I’m sure we have all heard of that fraud where tourists walk into a restaurant, order some basic food item-dosa, idli kind of thing-and are presented with a bill for thousands at the end of it. And the swindlers at the restaurant claim that the tourists should have checked the prices on the menu before ordering. I can’t say for sure if such scams have taken place, but such stories certainly do the rounds once in awhile.
If such a situation happened for real, would you say the tourists are at fault for not checking the prices beforehand? Certainly not. As a society, we have a cultural perception that price is fixed-more or less. When you go to a supermarket and buy some biscuits, the packet comes marked with a maximum retail price (MRP) so you clearly know how much you should be paying for it.
This applies not just to tangible goods, but also in the case of services. If you go a salon for a haircut, you have a general idea of how much you will end up paying. You may not always know the exact figure, but you have a general expectation regarding how much a service should cost.
However, this system works only if you are selling a new brand of an existing product or service. If you started selling a new brand of socks, you would know how much to charge for them mainly because you can refer to the prices of socks from other brands.
If you are running a startup, however, this easy system of figuring out how to price your products or services rarely works. The reason being that a startup by definition is trying to sell a product or service that is brand new, and has not existed before. Consider Dropbox. People carried around USB drives and CDs for their data, and shared files using email attachments.
Then Dropbox comes along, and starts to offer a completely new solution that has not existed before: they offer you server space in the cloud, so you can upload your files to a cloud-based Dropbox folder, and access them from anywhere. How much should Dropbox or Uber should charge for their services?
Conventional theory lists three pricing approaches: Maximization (focused on revenue growth), Penetration (focused on market share), and Skimming (focused on profit maximization). Let’s do a quick overview of each of these.
Maximization: This approach prioritizes getting the highest possible revenue growth in the short term. Using this approach, you would focus on getting the highest possible price for each sale.
Penetration: The idea here is to price your offering so low that you can quickly win dominant market share. WhatsApp’s pricing strategy-charging a nominal few rupees annually-is a great example of this at play. Another example currently at play is the launch of Reliance Jio services-low-priced in order to quickly acquire a large number of users.
Skimming: This approach sometimes has negative connotations. The idea here is to start with a high price, and then gradually introduce options at lower prices so that you are making the highest possible profit from each new catch of customers that you acquire. This strategy is more relevant for hardware manufacturers-Apple has perfected its use of this strategy-than software focused startups. This is because software is almost always an iterative offering that gets better over time, so it is rarely possible for software-focused startups to begin by charging the highest amount possible.
However, just knowing about these pricing approaches is not enough for you, as an entrepreneur, to decide how much you can charge for your solution. Not surprisingly, pricing is a very complex topic. You need to consider your own cost of production and maintenance, your capital expenditure as well as support costs. You also need to consider value perception from the customer’s point of view.
And, as relevant, you need to examine how your competitors (you can have competitors even if you have a unique solution that has not existed before) are pricing their offerings. In addition to these and many other factors, you also need to consider when to ask your customers for money. In the next article, we will go into more detail regarding these facts, and how you can weigh all the different factors to arrive at an actual price point for your solution.
*This article was originally published on March 20, 2017 in Telangana Today, and can be accessed at Pricing strategies for Startups