Thoughts in Time

Since a startup is fundamentally the search for a profitable business model, it is important for the founders to consider a different type of testing for their business. Traditionally, a company will build a product prototype, then alpha, then beta, then V1. At each stage, there are forms of product testing that take place.

At a high level, the goals in product testing are:
1) Does the product work as spec’d (BUGS)
2) Is the user able to use the product to accomplish what it is designed to do (Usability)
3) Does the product provide the user value that can be exchanged for economic value in some way. Would they pay or would an ancillary party pay (Value)

These are important things to test for, and a product that is buggy, not usable, and doesn’t provide the value a user expects, or create value that is could be monetized is destined to FAIL. I learned this the hard way with Pikum as the product was deficient on all three levels.

While product testing and iteration is important, another sort of testing is even more important and should be done at the earliest stage of development. Problem and opportunity testing.

Every startup starts with a premise about the need for their product as envisioned. This can be framed as pain, or as opportunity. For instance, Higher One’s initial hypothesis was that “colleges and universities want to provide financial services to their students through their ID card, but can’t do this as well as if they hired an outside provider.”

Most startup’s premises are INCORRECT. This is because generally you are making assumptions about the market, sales and distribution channels, etc with less than perfect knowledge. As Dick Cheney might put it : “You know the known knowns, but you don’t know the unknown unknowns.”

Therefore it is important for startups to develop and adopt a methodology for testing the problem. How can you do this without your product? Simple, go speak to potential customers. Get introductions to people who are potential buyers, influencers, or experts in the market you want to enter (or if you are creating a market - from places where the market will emerge from). As a founding team, institutionalize methods for capturing known unknowns, new unknowns, and strategies for answering them.

In short:
1. Write down your problem / opportunity assumption and known unknowns
2. Seek out people who can help you test this assumption
3. Create a framework to use with those discussions (so you get the knowledge you need)
4. Iterate your problem as you learn more.
5. Repeat

Here is an example of how this worked with Higher One.
1. We started with our assumption that the problem for schools was that although they wanted to, they couldn’t easily provide sophisticated financial service products to students through the ID. This was in our first executive summary.

2. We got introduced to 3 local university CFO’s and setup time to speak to them about our ideas.

3. We prepped for the meetings by focusing on what questions to ask to confirm our hypothesis and to uncover where there might be other problems relating to our general area of interest (students + financial services offered through schools).

4. We learned that while our problem was valid, there was not a huge amount of pain or incentive for the CFO’s to look for a product here. However, we uncovered that colleges and universities often had to make payments to students and that making these payments was expensive, difficult, and not easily solved by traditional payment products. We iterated our problem - which impacted our product design, but less than one might expect. The important part was that this was the MUST HAVE in our product. We had to develop a payment solution.

5. We sought out further CFO’s to validate that our revised problem hypothesis was correct. This lead us to some of our first customers.

Recently, there has been much debate about “Fat vs. Lean” startups. This debate appears to center around two points. One, how much capital is necessary (Capital Intensity) - defining lean as using little money, versus fat as lots of money. The other point is how capital is utilized (Capital Efficiency). I think this is much more important. Lean startups are capital efficient. So a company like fellow South African entrepreneur Elon Musk’s SpaceX is Capital Intensive, but it could be Capital Efficient if it is accomplishing business building in the most efficient manner possible.

A great way to be lean is to incorporate problem testing into the mesh of the company. If you are quickly uncovering whether your problem hypothesis is correct, or iterating it to be more acute, you will be able to be efficient with your resources (including capital, sweat equity, etc), and will give yourself a much great chance of success.

To that end, I’m currently engaged in this process with my new startup (If you’re a senior HR executive or consultant involved with hiring, please contact me at sean (At) p2institute (dot) com. I’ve spoken to tens of people involved with HR and hiring. My problem hypothesis has been iterating, and I believe this problem testing has already saved time, money, and effort that would have been wasted had I not taken on this process.

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)