Poor pricing sinks products
VC investors are experts in discovering which startups can and will grow in size and profitability and invest accordingly. A considerable part of the puzzle driving said growth includes pricing and its role in a business’s overall unit economics.
Infamous American businessman Warren Buffett once said, “The single most important business decision in evaluating a business is pricing power. This means that if you can increase your prices and still keep your customers loyal, then you’re in a good place.”
In our SaaStr session, "How Not to Go Cheap: The Data Behind Staying Away from Freemium and Focusing on Premium," our CEO and co-founder, Hristo Borisov, shared some important tips on business pricing models based on our research and experience.
During the session, Hristo mentioned a stat from leading consulting firm, Simon-Kucher, which revealed that about 75% of new products fail due to a poor pricing strategy and customers being unwilling to pay. But how can businesses avoid these pitfalls, and what does a poor pricing strategy look like?
Over the top, feature shock
According to Madhavan Ramanujam’s book, “Monetizing Innovation,” the most common reason for failure over product pricing is ‘Feature Shock.”
Feature shock is where businesses create catch-all situations with products by cramming too many features into them and making them overly expensive. This happens because companies may overestimate the target customer’s needs, and customers are unwilling to pay for a product with features they don’t need.
The lesson is to design a product with only the customer's desired features. An excellent example of 'Feature Shock' failure is Amazon's Fire telephone which the public viewed as overpriced with unnecessary features.
Undervalued minivations
'Minivations' are products that failed because they were priced too low from the outset of product development. They cost less than customers are actually willing to pay for the product and sacrifice profits.
A shining example of this is Audi's SUV, which underestimated demand by 14% and, as a result, under-priced the product and missed out on significant profits.
Make-or-break hidden gems
‘Hidden Gems’ are products that are never even launched despite a possibly huge market potential because their developers believed they might cannibalize existing business.
The key example is Kodak which didn’t launch digital photography in 1973 when they developed it because they feared it would destroy their analog business.
You might think this is pretty uncommon, but these ‘Hidden Gems’ often occur when companies reach an inflection point, for example, when switching from offline to online business.
If avoiding risks can sink Kodak, think what it could do to those start-ups who are busy bootstrapping in finance and business. It's all about taking risks, but making sure they're calculated.
Potential killers: Undeads
Like their namesake, ‘Undeads’ are products that should have never been launched in the first place because customers don’t want or need them, and they can even harm a brand image because they’re so off the mark.
A perfect example is Google Glass, a lightweight wearable computer that became a blip in Google’s brand reputation.
Business pricing models: Premium or freemium?
A key part of our pricing strategy has involved getting our target customer 100% correct. We focused and still focus on supporting scaleups and enterprise companies rather than early-stage startups.
This laser customer focus meant we could create (and continually innovate on) a product that supports specific needs, including scaling, rather than creating something with the potential to cause ‘feature shock.’
“We did something very unconventional,” our CEO Hristo recalled. “Usually, companies start with a freemium option in their business pricing model and figure out the actual pricing later, which is then hard to charge. But, we decided to focus on the monetization of a few customers directly with a premium model that remained cost-effective by delivering greater value. Very few people were doing that in the market.”
It was a risk going for premium pricing, but our pricing model, a superior product, and cashback offer keep the product desirable. Our customers understand that the more they use the product, the less they will pay, so it is a win-win.
Retaining customers
So, how can business pricing models attract customers and keep them loyal? The pricing structure must reflect the value being delivered to the customer, i.e., your product must be worth it.
“We really like that when you pay with your card you get the cashback offer. We changed to Payhawk because of the cashback, but we stayed for the product!” Benoit Menardo, Co-founder at salary advance fintech, Payflow, said.
Our focus on service and customer-centric innovation ensures that we continually improve the product to offer the best outcomes and experience. This kind of innovation would be impossible with a freemium model, and our customers understand that they’re paying for a product that will scale with them and support them as they grow.
Identify buyer willingness
We designed our price structure by identifying the customers’ willingness to pay. We did this using market research with several questions on price. And by applying Van Westendorp’s Price Sensitivity Model. A mathematical theory developed in the 1970s that still holds today.
The result is a graph that reveals the perceived acceptable levels of pricing within a range of lower prices (and more customers) and higher prices (with fewer customers). The optimum point being somewhere in the middle.
Lower prices with lots of customers may suit some companies, but as we mentioned above, for us it would stifle our ability to innovate and improve our product for our customers. We don’t offer freebies and rewards to capture as many customers as possible, but instead we focus on our target group and deliver competitive benefits that add value to their operations, including: 80% less manual data entry and processes, and a four times faster month-end close.
We're not saying it's easy to nail pricing. Besides studying the theory of pricing failure, we spent a lot of time iterating on our pricing strategy and tried 15 business pricing models in the first two years.
Whether you offer an "all-you-can-eat" model which provides the same for every customer, or an "a la carte" type customized solution, the important thing is to ensure customers get value for their investment. And this is almost impossible when delivering freemium.
Interested in saving time and delivering value to your business with spend management? Download our ebook, Grow your business with Payhawk today. Or if you’re ready to talk solutions, book a demo today.
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