You have to figure out: What is the target market willing to pay? This question can be hard to answer.
McKinsey has a nice blog post that covers the ins and outs of pricing and pricing research techniques. One thing we know about pricing research though, is that it tends to underestimate the price people are really willing to pay. The simple fact that we are asking about price tends to drive down people’s estimates. It’s human nature to respond with a lower price.
Instead of focusing on what they are willing to pay, try to understand the value your product delivers.
At a minimum, you need to understand the reference price customers use. Think of a reference price as the typical price customers expect to pay for a category. Starbucks is recognized has having been bold because they wanted to charge $3.50 when the reference price for coffee was under $2.00.
For pricing specifically, you need to answer a few key questions:
- What do prospective customers value about your product offering?
- What incremental benefits do they get versus their other choices?
- How much are these improvements worth over competitors’ products or existing solutions?
- What’s the reference price they use?
- What features of the offering do they view as “table stakes”—that is, which features must a product offer in order for the customer to consider it at all?
- For which will they pay a premium?
In the simple example below, people are willing to pay a lot for a brand name. That’s not likely to be the case for startups or small firms because their brand name is just not known.
Figure caption: Pricing a Black T-Shirt
And, it helps to think creatively once you know what customers’ reference price might be. There are a variety of ways to get a price higher than the reference price. Here are just a few to consider:
- Build more value into the base – Starbucks did this by creating a completely customized coffee.
- Give away the hardware for free, but charge on the consumable part – This is the razor and blades model.
- Keep a low price on the base model, but upcharge for add-ons – This is the idea behind the freemium model, but the base does not have to be free. Low-fare airlines are another good example. The flights are cheap, but you pay extra for luggage, seat selection, boarding priority, and drinks on board.
- Bundle parts to give customers a discount – This is the value meal model. A burger, fries and drink together is cheaper than sold separately.
- Create a membership - Instead of a series of transactions, establish an ongoing relationship that they value.
While pricing may be challenging, there is room for creativity. The key is to try and figure out what potential customers will accept. Don’t worry - if you price too high, you can always drop price later. That’s what Apple had to do when they introduced the first iPhone. Within 30 days, they dropped the original price by $200, or about 30%. Some people were upset, but it set the iPhone on a faster sales trajectory. And the rest is history.
So don’t be afraid to build value in your offering and price it to reflect that. Experiment and be willing to adjust based on market feedback. Don’t assume your only option is lower price.
Todd Saxton is associate professor of strategy and entrepreneurship and M. Kim Saxton is clinical professor of marketing at the IU Kelley School of Business at IUPUI. The Saxtons are co-authors of “The Titanic Effect: Successfully Navigating the Uncertainties that Sink Most Startups.”