Pricing may determine startup’s success or failure
Let’s not begin this article with startup pricing.
Let’s talk about a general product that you usually buy from a market – A product priced for $1 v/s the same product priced for 99 cents. What do you think you would buy? Well, you may say that it’s obvious for everyone to buy the product marked with 99 cents.
But still, most of you would probably hand over $1 to the seller without bothering much to collect a cent from him. What it means is the customer’s perception of pricing is extremely important which cannot be ignored by businesses.
The above example conveys an important message:
Pricing can be a deciding factor for a business’s success, given all other factors remain the same.
Quite often, startups commit a big mistake of considering pricing as a math challenge. Though the truth is – it’s a psychological challenge to be solved. Before knowing why pricing is important for a startup’s success, it’s important to know what pricing truly is.
Mathematically, pricing = production cost + your margin
This calculated price undergoes a few modifications based on what is offered by the competitors.
But this mathematical definition has failed to convey the true meaning of product pricing. Many startups that begin quite well, fall flat in the middle of their startup journey just because they do not understand the pricing from the customer’s viewpoint.
When you offer customers your product with a certain price tag, their mind does not see the product but the value that they are going to get using your product. And this value which is delivered to customers decides the value that you as a company or a startup capture. Creating more value than the one captured should be the goal of a startup while deciding the price of its offering.
As can be seen in the image above, your product price should be somewhere between the cost of producing your product and the perceived value for the customers. You as a business will capture value by pricing your product above the cost (price minus cost is your profit). Customer captures value when he perceives to get the benefits (or ability of the offering to solve pains) from your offered product more than what he has to pay (perceived value minus price is the customer’s value).
Startups make a big mistake of running after a product-market fit while not taking the pricing too seriously. Most of them start with some pricing model without any strategy and think to adjust it after arriving at the product-market fit. But the point to be emphasized here is that product-market fit becomes meaningless if you fail to capture the value for your business. We have already explained the role of pricing in capturing value.
From the above discussion on the importance of pricing, the following conclusions can be drawn:
- Price explains your customer’s surplus
As already explained, the price should be lower than the value of the product that your customer perceives. Perceived value includes both, the tangible gains that the customer gets by using your product as well as the intangible gains like enhanced experience, increased social status, feeling of being safe, etc.
The customers’ actual profit (or surplus) is the difference between the benefits that they receive using your product or service and the price that they pay (price paid by the customers is the cost for them) for your product.
Here the customers’ profit not only points to the monetary gains that they receive as in a B2B business but also the non-monetary benefits for which consumers pay money as in a B2C segment.
Every customer wishes to increase his profit. Therefore they cannot ignore the offer in which their benefit far exceeds the price they have to pay. Hence pricing, along with the perceived value, plays a significant role in arriving at such an offer.
- Price determines cost
This may sound awkward but the truth is that the customers pay for the product based on the value they expect to receive. So the only way to earn profit from your business is to let your consumers decide the price for the offered value. Once the price is determined, the cost should be worked out. Yes, it’s true that the parameters that determine the cost of the product like minimum quantity to be produced, material, production process, etc. need to be optimized to land on the cost already worked out.
- Price influences customers’ expectations
It conveys information to customers. For example, a high priced item increases customer’s expectations while the one tagged with a low price creates a cheap image about the product in the mind of the consumer. Sometimes, the consumer expects a higher price for the product, and the same product, if offered at a considerably low price, may force them to suspect the offer and they may lose interest.
How about getting a brand new 5 star rated Daikin air conditioner of capacity 2 tons for $200? Some might rush to the dealer while others will suspect the reason for such a tempting offer. Eventually, the brand may lose value.
This is true even for the startups that have no close competitors in the market for customers to compare their price with. I experienced the same thing in my 1st startup when I offered my product (a clean cookstove that reduced the fuel expenditure of commercial kitchens by 85%) to the commercial kitchens for free.
Most of the prospects, whom I interviewed, were hesitant to take the product for free even though they could see their savings. Our revenue model was based on supplying the fuel (along with free stove) at a price that included our profit margin. Thus price plays an important role in influencing customers to an extent.
To Wrap Up
Pricing is undoubtedly one of the most important aspects of any business. If you take the pricing as an afterthought, you may fail to extract the true value for your business.
Do you feel there is something more to be included? Kindly write to us. We will be more than happy to consider your valuable suggestions.