How not to price your product

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This is article #5 in my series How not to build a business. I open up about all the mistakes I made building a software as a service and all the lessons I learnt in the process.

My mistakes: Not being patient and not understanding my worth

It goes without saying that pricing is a critical aspect of any business. If done right, it can help your conversion and drive your business. One of the beautiful aspects of software as a business is its recurring nature. Instead of a one-off transaction, like buying a pair of shoes, customers pay repeatedly for the usage of products. Being part of that category, at iMenoo we charged a monthly fee. We decided to establish our first price at 49€ a month, per restaurant.

After a month or so, we found out that closing sales took longer than expected, requiring multiple meetings and calls per client. We wanted to make this process more worth our while, so we started to explore different pricing tactics that would enable us to charge more. The second pricing scheme we came up with was charging restaurants based on the diner capacity they had at their establishment. We wanted to charge around 2€ per month per seat. If a restaurant had 50 seats, they would be paying us around 100€ per month, so it would be double than before. In order to avoid this scheme working against us, in restaurants with fewer tables we applied a minimum fee of 50€ a month. We did some experimentation, but unfortunately, the new pricing did not fly with restaurant owners, who already had huge expenses and were not going to pay so much for a nice-to-have product.

I was torn by how people would always say: “What a cool product”, but did not instantly buy it. As a result, I came to the realisation that if they were not buying it had to be because the price was too high. I was so desperate to increase the sale rate, that I never stood my ground when clients asked me for a discount. I learnt the hard way that restaurant owners are savvy negotiators who do not hesitate to take any discount that is not pushed back on.

A few weeks went by, but the pace of sales would not increase, so we changed course again. We reduced the price to a ridiculously low number: 5€ per month. This new strategy aimed for that heavenly phenomenon that everyone wishes for in their business: virality. We were so naive that believed that a throwaway price would set off thousands of requests from clients. After all, thousands of people were eyeing our site, waiting for us to have the right price in order to buy. The effect of this excessively low price was twofold: firstly, it devalued our product in the eyes of restaurant owners, and secondly, it made the sale even more pointless since the payback period was too long. I remember a conversation with the owner of a well-known sushi chain in Spain; when I told her that the price was 5, she looked at me surprised, with her eyes wide open, inferring that it was very expensive. She thought that I was elegantly referring to 5 as 500 hundred € a month. When I reassured her it was 5 as in 5€, she could not understand it. This demonstrated that the price reference we were using was not correct, since it was so apart from what customers expected.

Our last pricing strategy was inspired from SaaS pricing pages. We created different tiers, spending hours designing our pricing page. We had a free tier and a paid one, this time charging 25€ per month. We threw in arbitrary features into each tier without any clear criteria, such as being able to hide and show dishes based on availability. We did not last much longer than that. In a short period of time we had tried many alternatives and made countless mistakes. Luckily, the learnings were plentiful.

Learnings

#1 Price for value

My first learning is that, before deciding the exact amount you are going to charge, you should try to discover how it is that your users get value from your product. Getting this right makes all the difference. For example, in a marketplace, normally the way to measure value delivered is the number of transactions and in the hospitality space you can see people find value based on the number of reservations. If a product is used, it provides value. In our case, clients derived value from our menus, so the right way to charge would have been based on the number of menus being used by establishment.

With a “price for value” strategy, you make sure that you charge when your users are obtaining value. As a result, your customers expand their spending based on their usage. If they need more seats because they are growing, it is an easy conversation. The growth and payment trends are aligned. In the same way, if they use your product less, they contract instead of churning.

Let us see an example of pricing done right: Slack. Their free plan providing a history of 10,000 messages makes it easy to convince users to try the product. Once enough people within the company are in Slack, the network effect becomes strong and the tool consolidates as a central piece of the company’s communication. Expansion revenue is golden because as the company grows, Slack charges for more seats and it requires zero extra effort from a sales standpoint.

#2 Find out what level of product you are

It is common for founders to think too much about micro improvements on their pricing which do not move the needle. Often, magic pricing comes up in the conversation: “Let’s charge 49, instead of 50, that will totally make the difference. Let’s put the most expensive plan to the right and the least to the left. Let’s use such and such psychological tricks.” These suggestions may make sense when you are a multi-million dollar corporation, but not when starting out.

When thinking about pricing at a startup, in my opinion, it is better to frame the decision an order of magnitude above details. You have to figure out what kind of product you are. Are you a 10€, 100€ or 1000€ a month product? Once you have decided the level of product you are, it is useful to create a buyer persona and carry out some investigation with real life sales to see if your hypothesis is right. As every aspect of starting a business, a fast feedback loop and iteration is the right approach.

#3 It is easier to start high and reduce

Whatever you do, do not undervalue yourself. If you are going to make a guess, it is a much better decision to overvalue your product. The price you start at is important because it will serve as a reference in your negotiation. Even if you believe you are overcharging, put on your best poker face. This is known as “anchoring effect”, a cognitive bias whereby an individual's decisions are influenced by a particular reference point. Overcharging will help you find your most willing users. Of course, you may lose some customers along the way, but you will be able to identify the people who really care about what you are selling. Let’s say you have decided you are a 50€ a month product. Start by setting your price at 200€. If you are a 500€, set it at 2000€. This strategy is known as “price skimming” and I would say it is one of the best when starting out.

#4 Experiment with your pricing

Pricing is as much an art as it is a science. Do not be blinded by your conception of what you are worth, let the market tell you. In order to let it do so, you have to probe it, trying different alternatives.

One of the best stories I have heard regarding price experimentation happened to the analytics company Segment. The founder thought they had a $50 a month product and had been closing sales for that amount. A mentor from the startup incubator Y Combinator told him to ask for $10,000 a month to a corporate client they had a meeting with. As you can imagine, the founder thought this to be an outlandish price. After all, he had anchored his product’s value at $50. At the end of the meeting, the corporate client thought that $10,000 was too expensive, but he was willing to pay $4,000 a month.

My recommendation is to review pricing often and experiment until clients churn. I recommend trying simple pricing that customers understand without having to make an effort. You have to be careful in order to find that price point at which your churn’s impact is offset by the additional revenue from clients willing to stay with you at higher prices. That is the art of pricing.

#5 Beware of the dead zone

When pricing, it is essential to think about the customer cost of acquisition. In the end, it all comes down to simple mathematics. Do you make more from your customers (lifetime value) than what it costs you to acquire them (cost of acquisition)?

The diagram below outlines the different costs of customer acquisition depending on the type of business catered to. It is way cheaper to acquire a client if you are a B2C business. There are more potential clients and less decision making involved. However, the price tag for B2C is much lower than what you would get by closing a complex sale with bigger clients. In the diagram, the “dead zone” represents how the playing ground is for businesses catering to small and medium enterprises (SME’s) - of course, us daredevils at iMenoo could not avoid it. More often than not, the cost of acquisition is high and SME’s normally do not have the budget to pay you enough. This does not mean success is impossible in the SME space, just that it is more difficult.

Conclusion

You have taken your clients through the whole funnel. They like your product and are willing to pay for it. Giving enough thought to pricing is critical for you to close in on the deal and ensure the whole process was worth it. You better stand your ground and practice your poker face if you want to be successful.