Mastering Startup Pricing Strategy for New Product Introductions
A friend with a healthcare startup discussed pricing strategy with me after reviewing Y Combinator’s Kevin Hale in the video “Startup Pricing 101.” My friend learned that setting prices too low can hurt a startup by undermining the brand and perceived value for the early adopters critical to young startups.
Revisiting Past Insights on Pricing Strategy
Hale’s presentation reminded me of a piece I wrote in 2007, “Pricing New Products: Turning Portfolio Uncertainty Into Profits,” for The Journal of Professional Pricing. I was working for Rapt, a startup specializing in pricing software, which Microsoft acquired in 2009. In my white paper, I formulated pricing strategies for what I termed as the five types of New Product Introductions (NPIs). The table below, sourced from my paper, summarizes these pricing strategies:
Startups often innovate with breakthrough products and also introduce what I label as “replacement products” – evolutionary products designed to challenge established incumbents. Hale addressed entrepreneurs involved in both of these categories during his talk.
Understanding the Pricing Landscape for Startups
Hale explained that (early) startups are either in a stage of product development or product introduction. At either point these companies are selling to early adopters willing to take a risk buying a product that could help them leapfrog their competition. Thus, early adopters focus more on value than price. According to the breakthrough pricing strategy, the startup should set a premium price. On the other hand, the replacement pricing strategy uses price to clearly communicate value relative to incumbent products.
Hale recommended that startups target pricing at one-tenth of value and increase price until they are losing about 20% of deals or customers. This strategy implies that a breakthrough NPI can achieve quicker and higher price increases than a replacement NPI. The breakthrough NPI’s pricing is anchored to the perceived value of early adopters, whereas the replacement NPI’s pricing is more anchored to the perceived value early adopters associate with incumbent products.
Avoiding Common Pricing Mistakes
Hale pointed out that start-ups can make any one of four pricing mistakes: pricing too low, underestimating their cost, misunderstanding their value, or focusing on the wrong customers. Consequently, Hale advised start-ups to “get organized when optimizing pricing.” In essence, entrepreneurs must conduct thorough research, gain as much clarity as possible, and base their pricing on solid economic fundamentals. These fundamentals include understanding what drives entrepreneurs to sell and what motivates customers to buy. Selling gets more compelling the greater the difference between price and cost. Buying becomes more compelling the greater the difference between value and price.
Deciphering the One-Tenth Pricing Rule
A starting price at one-tenth of value at first blush seems low. Yet, I interpret Hale’s rule-of-thumb to mean that a startup’s product needs to create so much value that a tenth of that value provides plenty of economic value to the entrepreneur’s business. Otherwise, the product is likely focusing on the wrong customers or is headed for failure. It is even possible that the new product is more of an enhancement, extension, or complement. Entrepreneurs need to understand the differences.
Conclusion
The process for startups to set the prices of new products is an intricate balance of capturing value and attracting early adopters. While startups must avoid pricing too low, underestimating their cost, misunderstanding their value, or targeting the wrong customers, they also need to structure their prices to reflect the significant value their products bring. Whether they are breakthrough or replacement products, pricing should be rooted in economic fundamentals, understanding both what motivates customers to buy and what incentivizes entrepreneurs to sell. Following Hale’s advice, startups must strive to create a product that delivers such exceptional value that pricing it at one-tenth of its value still yields substantial economic benefits for the business. The journey from product conception to market introduction demands a clear understanding of pricing strategy to increase the odds of running a successful and profitable venture.
