Sunday 16 June 2019

Startups! Don't sell yourself short - make sure price is right from the start

In his latest instalment, the voxgig founder says some classic price-point principles apply and there are key lessons to learn

Stock image
Stock image

Richard Rodger

Last week we launched our website, Reaction so far has been enthusiastic, although we have not done any publicity. We have decided to do a soft launch after all. Being live changes everything and is a big step forward.

A startup lives and dies on forward progress, and if things stall, then you can really lose the psychological energy that keeps the team productive.

Opening your shop front, whether that be a website, or a traditional retail space is a little like buying a fixer-upper home. Visitors are genuinely impressed by the improvements you've made, but all you can see is the ever-lengthening snag list.

I look at our website at the moment and I can see a hundred features we're missing, and I know how to trigger all the bugs and make it crash.

But this is normal, and this is the plan. We went live early knowing this would be the case, exactly so that we could get early feedback and make things even better.

There is a grave danger with this strategy, and it has bitten many a first-time entrepreneur, myself included.

Because you see all the flaws, you miss the business value that you are providing, and you set your prices too low. Everybody makes this mistake. You might be reading this right now and thinking, "Well, of course I won't, now that I know about it!" Well, you will. I don't think there's a cure, but perhaps you won't take quite as long as I did to cop yourself on when it comes to pricing.

In my very first startup, which I launched in 2003, I sold enterprise data-processing software components. Yes, it really was that boring. The dotcom crash was still in everybody's minds, and I wanted to sell something sensible that was actually needed.

Bearing in mind that my customers were big companies with large IT budgets, can you guess how I priced my first product? You could buy an unlimited licence for $50.

My first sale was made before I launched the website, through a business contact. After I quoted that price, $50, my contact said, "oh, I though it would be more like $5,000…".

You would think that the lesson was clear. You would think that I would have immediately changed the model. Nope. I decided to stick with the $50 price point.

I can't tell you why. I never wrote down my reasoning for that decision. I've since learned that it is very important to capture your thinking - it accelerates learning because you can easily compare cause and effect. It's part of the reason why I write this diary.

In that first startup, I did eventually raise my prices. I created a very complex series of pricing tiers, culminating in a price point of $3.000 for the full works. I also had a "reasonable" price option of about $200 that covered most of what people needed. What did my sales look like? What did people buy?

They bought a lot of the $200 option, and they bought some of the $3,000 option, and almost none of the $50 option. Why? It's like wine in a supermarket. You never buy the cheap plonk. But you only buy the really nice stuff for special occasions. Mostly you buy the reasonably priced stuff.

OK, that is a vast oversimplification. But here's the key lesson. For special occasions you are price insensitive. You know you need to buy something expensive to get all the 'features', so the price does not really matter if you can afford it.

It works the same way with corporate customers. Some of them will just buy the most expensive option because they want the full package with full customer support. They may even be required to do that as a matter of policy. Smaller organisations on the other handle will choose the reasonable option.

Here's the other thing to realise about this pricing structure: most of your profit will come from the smaller number of premium sales.

That's because delivery of a software product has the wonderful quality of having zero marginal cost. If you sell apples, you still have to buy them wholesale.

The marginal cost of selling another apple is the wholesale price you paid for it. But software is just ones and zeros, completely ephemeral, and it costs you nothing to sell another licence.

Well almost nothing, but cloud hosting costs are small enough not to really matter on a per customer basis.

So what pricing model are we going to use for voxgig? What lessons are we going to apply? Unfortunately, history does not repeat itself, it merely rhymes. Every new product and customer base is different in its own way.

Since we are an online service, and a key metric is users, we have to have a free account option. The trick is to get free users to convert into paying users. This is the so-called 'freemium' model, used by many online services. If you use Dropbox, you'll be familiar with it.

We will not use a complex pricing structure. It's worth taking a little time to think about why you might end up with one. It has to do with something called 'consumer surplus'.

All customers are different. Some will happily pay more for the same product. The classic example is grocery vouchers. Why do supermarkets use vouchers? If you are a wealthy stockbroker, you will not be bothered to cut vouchers out of the newspaper to save money on milk.

But if you are a pensioner on a fixed income, and with time on your hands, then it makes economic sense. As a business, you don't want to lose sales to pensioners, as you can still make a small profit, so you use vouchers to lower the price for them, and still charge a higher price to stockbrokers. Your overall profits are higher.

If you take this idea too far, you end up with complex pricing schemes that try to eke out every drop of profit from each type of customer. Unfortunately this causes many customers not to buy from you in the first place, because they can't decide what to buy.

There's a balance point where your pricing options mean there's an affordable option for everyone, and you don't lose too much profit undercharging people with big wallets.

In the software-as-a-service world, where we live, the general consensus is that you should have five tiers. These are:

a) Free: this tier let's people try out the system and builds your user basis;

b) Entry level: this is for small businesses, startups, and individual budget holders, and needs to be quite low;

c) Professional level: this is your main price point, for serious businesses with multiple users;

d) Enterprise level: this is the 'works', and is much higher than the professional level as it assumes price insensitivity; and

e) Bespoke: this is the real high-end, where the client is a large company with a unique problem that needs to be solved at any price.

There are variations, but this is considered 'normal'. In a startup you are supposed to innovate, but not across the board. In fact, you should choose just one thing to innovate on: technology, or business model, or user experience, or even pricing.

One area of innovation is all you can manage. It is tempting to try to innovate in lots of areas, simply because you have the freedom to do so, but that's just a lack of focus.

So we won't innovate on price. We'll follow the norms here. We haven't decided on numbers yet - we need to talk to many more potential customers first. We will go with charging on a per-user, per-month basis. This again is fairly normal.

On a practical level, we won't be charging for anything yet. Our next step is to build out a very simple initial feature set and validate interest with a free version.

It still 'costs' people time (and thus, money) to register and user a free service, so that will be an important measure of how much need we are addressing in the market.

n Newsletter: 1.047 subscribers. Yes that is only five more than last week. We decided to focus all our efforts on the launch, so newsletter promotion took a hit. Such is startup life!

Richard Rodger is the founder of voxgig. He is a former co-founder of Nearform, a technology consultancy firm based in Waterford.

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