-house support. You will have a long sales and onboarding cycle and once a customer is onboarded, you will be able to retain them for at least a few years if not a few decades — unless something goes horribly wrong. Also, all the points mentioned in the $1000/month category will apply.

Additionally, how you slice your pricing matters.

$/seat means every user gets value.
$/team means the value is for teams, not for users.
$/transaction or usage-based pricing means your product delivers value at every transaction.

It's a way of conveying exactly 'who' the value is for and 'where' the value is.

Pricing is useful friction.

Your product's friction needs to align with your business and distribution model's friction.

A low-friction product that's easy to use and accomplish tasks on should have a low-friction model. Examples include all social media networks, Gmail, freemium tools, etc. If you price these products highly and create a high-friction model with high barriers for entry, you'll lose out to competition who are free/more affordable, plus you will be hampering your own product's distribution and growth. Imagine what would have happened if Facebook or Whatsapp had started as paid platforms.

A high-friction product that has a long sales cycle with lengthy onboarding needs a high-friction model. If you have a complex product that serves expert needs and takes time to learn and implement organisation-wide, users won't probably be convinced to buy your product and simply purchase it from your landing page. If you price this product cheaply and use a low-friction model, big organisations by default will think your product is not for them.

Successful low-ARPU products tend to be low-friction (like social media apps), and successful high-ARPU products tend to be high-friction (like enterprise B2B SaaS).

Parting thoughts

Pricing will determines your first impressions as well as how many prospects you convert. It has a huge impact across the marketing funnel, from top to bottom. Treat it as a second-class citizen and disconnected from every other brand and product decision at your own peril.

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