Setting a price to a startup product / service is one of the toughest issue an entrepreneur has to solve. This is both complicated and super critical to the startup success. It’s probably the keystone of any business model.
There is no magical formula to find the best price for any product. However, experience shows that there are some great tips to help entrepreneurs builing great pricings.
Let’s find out what are these main tips you should be aware off before setting your price!
Not below per unit cost : make a minimum margin
Yes, indeed! This first tip may sound really obvious… To make profit, you need (off course) to make a decent margin! But still, we think it’s really important to start by reminding that.
Yet, beware! Don’t fool yourself with such an obviousness. Make sure you have well calculated your “per unit cost”. It’s not always as easy as it may seem at first sight. Usually it includes all direct costs necessary to sell each unit sold : raw materials, external services, … It’s also a good practice to include acquisition costs in the per unit cost :
- for a “one shot buy” business model (if you have a poor customer retention), incorporate full acquisition cost
- for recurring business model, include the average acquisition cost (based on the full acquisition cost divided by the estimated average retention period)
However, don’t include in this “per unit cost” all your business costs. All “fixed costs” that are not directly related to sales of your product shouldn’t be included in the “per unit cost”. These costs will be paid with your gross margin you made by selling your products with a minimum margin. We will detailled that point in the “break-even point” tip.
Perceived value : capture the maximum value
Setting a price for a new product/service only with the “per unit cost” approach is not sufficient, because it doesn’t value properly the startup offer and usually leads to a low margin. Entrepreneurs need to estimate the real value they create for their potential customers to set the pricing that will value the best their offer.
So, entrepreneurs have to discover and quantify the “perceived value” of their customers for their offer.
To do so, the first step it to understand well gains and pains of these potential customers to buy the product/service. The perceived value can somehow be quantified as gains minus pains. This is the rational approach to estimate the perceived value.
However, this approcach has to completed by a psychological approach of the customer. Indeed, customers are most of the time influenced by irrational issues that can greater or lower their perceived value. For instance, the price itself may influence the perceived value : A high price will give the impression that it’s a good product, while a low price usually refers to a “cheap” / “low cost” product (ie, bad product …). Likewise, the rarity of a product / service may be perceived with higher value (if supply is lower than demand for instance).
Of course, if the perceived value of your product/service is below the “per unit cost”, it means that your business model is unsustainable. Again, it sounds obvious, but it’s not. Entrepreneurs are usually in love with their ideas and most of then will hardly accept such a conclusion.
That’s why it’s so important to build a business model on true feedbacks from potential customers (not on guesses!).
Price based on the customer segment
When building an offer, an entrepreneur may want to embrace a large customer segment to build a big business. However, it’s not always a good idea (even if the perceived value seems above “per unit cost”).
Indeed, the maximum perceived value an entrepreneur can expect from a large customer segment is defined by the lowest perceived value of one sub-segment of this global segment (some sub-segment may have a great percevied value of an offer while another may value it less). It results in a price based on this maximum perceived value. Thus, the bigger is the segment the lower may be the global perceived value, resulting in a lower price for the whole segment.
Entrepreneurs can figure out this issue with two alternative approaches :
- Reduce the customer segment to increase the global perceived value, and hence be able to have higher prices and margins. This choice can help some entrepreneurs building more profitable businesses. Sometimes this approach is necessary to build a sustainable business.
- Break-down prices for the different segments. This approach implies necessarily to break-down also your offer in different products / services to justify price variations.
Nevertheless, it can be a good choice for some entrepreneurs to target the biggest customer segment, even if it implies a radical cut-off in price and margin to fit all customers expectations. Indeed, it may be a good decision for some businesses, especially when they benefit from large economy of scale : per unit costs may lower rapidly with high volume, resulting in higher margins despite low prices.
As you see, depending on each businesses, the choice of the customer segment is structuring when it comes to setting a price for a startup product!
Never set a price too low when starting your business
A lot of entrepreneurs think they have to set prices low at the beginning to help them sell their products / services to their first cutomers. Indeed, it might seems easier to sell with lower price… But unfortunately it’s usually a common and serious mistake!
Why that? Because when a price is set it becomes almost impossible to increase it after. Customers don’t appreciate at all. So, entrepreneurs are then stuck in the mud to change their pricing and they start struggling to make enough profits.
That’s quite a shame, when you know that entrepreneurs work hard to build great offers to answer their customer pains!
One good alternative way to be more attractive for first customers is to show the real price that best value a startup offer and to accept discounts for them. If so, it’s really important that customers clearly understand that such prices are exceptional (for instance : only for the 100 first customers, or only for the first product, or only for the first year, …).
Of course, a price has also to be set with the competition in mind. Even for a startup.
Yet, it doesn’t mean that startups offers have to be cheaper or more expensive than competition. It means that startup prices have to be consistent with value propositions from both startups and competition.
So, if a startup has built a business model and product to provide great savings to customers, its prices should be really below competition to make a great price gap. Customers will probably have pains to leave competition. In such a “low-cost” strategy, prices have to be really attractive to help customers change.
At the opposite, if a startup build a high value product / service, its prices have to be higher than competition offering less perceived value to customers.
It’s a great mistake when setting an inconsistent price with the value proposition. Customers will flee or think that this contradiction may hide some bad surprises.
Break even point calculation to set a price
Entrepreneurs can’t set a price only with a “per unit margin” approach. It’s of course really important to capture a large part of the perceived value, but it’s not sufficient.
Entrepreneurs also need to have a global approach of their business model to price well their offer. Indeed, any business has fixed costs to assume before making profits. This means that the “per unit margin” made from each product / service sold has to be multiply by a minimum quantity before making any profit.
Hence, if the “per unit margin” is pretty low this minimum quantity may be really important to reach profitability, while in high margin businesses this quantity is usually way lower. So depending on the magin, the quantity to sell will vary. That’s why the pricing strategy is directly correlated to the minimum quantity to sell with a given context of fixed costs (ie, ressources). This is why it’s so important to calculate the break-even point of a startup to help setting a price strategy.
The break-even point tells you the minimum quantity to sell for a given price and specified context of fixed ressources. An entrepreneur should then analyse if with such a pricing he can be able to sell and produce such a quantity with ressources he gots.
Such an analyse may help entrepreneurs tuning and improving their price strategy.
To calculate your break-even point, we can recommend you to use our free & easy financial plan tool for startup : Download it here.
Last but not least, building a price strategy for a startup is also about building an assortment of prices to maximise the customer basket.
A great way to do so is to create “decoy pricing” with bargain offers that are clearly better than regular offers to incite customers to buy more, with “up-sells” or “cross-sell”.
For instance, let’s say you want to sell t-shirts for 10$ each with a 5$ margin. How can you make your customer pay more? Maybe you could build a price strategy with a decoy offer, like a “one t-shirt for 15$”, while selling “2 shirts for only 20$”. Your customer will then think that’s a great offer and they will choose to buy 2 t-shirts! You will then probably sell more t-shirts with a higher average margin!
We hope this article helped you. Don’t hesitate to share it on social networks! Good luck with your startup pricing!