Pricing Decisions for Start-Ups

Pricing during Start-Up

Wybrand Ganzevoort Entrepreneurship Articles Leave a Comment

Have you ever run into a convenience store to buy a drink? Whenever I stand in front of the drinks’ refrigerator I am amazed at the variety of water on the shelf. Some of the labels claim that the water within Price of Watercomes from a rare spring high up in an unpolluted mountain or melted from an ancient iceberg. Despite the common sense niggle that the expensive bottle cannot possibly be worth the price tag and my own thoughts that the water is in fact not much (if any) better than tap water, the lure of the clear bottle and the elegant label makes me hesitate. If I am going to buy water in a bottle, then surely I should opt for one that is bound to be the purest there is. It can’t be cheap to get water down from the mountain. Then again… it really is just water in a bottle.
Price is a lens through which the customer views your product.  It can never be isolated from your product.  It is part of your product.  Price also provides the customer with a perception of quality.  Entrepreneurs easily fall into the trap of wanting to compete based on quality and price.
But what would happen if you priced yourself as the cheapest in the market?  How would your product being the cheapest affect the way that the customer views you?
Another question to ask is “How many cheapest companies are there in the market?”.  The answer to this is only one.  There is always only one cheapest company in the market.  Take a moment now to think about some brands that have made themselves the cheapest brand in the market?  Think about cellular phones, or telecommunication networks.  What is your perception of this brand?  Once a brand has priced themselves as ‘cheap’, it is difficult to move away from that perception.
On the other side of the price market, we have a company like Apple.  At the time apple was launched it took a different strategy, despite being a relatively small start-up compared its competitors.  Instead of pricing themselves as low, they decided to price themselves high.  They wanted to be perceived as remarkable, as different.  They wanted the customer to understand that this difference was worth paying for.

The Pricing Trade-Off

Below is an extract from the Apple business plan written in 1981.  Have a look at their pricing strategy.  What Apple did in 1981 already was to create a product trade-off strategy.

Pricing Comparison

We see this strategy employed so many times these days that we have taken it for granted. The pricing trade-off strategy is often employed by companies in order to anchor the customer’s mind around a price point unique to that of their competitors.
To explore this a bit more let’s say that you want to purchase a smartphone.  A phone has certain standard requirements, like being able to call someone and being ale to send an instant message.  The entry level phone is able to do just that, so when you go into the store, this is exactly what you have in mind.  Once you start seeing the options available to you, your mind begins to compare the features that you could receive if you were to pay a bit more.  You suddenly realise that model A has a slightly smaller memory than model S and model S has the newest video capturing technology.
What the cellphone brand has done is to provide you with a trade-off sacrifice.  If you were to buy the less expensive phone, you would be sacrificing the better technology.  You don’t really require that technology, but emotionally you are feeling the sacrifice that you are making by paying for the ‘cheaper’ of the options.
Daniel Pink explains this trade-off clearly in his book, To Sell is Human.  He uses the example of a researcher asking a student to volunteer by looking after a group of juvenile delinquents for a weekend.  The student’s immediate reaction is no.  The researcher then asks the same student if he would not mind coaching a juvenile delinquent for an hour a month.  When the researcher asks this ‘trade-off’ question, after he has asked the first question, the student has a much higher chance of saying yes.  In effect the researcher created an anchor in the mind of the student.  When the student was faced with another proposal, they traded off the advantages and disadvantages of the proposal against that of the previous proposal.  We call this previous proposal or offer, an anchor.

Pricing Anchors

When I moved into our new property I had to dig some holes to install a fence.  The holes had to be quite deep.  I started with the first option, which was digging the holes myself with a spade.  Halfway through the second hole I decided that this option was too costly.  Firstly, it was hard work and secondly, I did not have the time to dig all the holes.  The options available to me were the following, I could just carry on and dig the holes, I could hire someone to dig the holes for me, or I could buy or hire the use of an auger.  I settled for the last option, spent a bit more and got all the holes dug in a very short time.  This option was the more expensive option, but it did the job faster than the alternatives.  It was difficult to make the decision though, considering the price anchor which was in essence getting myself to do the job for free.
Your customer would have specific price anchors in mind when they consider your pricing.  When you price your product or services offering, your goal will be to find out what these anchors are.  Many of these anchors are based on the alternatives that the customer has thought of.  These alternatives might be the price of a similar product or it could be the price of another type of product altogether.
Let’s consider an example from our company.  One of the services that our company offers is Anti-Corruption compliance.  In many cases when we discuss this product, the client has no anti-corruption compliance practices in place.  They are therefore comparing the cost of doing nothing to the cost of our services.  The price anchor in this case is comparing our price to a zero price.  In this case we assist the client in understanding the broader alternatives.  We explain the risk involved if one of their employees were to be implicated in corrupt practices.  When we explain this the alternatives now potentially become much more expensive, based on the cost of the potential reputational damage to the brand of the client.
In order to decide on a price for your product or service offering, you will need to understand your customer, and understand the pricing alternative, or the price anchor that your customer has in their mind.  Many Entrepreneurs take a guess at what this alternative is, but the best way to know for sure is to go and ask your customer.  Talk to them and ask them directly what other solutions they have considered to solve the problem.  The pricing linked to these solutions are the anchors that you will compete with.

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