Whether you’re a freelancer, an independent professional or a small business owner, one of the most important financial decisions you will face is how to price your offering (product or service). In an earlier post, I had shared a recent study that cites 9 of the 14 reasons for startup failure as finance-related. 2 of those 9 are about pricing. So, not only does it impact profitability and viability, but it determines the personal wealth you will generate from your venture. As such, I consider pricing strategies and decisions as key elements of a holistic financial plan for self-employed people.
To further stack the deck, in today’s difficult economic environment, the types of pricing models continue to proliferate across all industry sectors – going beyond the traditional (contractual, volume-based, bundles, tiers, etc.) to evolving (trial-based, performance-based, up-sell / cross-sell, markdown, feature-based, license-based, gain-share, etc.) and experimental (pay-as-you-go, pay-per-use, pay-per-transaction, pay-as-you-wish, freemium, subscribe and save, third-party charging, etc.)
How do you pick the model(s) that will work best for your business and financial goals, while warding off competition and growing your customer base?
The Most Common Protests:
“The market sets the price.”
I hear this even more often in the current difficult financial times than ever before. My response is (as a former boss used to say often) that markets are just not that efficient. If you resign yourself to this belief, we may as well shut up shop and go home.
“I do not have the resources of large organizations to do all the market research and mathematical analysis to create pricing models.”
Let me just say – as someone who spent years as a Corporate Pricer and then as a Pricing Strategy Consultant – you do not need to conduct exhaustive research beyond what you do for your business model (assuming you’ve worked on that already – if not, let me refer you to Alex Osterwalder’s excellent Business Model Generation.) Yes, there is going to be some math involved, but, nothing that the garden variety spreadsheet app cannot handle.
“I am in [the early years, a highly-competitive environment, a commodity business - insert any number of business scenarios here]. If I don’t do the necessary [price-cutting, discounting, conceding on terms and conditions - insert any number of weak pricing behaviors here], then my competitors will eat my lunch.”
Valid scenarios / concerns. But, when they drive you to, basically, a cost-plus pricing model, it will undermine pricing confidence to sell and negotiate effectively. It is this lack of pricing confidence that will allow the circling sharks to close in, more than anything else.
The end-result of all such mindsets tends to be either money left on the table or margin leakage – both of which are not easily resolved after they occur. And, once customers get accustomed to some of these poor pricing practices, the impact to financials is irreversible.
Where to Start
Clear a day for some deep thinking and craft detailed answers to these 5 critical questions for your business.
1) Who are your target customers?
Go beyond a general description like “high-income consumer” to a specific persona level – e.g. middle-income value buyer mom, high-income convenience buyer single Gen Yer, experienced business purchaser working within a centralized corporate procurement system, etc. You can decide what level of granularity works best for you, your sector, your particular business. I try to have at least 5-7 attributes per target customer segment because it allows me to become very specific about them and understand their willingness-to-pay.
2) What is your value proposition for each of those target customer personae?
e.g. Tiered plan options for the value buyer, added service aspects for the convenience buyer, etc. Again, define these value propositions in very specific terms for each target customer persona and try to differentiate what features / services / terms / conditions they will value over others.
3) What are the competing alternatives for each of those value propositions?
Think holistically and thoroughly here. Let’s go through an example I’ve been using for years because I still like it a lot for its simplicity and audacity.
In their early days, what helped Southwest become a true disrupter in the airline industry was that they identified the car as their key competition – and that they needed to offer better, more convenient service at a price that would make it worthwhile for their target customers to leave their cars at home and fly with Southwest instead. They did not focus on American, United, et al, which was a rather brazen move in those days of airline behemoths.
4) What are your key differentiators vs each of those competing alternatives?
Continuing with the Southwest example, they offered service features, in addition to lower pricing, that others did not: fun atmosphere, no assigned seating, flight attendants required to clean airplane, turn around an aircraft in 15 minutes. They also took their value proposition beyond the customer and ensured that pilots and flight attendants, who were key to the success of this game-changing strategy, also had unique value propositions: pilots paid per trip, flight attendants paid per trip (lower pay, but more flexibility), job security valued over pay, compensation in terms of stock options, extremely selective hiring policies, etc. Now, whatever the state of the airline industry today, this continues to be an effective business and pricing model for Southwest – low-cost, low-price.
5) Can you effectively communicate both your value proposition and pricing model to a customer in a way that is easily understood and considered fair?
Again, with the Southwest example, the customer knows exactly what (s)he is getting when (s)he buys a Southwest ticket. At the current time of writing, when most other airlines charge for checked bags, Southwest allows 2 checked bags in for free and advertises it proudly. And continues to get top-ranked for better customer experience and happy employees.
Your business model and your pricing model should form a virtuous cycle, meaning that each should have feedback loops into the other to help you hone them further. If you are not able to articulate specific answers to the above questions (which are really about connecting those feedback loops), no amount of financial planning or analysis will stem the inevitable profit leakage. And, if you’re really struggling to answer these questions, my suggestion is to get some professional expertise if you can. This is one of the most important aspects of your financial plan, so don’t try to muddle through as best you can.
As always, I’m happy to help too – post your questions in the comments section or email me.
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