One of the classic issues that I see consistently confront new entrepreneurs is something I like to call price trepidation. Essentially, it usually means someone has either a product that is altogether relatively new to the market, or they have competition in the market in which they’re looking to gain some market share. A mistake, I’m not saying it always happens, but I see it often enough, is that the entrepreneur believes that the way to assure client traction is to price their product ultra-competitively. In other words, too low.
Intuitively, that makes sense, right? My old boss in New York used to say “treat stocks like socks” (haha, cheesy I know) but his point was to buy low. Who wants to buy a stock when it’s overpriced? He was essentially imploring us to take emotion out of the equation and treat blue chips like you would a simple durable good that you use every day. And it makes sense for socks, right? If you happen to be shopping for socks, and you spot the very same socks you usually buy for half-price, I mean, you would be pretty foolish not to purchase them, right? And I’ve seen entrepreneurs on all sides of the dice employ this ideologue in order to build a fast user-base.
The problem is that your company isn’t a giant warehouse of overstock (well, it could be!), especially in its initial stages. And further, your socks probably aren’t front-and-center in front of the consumer. And usually the entrepreneur isn’t employing the same rationale as the department store in this case. In this case, a start-up usually has some bottom line that they need to meet, whether it be a path to profitability, or a path to another capital round. In most cases, there has been significant capital, or at least sweat equity injected into the company, and now you’re at the point where the product is complete enough to sell. So where do you price it? It’s the magical question, and the one where I often see the “price trepidation” take hold, and the new entrepreneur wants to discount in order to get the client. It’s usually too early for that. The sweet spot, of course, is the highest price you can charge and still get the customer to buy in a timely manner. It can’t be too high, right, or you look ridiculous. But you also don’t want to set a precedent of pricing too low and having to adjust later. “You never get a second chance to make a first impression” and that literally holds true with pricing, too.
The way I generally suggest to my clients to do this is to NOT think in terms of your company, but think in terms of your client. This might sound like it makes sense, but it’s really common for me to see the opposite. Here, I’ll make up a simple scenario: An entrepreneur thinks, “OK, we built this product, it took us nine months and five hundred thousand dollars. Our ongoing costs are going to be 450K per year. The sellable market is three million people, and we surmise that we can within 24 months capture .1% of the market with our SaaS model, so if we price it at $19.99 per month, within two years that’s $720,000 annually. We will erase all losses within three years. That’s pretty good!”
OK, I know that was ridiculously simple, almost to the point of being impossible, but let’s go with it for a second. Provided they follow through with their numbers, it all seems plausible, but wait, have we even talked about who they’re selling to? Who are the three million sellable market? Is it an average consumer? Is it an attorney? Does it seem logical that a piece of software might be worth more to one or the other? My advice to clients is to think in terms of their client first and again, price accordingly within the confines of the market and how good your product is relative to other options, get it visible in the same vein as the others, and then gauge sales. In this case, if the entrepreneur finds that the appetite is strong around $29.99, that’s a tremendous gain in price.
One of my recent clients was approached by Orbitz for a piece of software development in order to better analyze SEO. Initially, he did the exact thing as the mock entrepreneur above. He calculated his time, his employee time, length of time to develop the project, and wanted to quote them 50% above cost. One might sit there and say that’s a nice revenue hit that didn’t exist before, a quick development build, and worth the credibility to their company. All true, but I implored him to consider the value to Orbitz. He was building SEO software for a 900MM company on a contract basis. A consumer buys airline and hotel tickets on Orbitz exclusively online, and much of that had to start with search. Basically, he was going to improve a key component of their success. We looked at his quote again, and all of a sudden, it appeared embarrassingly low. So low, in fact, that he now worried that it exposed him for what he was: a skilled two-man development shop. We concluded that he could make all the same arguments in his pitch and justify a quote DOUBLE what he was currently asking. And we did. And he got it.