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When pricing their product or service, many entrepreneurs keep things scientific.
They consider the cost of the overall operation and simply add enough of a markup to clear expenses and start earning profit. Market history and competitor pricing strategies might also enter the equation, but that’s about it. However, according to Steve Blank, author of The Startup Owner’s Manual, smart startups know that pricing is more art than science. These businesses price their product or service based on the value it provides the customer, thereby maximizing their overall return. Why? Because customers who love what they’re getting are willing to pay more. In fact, they might even assign a greater level of worth to a product or service when it costs a little extra. Though there is no precise method when it comes to value-based pricing, the following tips will help you put a dollar amount on the value you’re offering so your startup can begin pulling in every penny it deserves.
Know Your Target Customer
In order to understand the value your target customer will be getting from your product or service, you first need to answer one simple question: who exactly is your target customer? According to Blank’s lean startup methodology, the process of answering this question is known as customer discovery. First, sketch out a rough archetype of your customer—their wants, their needs and so on. Once you’ve done that, step out of your office and interact with potential customers in their place of work. Ask focused questions to better understand their daily routine. You want to figure out each task they perform, how frequently these tasks occur and whether they’re crucial or trivial. You should be able to sketch out a “day in the life” of your customer, which is the first step to figuring out how your product fits into their routine.
Identify Your Product/Service’s Ability to Fulfill Needs
Once you have the hard facts about your customer, you can begin working toward a solid understanding of their buyer motivation. The bottom line is that the level of value your customer assigns a product or service will be directly proportionate to its ability to fulfill needs. As such, look at the “day in the life” you’ve constructed and identify the pains or inconveniences that pop up while your customer performs their usual tasks. If your product or service manages to address these inconveniences in a major way, your customer is going to get a find a lot of value in what you’re offering—and the cost should subsequently increase. On the other hand, if you’re not able provide any sort of pressing solution, you will want to keep your pricing low—or else return to the drawing board altogether.
Think About Distribution
When marketing a product, your selected distribution channel will affect your pricing model. By distribution, we mean everything from delivery to sales to service. The bottom line is that customers will only be willing to navigate a complex distribution channel when the product provides significant value. As a result, be sure to keep the distribution complexity proportionate with the value offered by the product. If your product is simple and offers minor convenience to the customer, the distribution channel should prioritize accessibility (e.g. online sales, simple installation/support, etc.) and the cost should be relatively inexpensive. If your product is complex and offers great value to the customer, it is alright if the distribution channel requires a little more time and effort for you and the customer (e.g. direct sales, complex installation/support, etc.). When distribution doesn’t complement value, it will be harder for you to assign a cost to your product that you and your customer will find favourable.
Above all else, remember to keep your pricing model simple to communicate. If you and your sales team can’t readily explain how you arrived at your prices, customers will be less likely to climb aboard. Additionally, revenue model and pricing model go hand-in-hand, so spend some time researching different revenue models (e.g. freemium, pay-per-use and pay-per-user) to determine which one fits your offering most effectively. Finally, though the above tips will be able to guide you through value-based pricing, it’s important not to throw conventional wisdom out the door. Even though a value-based approach should be your top priority, methods like referential pricing (e.g. the product price compared to the cost of the overall project) should still occupy a space within your decision-making to ensure your pricing model propels your startup to profitable growth.
For More Information
For more information on pricing models check out this great article from MaRS Discovery District.
For more information on UBC’s commitment to helping local and area entrepreneurs, check out what our partners are doing Entrepreneurship@UBC.