Thoughts in Time

I believe that fundamentally, the startup process is, as Steve Blank would say, “the search for a profitable business model.” You start with a vision of a product to solve a problem. You try to validate hypothesis about the problem, your product, the market, the competition, etc. You also try to learn what the right price is. If your price is wrong you could be quite a ways from finding a PROFITABLE business model .

On a day when Spirit Airlines announced that it will now charge a carry on bag fee, and having experienced the death by a thousand cuts fees of Euro airlines like Ryan Air, I thought that it might be fun to share some of my thoughts on product pricing.

Steve shares a great way of doing this in “The Four Steps to Epiphany.” When he’s with a potential customer, he’ll ask them to imagine that the product is FREE and to talk about how they would use it. Then, he’ll share that, in fact, it’s not free. It costs $1MM. He says that this generates a strong reaction that often leads to great information about pricing. For instance, someone might say, “Steve, you’re crazy. I would use that for $250k, but $1MM is just too much.” Now, your startup might not be selling enterprise software with a yearly licensing rate in the hundreds of thousands, but this model of revealing pricing is quite powerful. Here’s why:

1. Imagining how someone would use a product that has no cost frees them to explore how it could create value without worrying about downside. This will reveal to you where they see benefits. You can ask probing questions about why they would use it in certain ways and what those benefits would be. This reveals the business value, and will help confirm some of your product / benefit market hypotheses.

2. Asking them how they would use it if it was VERY EXPENSIVE helps quantify the pain of the problems that they’ve just imagined solving. If they’ve just imagined all these wonderful ways to use your product, but aren’t willing to pay anything, those wonderful ways are frivolous and not important. You might want to reexamine if there is actually any pain there.

3. This questioning sequence / mechanism will lead to beta customers who are willing to pay more. There’s a powerful psychological force underpinning this. You’ve given something to them through the visioning process and are taking it away, so you have set this up as a loss from a set point. They will be more willing to pay to keep what they had envisioned than if you did this the other way around….

Popular wisdom is that it is much easier to cut the price than it is to increase it. This might be true of a product in the market, but when trying to figure out your pricing, you want to do the opposite. It will give you powerful insight into the value you are creating for customers.

AIRLINE PRICING vs. Startup Pricing
Barry Schwartz was a professor of mine when I was completing the UPenn Master in Applied Positive Psychology degree program. Barry wrote The Paradox of Choice, and is a popular speaker. One thing that Barry points out is that bundled pricing is inherently preferred by consumers, even if they pay more. This is because there is pain each time we pay out…and we remember that pain! Our remembered experience is much worse. So when you buy a cheap Spirit Air ticket and subsequently pay for checked bags, credit card fee, airport check-in fee, carry on bag fee, bathroom fee, and in flight oxygen fee (ok - I doubt they’ll get there) you remember each of those charges and when asked about your experience you are going to give a much more negative review than had you actually paid slightly more, but paid only once.

Most startups don’t have this issue. Why? Because they don’t have a smorgasbord of product features available. The freemium model could devolve into this as a company grows, but most companies who have been successful with a freemium model seem to have done so by keeping the pricing plans simple (no more than 3 paid options). Since too many choices can paralyze users into inaction (due to something called anticipatory regret) less options are better in general.

So, as a startup, what are some other things that you want to take into consideration with your pricing strategy.

1. Keep it simple - Don’t make your pricing one other thing to understand about the business before a customer will buy.
2. Base it on the pain your are reducing for customers - what is their ROI? - If they’re saving huge amounts, you want to capture some of this economic value, and customers will be willing to pay.
3. More choice = more indecision - Even if you keep it simple, having too many choices will lead to decision paralysis. Keep it simple…and short.
4. Understand the alternatives… including “do nothing”
- Starting to use your product has costs - even if it’s free. It’s the cost of not doing what they were doing before. Make sure you understand the hard and soft costs of abandoning the status quo…or using a substitute.

More in depth pricing strategy - what does google do?
If you want to go further, I would encourage you to also think strategically about what your pricing will enable. Is it a core part of your business strategy? If you’re trying to enter an existing market with a low cost product, then PRICING IS YOUR BUSINESS. This is akin to finding a market where you can make $1 where previous incumbents had to make $100. Jingle networks is a classic case study.

With Higher One, we had two pricing decisions. One was an upstream one. We had to decide how much we would charge universities for our service. Since revenue would also derive from downstream pricing (how much we would charge for banking and payments services), we ultimately decided to set a very low cost for universities, leading to an extremely high return on investment for them when they adopted our service. Although it was still a slow sales cycle, this pricing gave us a large advantage versus software solution based firms who had to earn off of the software package and didn’t have the downstream revenue generator. It enabled the business to create a very defensible business model. There is a great article that speaks about this concept and how it applies to google’s current pricing strategy with their various business efforts. I would encourage you to read it here. (thanks to @GusFuldner for tweeting this)