The Difficult Task of Startup Pricing

“…especially in the early days of your startup when you are less likely to reject work, when it’s done and dusted, and you assess your invested hours, more often or not you will find you have been underpaid. It is always hard to walk away from a job, but sometimes it is the necessary thing to do to maintain your a) business and b) soul.”

– Stephen Moore, Startup Pricing: It’s Not Always Right

Charging more can earn you less, underpricing can leave your company undervalued… The laws of nature seem to go haywire when we talk about pricing.

An exploration of why we tend to underprice by Stephen Moore, Co-Founder of Roots Furniture, triggered a discussion on how to best approach startup pricing. Did the Startups Live community pin down this slippery fish? Wade into the fast moving current with us to find out…

“I have a funny story about startup pricing,” Wil Schroter began the talk. “In 1994, when I was getting started building my web design firm, I was 19 and I had no idea how pricing worked. I was a theatre student, not a business student. I would literally walk from storefront to storefront on the main street of campus and ask the business owners if I could build them a web site. I had no idea how this all worked. In that time, I think my effective rate was 9 cents per hour.”

“I was so enamored with getting paid to do this that I had no idea what a market rate was. I went into a restaurant one day and the manager said that they didn’t have a budget to build a website (mind you it was 1994 and we were literally explaining to people what the Internet was). We agreed that in exchange for building their website we would get a credit for $500 worth of ribs.”

“At least you didn’t go hungry …?” Steph Newton asked.

“You would think that’s totally lame. But when you’re a 19-year-old college student, getting $500 worth of food is like hitting the lottery.”

“I learned later that pricing is such a fine art that every few people understand.”

“I wouldn’t mind 500$ worth of ribs now,” Pierre Accari admitted.

“Retailers learned this so long ago – overprice everything and then discount,” said Wil.

“We priced too low initially,” Nick Neo acknowledged. “Feedback from our customers has helped us refine the model.”

No one refuted that pricing is tricky, or that many lack know-how. So where do you turn for answers when you’re uncertain?

Pierre said, “I am working on a product and asking potential customers about the price. The range is wide and each customer has its own interests in mind.”

“Don’t people have to keep their eyes on the kind of profit they want to make as a core consideration?” Dr. Deborah Hecker asked.

“It’s not whether they are pricing for profit, it’s whether they are winning the business, which tends to be the challenge,” answered Wil.

“I’m not sure how many folks here are in professional services but there is a fairly routine way you can price products and then work backward. After many requests for more details, he explained, “So basically it works like this. Pricing isn’t a single price that you offer as a take-it-or-leave it. The best way to price is to break the price into smaller pieces.”

“Starbucks style, you mean?” Imran Siddiq looked for clarification.

“Yes. You need to make pricing a conversation about options, not a game of poker.” Wil continued with his line of thinking, “A good way to think about it is this:”

1. Set a benchmark for your startup pricing ‘We normally charge $10,000 for this work’

2. Offer options for how to get a lower price than the benchmark. ‘We can do less work and save $$’

3. Explain what drives the price most significantly (no one ever thinks to do this, yet it’s what you’re really saying) so that the customer understands why/how the price goes up.

“Don’t think of pricing as a fixed bid instrument. That’s such a miss.”

The author of today’s conversation-starting article, Stephen Moore, was able to join in, and Steph asked him, “Do you have any personal experience over/underpricing that you’d like to elaborate on?”

“It took us a long time. Some jobs we worked on, ended up paying us peanuts, because we were scared to go higher. Now we itemize everything (we build furniture / shop fitting) and we are quiet honest with what wages we take. We’re still much cheaper per hour than an established company, but feel this is fair as we are learning. You have to be careful – underpricing can undersell the quality of your work and not always work in your favor.”

“You said you’re pretty transparent about wages / pricing – how does that fly with your customers?” Steph asked Stephen.

“Depends. We tell them our day rate for site work straight off the bat, usually so they can understand why it is cost effective to let us do most of the work in the workshop. And as I said, we are honest with our wage, but it’s cheap compared to say your plumber or something that is also on the job. So I believe they know we are being fair… repeat business is key. If client relations are going well, or the job is exciting, we sometimes let certain fees go, or take off some profit margin to ensure everyone is happy.”

Unsurprisingly, clear communication about pricing with customers emerged as a key element of pricing.

As Abhishek Mishra put it, “…you need to perfectly communicate to your customers what values will they get if they are paying X. Suppose your competitors are charging less for a product than you. Then you need to justify why are you charging more. That’s the trick I think.”

“I agree with you about giving customers value in terms of service and quality,” said Dr. Hecker. “That’s what differentiates you from the mainstream.”

Abhishek added, “Best example is Apple. The Apple products are mostly overpriced compared to their competitors…why? I guess they provide undoubtedly the best service+product. People don’t hesitate to buy an iPhone as they know that the cost is worth it.”

This comment generated some pushback.

“It’s easier to charge more money once you’re established,” said Nick Neo. “I’m not sure the Apple comparison works for startups, but I guess it depends on your field.”

Wil jumped in, “I think the Apple comparison might be a dangerous one. If you can build the following Apple has then by all means price away… but for the rest of us mortals… not an option.”

“It’s all about that massive following and brand – justifies the price,” said Lauren Tiffan. “Startups have to be more value-driven in pricing than a massive brand like Apple / Starbucks.”

Stephen chimed in, “I think brand is a long-term project of a startup though. Can’t be relied on from word go to charge high prices. You will only build your brand by customer satisfaction. So there lies the balance of your desired price vs getting the clients / jobs.”

Abhishek expanded on his earlier comment, “The Apple analogy might not be best for any startup. But think of it from the perspective of a brand manager. I think pricing lesser than what your product is worth may give you short-term customers. It doesn’t mean that you price your products like Apple. But make a statement about why you price so and so…”

Pierre returned to Stephen’s earlier example – “being willing to do a little more for less for the sake of building relationships and repeat business. Sometimes you give a freebie to your customer as a goodwill gesture and it can pay off later on.”

Wil sought to lean on this notion further, “I don’t think startups have the option to be quite that stoic on pricing. But let me give you some ways you can still get there.”

Option 1: Present your desired price and then discount it. Again, this is how retailers do it. ‘Whoah, 30% off? Amazing!’

Option 2: Pricing Tiers – anyone not doing 3 price tiers is just being lazy. I can dig into this if you want.

Stephen mildly protested the last point, “A little unfair. In my line of work there isn’t even 1 tier – every job priced on scale, design, timeframe, materials etc. But in an ideal world it could be offered if right for the startup.”

As with the call to work backwards from pricing, the group requested Wil elaborate on his tier strategy.

Startup Pricing Tier Strategy (not limited to SaaS)

Tier 1: price is so low that you’re taking ‘price’ off the table as a question – but offers only the bare bones basics – almost too little

Tier 2: the ‘just right price’ – really the price you want to command – it offers the part of the package that is where the real value is

Tier 3: the ‘cadillac price’ which means an insanely high price that offers every option and then some. This is critical because you need to test price ceilings and can often offer personal services/over-the-top outcome, just to see if anyone is a buyer at that price.

This proposed system sparked a flurry of comments and some concerns.

Michael Kassing informed the group, “We do both option 1 and option 2. If you buy our suite, you get a 20% discount on the total – and several of our products have a tiered pricing structure, so the more you use the less the individual units cost (per minute pricing).”

Nick said, “We have three tiers similar to those described, which is good. We also have further options in tiers one and two.”

Christoph Ranaweera worried, “Option 1 might run into the cheap cheap cheap situation here. People get used to discounts and don’t pay the normal rate – and your product is not considered great, just one that works with discounts. (Option 1 works with retailers cuz it’s not their products, they just want to sell them.)”

Imran noted, “I was looking in to few Kickstarter campaigns and how they were bundling their packages. In almost every example, only one price would be the 80-90% of campaign goal. I thought campaign creators did not know how to price properly, thus so many varied offers, until I realized that the actual price was all bundle prices accumulated.”

Speaking to no one in particular, Wil said, “You have to remember that there are buyers at all different price points – so again, the one size fits all price is just short sighted.”

“You can also move through the tiers from beginner to expert or minimum services to maximum,” Sherad Louis-Charles said of tiered pricing, viewed through a slightly different lens.

“Also, if you are early in your product dev lifecycle, price tiers allow you to test all parts of price elasticity,” said Wil.

“…and find the sweet spot in terms of margin to effort,” David Krock added.

Pointing out another landmine in the field, Sherad asked, “What do you think is a major factor in justifying/charging a higher price for the same service?”

“The multi-million dollar question…” said David.

“A more personal service,” offered Stephen.

“The value that it brings them.” [Pierre]

“And also then proving said value over time, which folds back on itself in terms of justifying for future clients the increased price.” [David]

“It might sincerely be all of the above.”

“We are also a two man team – you meet us, design with us, see your build, and we install it. A very human touch to the job. No faceless company etc. I think that is something a client would pay more for.” [Stephen]

“There is a layering of factors.” [David]

“Rapport builds better price confidence.” Dan Rockwell.

Tiered pricing for SaaS solutions has become commonplace. How it might apply to professional services is maybe less obvious. Wil tried to help in this regard.

“Let me try to illustrate a professional services example of tiers:”

Tier 1: This is the least amount we can do to get the job done, and it will cost you the least, but frankly we can do better. The point of saying ‘we can do better/more’ is critical to the conversation. Can’t stress this enough.

Tier 2: This includes Tier 1, but here are a couple things we think would really improve the outcome and here’s why we think it’s worth the investment.

Tier 3: You weren’t even thinking this big – but we are, because that’s how we do stuff around here – but if you wanted to be a total hero, here’s what we’d propose you consider.

“Pricing is an opportunity to show off your creativity and thought process. It shouldn’t just be ‘price poker.’ It’s not the customer’s job to know how to value your product – it’s your job.”

“This hits the nail on the head,” said Stephen. “Sometimes customers demand extensive breakdowns of why something is the cost it is – I assume they are looking for ways to save cash. But like you say, that’s not for them to know every detail, when it’s you putting a value on your own work.”

“I look at that as a buying signal and I dig in and say, ‘not only will I detail the price, but I want you to understand why you’re going to be excited about what you’ll get.’”

“Tier 3 is how small agencies become big agencies, btw.”

“We’ve talked about pricing services but what about physical products?” pressed Eileen. “Is there a method to that as well?”

“Physical products often use the typical retail model of discounting. The old 50% off MSRP style,” answered Wil. “That said, I think because of the less fluid nature of how physical products are sold/distributed (you have to commit a specific price to a retailer) you have far less elasticity. That’s why they start high and work backward.”

“…and why they try to avoid retailers and go direct to customer,” added Christoph.

“I think in physical product realm there is a lot of room for creativity, too,” said Imran. “Think about the large menu at McDonalds with bigger coke or french fries or a latte at Starbucks with extra cream. Those extras cost 1-4 cents and the price increase is much higher.”

“Even with single product you can do a lot – different sizes of latte is price tiering, the extra coffee you get is not proportional to price you pay.”

Things get a bit weird when you start to separate price and value. Weird and fascinating. Here’s Wil:

“The ‘value’ part is what most vendors don’t do a good job conveying. Think about a product or service that you love the most. It could be where you get a massage or that one consumer electronic that you can’t shut up about. Now think of someone who doesn’t give a shit about that product. Consider how you’d communicate the value to them. That delta is the diff between what a vendor thinks something is worth (who knows the value) and what a typical customer thinks it’s worth.”

“For example, a masseuse isn’t selling a massage they are selling how valuable relaxation is to you.”

“The masseuse is solving a problem, addressing a pain point,” said Dr. Hecker.

“Definitely solving a problem, but what they are selling is the value of the outcome as it relates to the customer. Not the actual product per se.”

“I was thinking about the massage thing today in fact because I was planning on taking my wife for a spa day (it’s our 5th anniversary). And I’m thinking, Man, the value of this massage to me is $0 because it doesn’t ever help me. But the value to my wife is $1,000 bc of a very different outcome. But we’re going to get the same product.”

“When I was selling websites for a living, it occurred to me that people weren’t buying my website – they were buying what the website was going to do. So I focused heavily on that aspect of the sale.”

“So I would say ‘You’re going to spend $10k, but let’s talk about what we think that will accomplish…’ Everyone else was just quoting numbers. We were talking about outcomes, because that’s what the customer really wanted.”

“In other words, the value to them,” said Pierre

“For sure. If your pricing is limited to ‘this is what it will cost us, so here’s the price’ then you’re selling the wrong product.”

“I don’t go to a restaurant and say ‘Hey, what does the Filet Mignon cost you, because I want to pay the cheapest amount over your cost?’ I say ‘I want that damn delicious filet .. $40? Wow that’s a lot. But man it sounds tasty.’ I’m thinking outcome, not cost of goods sold.”

Somehow the hour was already up. It was time for last questions, but there seemed to be few takers. Quite possibly the talk of ribs and filet mignon had sent everyone looking for something to eat. Or maybe everyone was already reviewing their pricing and value propositions in earnest…