Pricing is an issue that haunts the marketing departments at the biggest of corporations. High tehcnology startups usually have enough critical issues to deal without adding subtle implications of pricing to the mix. Ultimately product or service pricing is one of those things that can effectively make or break the future of a startup. One of the most dangerous things about pricing is it kind of tends to sneak up on you. Bootstrapped software startups cannot afford professional marketing executives or teams, and usually asking a typical hacker or software geek what price they should charge for their peice of code would evoke the following response….
Kernel Panic – System Failure: Memory access violation, system rebooting…….
For the uninitiated joel spolsky’s article on pricing Camels and rubber duckies will serve as a good intro to the complexities of pricing(btw joel is a genius not because of any ground breaking material but because of his ability to explain something as complex as pricing to a 6 year old retarded dog (exaaaaaaaageration)).
This article will be much more focused on highlighting the nature, importance and perils of pricing in the context of a Hitech startup. Here the importance of right pricing for a startup cannot be emphasized enough, an improper pricing is one of the surest ways to you nailing your own coffin shut. The delicate art of getting the price right is complicated even more by the feedback effect pricing has on your venture. Pricing is affected by and effects many other variables like costs, sales, product and company placement, growth….. and the list goes on and on. But these things are for another day and another article, lets put them at the back of our heads for now(on the program stack for now in geek lingo). If the title is at all suggestive what follows ought to make some of you curl up and cry for mommy(i’ll try my best to scare the s**t out of you).
Pricing in a virgin niche market
Two things that are common to most high technology startups is a niche and a virgin market. These are attractive to startups because of the non competitive environment in which a bootstrapped startup has more room to breathe and develop without worrying about getting muscled out by a better funded competitor. Price wars are not advisable for burgeoning startup and hence the adage: niche thyself. Often times a niche also ends up being a virgin market. In other words people who are supposed to buy your product or service are….
- Not aware of it.
- Don’t know how beneficial it is.
- Don’t know how reliable it is.
Guess your marketing team has its work cut out for it. Let us not even get into the nightmares of product creation and management and promotion those deserve their own long articles once again. So getting to the pricing assuming that the product has already been built we start to see the difficulties. You see pricing in a virgin market is not like pricing in an established market. That’s because in an established market the pricing and price positioning is usually driven by established forces of demand and supply. For example if a company called “Beauty and yeast” is making a brand new anti dandruff shampoo, it has the luxury of observing the current market for…
- Segments (Rich, Middle class, poor people)
- Demographics(children, teens, oldies)
- Trends(conditioner based shampoos, natural shampoos)……………..
and then placing their product with a competitive pricing for their niche. But in case of a startup trying to establish itself in a virgin market the equation becomes lopsided. You have the supply side of the equation but are also tasked to create the demand side of the equation. So there is no established price range in the market, there are no segments in the market, infact there is no market until you create one. Scratching your head yet, well we are just scratching the surface. So how the hell do you decide if your ‘laser emitting robot dog’ must cost 450 bucks or 4500 bucks? I can hear some smart alec in the back whispering “Well we’ll just build the damn thing and if it costs 3000 per unit we’ll sell it at 4000 per unit, its that simple heheheheheh how smart am I.” To the smarty(all others ignore) Hey dumbass it doesn’t matter how much it cost you to build it, it only matters at what price people are willing to buy it for. So if parents think a robot dog is too costly for a kid at 600bucks what’s the point of you building one for 3000 bucks let alone selling it for 4000. So i ask you again how much should the ‘laser emitting robot dog with a gps receiver’ cost? Take a guess, i dare ya…
The Pricing Game
If you haven’t heard of it this is a game startups and their customers play. Startups hate it and their customers stay up all night unable to contain their excitement and giggling at the prospect of tormenting the poor little guys from ‘HackersInc’. Its a game of chicken except the fact that the customer can never loose and the startup can loose bigtime(read ‘go out of business’) irrespective of whether they made the sale to the customer or not. Let’s take a look at the contestants shall we…
The Startup: These guys are desperate to make a sale, they are eager to bag their first customer. They have the look of the little kid who wants the candy so bad he can taste it. Making a profitable sale to them is much more important than great margin(good profit) from the sale. They usually think “If it cost us X to build the unit lets charge X+Y, where Y is really low so that we don’t risk loosing the customer. Anyway even then we’ll be making a profit cause the suckers don’t know it only cost us X to build the unit.”
The Customer: These are guys who get their kicks by getting poor kids jump through hoops for them and then not giving them the candy you promised. They want the product cheaper than a bowl of wood shavings. They know the startup guys need them more than they need the startup guys. Even if they need the product badly not even god can spy the fact beyond their poker faces. They are in control and they know it.
Scenario 1: This is scenario one of how the pricing discussions might progress….
Startup: We want to charge you 12000 for the product.(even though it only took 4000 to build)
Customer: 12000!!! with a look signifying you’ve uttered the most ridiculous price in the universe(they are ready to buy at 10000). Ok we’ll get back to you.
Customer: we cannot buy it for 12000 sorry.
Startup: (reduces the price drastically to less than 10000 and are happy)
Scenario 2: This is scenario two of how the pricing discussions might progress….
Startup: We want to charge you 6000 for the product.(even though it only took 4000 to build)
Customer: 6000!!! with a look signifying you’ve uttered the most ridiculous price in the universe(they are ready to buy at 10000). Ok we’ll get back to you.
Customer: we cannot buy it for 6000 sorry.
Startup: (reduces the price drastically to less than 6000 and are happy)
So the moral of the story is u’ll get screwed either way.
The Sales Cycle:
You might be wondering why the sales cycle showed up in an article about pricing. Well it came up so that i can show one of the many ways in which improper pricing can kill you. The sales cycle is the repetitive process of making a sale from the instance a Lead is generated to the moment the customer buys the product. When you are a startup in a virgin market you have no idea what your sales cycle is going to be(though u hope its going to be a short one). Things are made all the more complicated because of the fact that you are a startup and have no track record or credibility. So once again the customer makes you jumps through all kinds of hoops before he decides to ditch you after you are 3 months into your sales cycle. So initially you have no estimate of your sales cycle but have to come up with the right pricing. It’s this pricing in a vacuum that results in a lot of headaches for the startup.
Pricing is the .50 caliber rifle pointed at your foot :
Ok so you built your product and even managed to make your first sale so you think you can just relax and let the barrels of money roll in. Well let me save you the suspense they wont come rolling in, “So what” you say “l’ll make more sales, after all this is a software product and its produced once and can be sold a million times eliminating the per unit production cost“. Well not so fast mr. Big shot unless you are selling activeX controls over the internet you still have an active burn rate. Burn rate is the rate of your capital expenditure, in other words it’s the money you’ll have to spend every month on those people called employees, on that space called an office and any other expenditure that goes with running a company. So your liquid capital or cash in the bank is always being used to pay for expenses and these expenses as your sales grow and the resources for support and maintenance need to grow as well. This is the perfect setup to make a pricing blunder.
Misaligned Sales cycle and pricing:
A bootstrapped company by its very essence means more often than not its walking on the tight rope between success and bankruptcy. It is often low on liquid cash and lives in a day to day manner. When you add a pricing blunder to this volatile situation I’m guessing it wont be a pretty picture. Let us for example imagine a startup ‘PricingBlundersInc’ starts out with a liquid capital of about 10,000 bucks. The company had a burn rate of 150 bucks per month. It estimated a sales cycle for their product ‘Badly priced product’ of about 2 months. And hence it priced its product at 400 bucks. But as it turned out their sales cycle turned out to be 3 months. So they end up spending 450 bucks while they can only earn 400 bucks in 3 months. Guess you can see where ‘PricingBlundersInc’ is going huh! Straight into the gutter all it needs is for 1 or 2 sales to get botched and that’ll hasten its inevitable doom. It can be clearly seen in the plot of the liquid capital of this company across a period of 2 years.
Well Aligned Sales Cycle and Pricing:
Unlike at ‘PricingBlundersInc’ the people at a similar startup ‘GreyMatterInc’ were wary of their sales cycle as it was never before tested and had no precedent so they made a conservative estimate of 2 months too. But they decided that 2 months might be a wrong estimate and that their pricing must accommodate for errors in the sales cycle estimate to some extent so they increased the initial pricing estimate for their product from 400 to 460 a very conservative 15% increase. This startup started out with 10,000 bucks of liquid capital and a burn rate of 150. And as it turned out their fears about their sales cycle turned out to be true and their sales cycle stabilized at 3 months. So what do you think happened to them? Well you have the data, Calculate! Turns out that increase of 15% saved their skin. Checkout their capital reserves across a 2 year period.
It has to be understood that all the issues that were raised here were grossly over simplified and was designed to demonstrate the perils of improper pricing decisions. Anyway entire libraries can be filled with stuff about pricing but i guess this should be enough for now. Btw i have fixed the rss2 feed on the blog so subscribe to eat from the link at the header. And for pete’s sake leave some comments, if i don’t see any comments after i learned to use the charting tool in excel, i’ll just beat myself silly.
PS: gr8 Scott adams article. i did not want to waste another blog entry for this link. http://dilbertblog.typepad.com/the_dilbert_blog/2006/10/in_over_my_head.html