Value based pricing - for start-ups

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CompanyConfidential:ConfianzysConsultingPvt.Ltd August2010

www.confianzys.com Email:[email protected]

VALUEBASEDPRICING:THECHALLENGESFORTECHNOLOGYSTARTUPS

ATHOUGHTPAPERBYTHECONFIANZYSCONSULTINGGROUP

THETROUBLEWITHPRICING

Technologystart‐ups,especiallythosetryingtosellafundamentallynewconcept,often

facetheirfirsthurdleswhenitcomestopricing.

What is the benchmark? What value do customers place on this

product?Howwillcustomersdecideifourpriceisrightforthem?

Allthesearedifficultquestionstoanswer.Sincefewcompanies(andevenfewerstart‐

ups!)havetheinformationorknowledgeneededtoanswerthem,mostcompaniestake

theeasywayout:CostbasedPricing.

Cost based pricing defines product price as ‘x % above the unit cost’. This could

howeverbefarlowerthanthemarketcanabsorb,resultingindelightedcustomersbut

unhappy investors! Or, it could be too high for the majority of customers. Here, the

start‐upwastesvaluabletimeintrialanderror.

Competition‐basedpricing involvessetting thepricebasedonprevailingprices in the

market.Whilethismayworkforme‐tooproducts,manytechnologyproductsthatoffer

a fundamentally different benefit cannot use this approach. Further, if competition

profitabilityislow,itdoesnotmakesensetoreplicatetheirpricing.

Value‐basedpricingisapricingstrategythatismarketandcustomer‐centric,andaims

ataligningacompany’sprofitabilityobjectiveswithwhatthemarketcanbear.

While value‐based pricing sounds like the best option, such an approachmeans that

start‐upsmustbeabletoanswerthefundamentalquestion:

Whatproblemarewesolving?

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WHATPROBLEMAREWESOLVING?

Value‐based pricing can be defined as price setting that is based upon the value that

customersaccordaparticularproduct(orservice),ratherthanthecostofproducingit.

Businesses often misunderstand the problem that they are solving and the value

customersderive.Evensalespeople,whoareintouchwithcustomers,sometimesmake

themistake of confusing the features that the product offers, for the benefit that the

customerderives.

Source:www.funnysalescartoons.com

Let’s take the case of a remote diagnostic tool that allows the call‐centre service

representatives of a telecom provider to analyze network problems at a customer’s

homeoverthetelephone.Inthiscase,thevaluetothetelecomcompanycanbemulti‐

fold,including:

• Savingsfromfewerhomevisitsbyservicereps

• Abilitytomaintainsmallerserviceteamsduetohigherproductivity

But,thisisnottheproblembeingresolved.

For customers, the problem is loss of productivity due to network problems and

inability to access the internet. The benefit is immediate problem resolution,without

havingtowaitfortheserviceengineertovisit.

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Thevaluetothetelecomprovideris inthehighercustomersatisfaction,whichcanbe

quantifiedthroughreferrals,andnotjustincostsavings.

HOWTOIDENTIFYVALUE

Aswesawearlier, customervaluecanbeofdifferentkinds.Due to thewidescopeof

possible‘values’,companiesfinditdifficulttoidentifyandquantifycustomervalue.

A useful framework to understand value is the Need‐Competition quadrant analysis

whichlooksatdefiningagivenmarketinthecontextofcustomerneedandprevailing

competition.

Of these quadrants 1 (emerging market) and 3 (felt need, mature market) are most

relevant to start‐ups. In an emerging market, start‐ups will be product evangelists

trying to solve a problem that has not existed before; for e.g. how to save time by

integratingone’svarioussocialmediaprofilesisacontemporaryproblem.

Inamaturemarket,start‐upstrytosolveaproblemthatalreadyexists,butinabetter,

faster or cheaperway. For e.g. how to save the time customers spend on reaching a

Low

High

High

Declining/saturatedMarket

1

2 3

4

COMPETITION

NEED

Feltneed,maturemarket

Unlikelymarketscenario

Emergingmarket

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customer service executive is a problem that companies have been grappling with,

althoughnewsolutionsmaybereached.

Somewaysthatyoucangetbetterat identifyingtherightproblemandestimatingthe

valueofyoursolutionare:

Ask your customers. Delighted at making a sale, start‐ups rarely ask their early

customerswhat value they find in the product. Youmay be surprised at the reasons

customers give. If an initial low price is themain incentive for a customer to choose

yourproductovercompetition,youknowtherearetoughtimesahead.

Is it a different problem or a different solution? Check if you are addressing a

fundamentally new problem (these are rare) or offering a new solution to an old

problem.Youmaybeabletocommandapremiuminthefirstcase,ifyouarethefirstto

addressacriticalproblem.

Whatalternativesolutionsdoestheproblemhave?Inthetechnologyindustry,most

companiesstillusetheperpetual/server/concurrentlicensingmethods,butcustomers

are looking at alternative Software as a Service (SAAS) models for practically every

problem.Alternativesolutionstoaproblemneednotbedirectcompetitors.

Beyondthese,start‐upfounderswhoareheavilyinvestedinthebusiness(andnotjust

financially)oftenmakepoorpricingdecisionsbecauseoftheiremotionalinvolvement.

Start‐ups end up justifying lowprices perennially on the grounds of promised future

business orwinning a ‘prestigious’ client, but ask yourself if the decisionwill indeed

helpfuturebusiness.

Toadoptvalue‐basedpricing,youneedto:

(a) Identifycorrectlywhatproblemyouaresolvingand

(b) Estimatehowcriticalthisproblemistoyourcustomer.

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A final suggestionat improving your pricing decisionswould therefore be to take a

good, hard look at every decision and justify it (or not!) to yourself using all the

informationavailable.

AboutConfianzysConsulting:

Incorporated in 2008, Confianzys Consulting is a first‐of‐its‐kind consulting entity in

India, focused on helping technology product companies by providing consulting,

training and coaching interventions in Product Management, Customer Management

andMarketingManagementareas.

Formoreinformation,pleasevisithttp://www.confianzys.com.