Pricing

Pricing is a crucial aspect of entrepreneurship that requires thoughtful consideration before developing your business idea. You need to recognize that pricing is not just about assigning a cost to your product; it's about understanding customer perception and the value they place on your offering. Interestingly, sometimes setting a price, even a high one, is necessary because free items are often perceived as low-value. An extreme of this phenomena are Veblen (opens in a new tab) goods, where the demand for a product increases with its price due to its perceived status symbol, such as luxury items like Birkin bags or even iPhones.

Pricing Strategies

The price of your product should mirror the perceived value you aim to deliver. By the time customers encounter the price, they should have encountered several touchpoints that build up this perceived value, because price is relative to the perceived value you are delivering.

There are several pricing methods. 2 of which:

1. Customer-Driven Pricing:

   • Willingness To Pay (WTP): This method involves directly asking customers how much they would pay for a new product.
   • Van Westendorp Price Sensitivity Meter (PSM): This technique helps establish a price range through four key questions about customer perceptions of product value.

2. Business-Driven Pricing:

   • Gabor Granger Technique: This approach involves presenting customers with different price points and gauging their willingness to pay at each level.
   • Monadic Price Testing: Customers are shown only one price point from a range, ensuring more genuine responses. This method, though more costly and time-consuming, provides a more accurate estimation of price sensitivity.

Willingness To Pay (WTP)

This method is beneficial for completely new products, where there's no established market price. You talk to customers, explain the concept, show how it works and ask how much they are willing to pay for it. Asking open question this way engages customers in the value the product brings.

The most simple quantitative methodology: Present/demonstrate the product and ask "How much would you be willing to pay for this?". This simple question is mainly used in two situations only:

1. For a radically new product, with no idea of what the customer will accept
2. For bargaining products (i.e. where bargaining is allowed, e.g. second hand products)

Van Westendorp (PSM)

This is also called the Price Sensitivity Meter (PSM). This method helps identify the optimal price range for your product by understanding customer perceptions of value, ranging from "good value" to "too expensive." In this method, you ask four questions. You present the product, then ask the price point at which it:

1. It would be good value
2. It becomes expensive
3. It is too expensive
4. It is it too low

These four questions help understand the price range within which the product should be sold.

Gabor Granger

In this method, you present 4 price points to the customers and ask if they'd be willing to pay at each one. For each price, they are asked their willingness to buy at different price point (yes, no or 5-point scale).

Extension: if no, ask why it is "Too expensive" or "Too cheap". Each time you use the previous price point to go higher or lower with the next one, so you can get the most value for your product.

Monadic Design

In this method, you want to test four to five price points, but you only show one to the customer. You split the group of customers that you want to talk to into groups depending on how many price points you want to test. You only have one price point for each customer so it's not very obvious that's it's a price question you are asking and you get a much truer answer.

Ideal method gives more accurate estimation of price sensitivity (than WTP, PSM, GG). However, needs more respondents, take more time, and is more costly than the other methods.

Pricing Frameworks

"Charge as much as possible without cracking a smile", Dan Kennedy

They key frameworks here:

1. Price to value discrepency
2. Virtuous cycle of Price
3. High Prices = High value

Price to value Discrepency

Focusing on increasing value rather than lowering prices creates a much more sustainable business model where high prices drive high value, better customer engagement, and improved business outcomes.

• Understanding Price vs. Value:

  • Price is what you pay, and value is what you get.
  • The goal is to increase the discrepancy between the two, so the perceived value far exceeds the price.

• Strategies to Increase the Discrepancy:

  • The Hard Way: Lower the price to increase the perceived value. This method often leads to competing on price, which can be unsustainable.
  • The Easy Way: Focus on increasing the value of your offering. This approach shifts the decision from being price-driven to value-driven.

• Creating a Vacuum:

  • You want to sell in a vacuum, where the customer perceives no alternative and believes that no one else can solve their problem.
  • This can be achieved by enhancing the offer's unique value proposition and making it incomparable to competitors.

• Providing a Discount Through Value:

  • We still want customers to feel they are getting a deal, but we achieve this by increasing the value rather than decreasing the price.
  • This involves adding elements that enhance the overall value, making the offer irresistible.

Virtuous Cycle of Price

Most business owners are not competing on price or value. In fact, they're not actually competing on anything at all. Their pricing process typically goes something like this:

1. Look at marketplace
2. See what everyone else offers
3. Take the average
4. Go slightly below to remain "competitive"
5. Provide what their competitors offers with a "little more"
6. End up at a value proposition of "more for less"

The problem is that everyone is broke. Don't compare yourself to them! When you have a commodity-driven or price-driven offering, you continue to compete on price. This cycle keeps going until everyone is barely afloat. It is the wrong game. It doesn't matter what anyone else is charging. We want a virtuous cycle of price, instead of a vicious cycle of price, where everyone keeps lowering their prices until no one can do any more for any less. So just increase your prices!

• Impact on Clients:

  • High prices increase the perceived value of the offering.
  • When customers pay more, they invest more emotionally, leading to better engagement and outcomes.
  • Higher prices lead to increased emotional investment from customers.
  • This increased investment results in better perceived value and higher quality results.
  • As results improve, customer satisfaction grows, reinforcing the perception that the high price is justified.
  • More profits allow for reinvestment in the business, further improving the quality and value of the offering. So, a higher revenue for fulfillment per customer.

• Impact on Business:

  • Higher prices allow for more profit, leading to better business sustainability.
  • Increased profits enable the business to attract higher quality staff and improve service levels. You get better.
  • Sales teams with higher conviction in the product can sell more effectively, driving even better results.
    • Imagine if you were trying to convince a past version of yourself from 10 years ago to buy bitcoin, but you couldn't tell it was you - that's the level of conviction you want.

High Prices = High Value

There is scientific evidence ¹ to show that when people think a wine is more expensive, they enjoy its taste more, even if it's the same wine. This increased enjoyment is also reflected in their brain activity, confirmed using functional MRI. This study shows that marketing actions, like raising prices, can actually change how much people enjoy a product - prices is a component of value in and of itself.

• Bi-directional Relationship Between Price and Value:

  • People often perceive higher-priced items as higher in value.
  • This perception can be leveraged to enhance the actual and perceived value of your offering.

• Creating a New Category:

  • The goal is to be so much more expensive that customers must pause and think, "This can't be the same category of solution as everyone else."
  • This forces customers to make a decision in a vacuum, as they see no comparable alternatives.

• Increased Quality of Prospects:

  • Charging higher prices can filter out less serious prospects, leaving only those who truly value the offering.
  • This leads to a higher quality customer base, which further enhances the overall success rate and perceived value of the service.

• Practical Application:

  • Example from weight loss industry: The "six-week challenge" with a $500 upfront payment, refundable upon achieving weight loss goals.
  • This method significantly increased engagement and success rates, as customers had real skin in the game. Higher upfront investment ensured serious commitment, leading to better results and higher perceived value.
  • If you have a service where a client must perform some actions in order to be successful, then it would follow, the more invested they are, the more invested they will be. Which in turn, will create better students & better outcomes.

Example

Alex Hormozi used an example of one of his portfolio weight loss companies. Initially, their metrics looked like this:

• Monthly Revenue: $450,000
• ROAS (Return on Ad Spend): 5:1
• Close Rate: 30%
• Profit: $150,000 per month

He simply increased the prices of the products and services, and did nothing else:

• Monthly Revenue: $1,000,000
• ROAS (Return on Ad Spend): 10:1
• Close Rate: 38%
• Profit: $400,000 per month

Instead of deterring customers, the close rate actually went up from 30% to 38%. As a result, the monthly revenue more than doubled, and the profit almost tripled. Strategic price increases can lead to higher perceived value, better close rates, and significantly increased profits.

Revenue Models

• Unit Sales
  • Fee paid for every individual item sold
  • iPhone, cars
• Advertising
  • Fee paid by brands and companies to get in front of potential customers
  • E.g. Google Adwords or Facebook Advertising works this way.
• Data
  • Fee for information (e.g. online or economic behaviour)
  • Twitter, Bloomberg etc.
• Intermediation
  • Fee for bringing together two or more parties involved in a transaction
  • Ebay, AirBnB, Alibaba
• Licensing
  • Fee for use of some IP
  • Windows or Adobe
• Franchising
  • Fee for right of using brand and business model
  • Mcdonalds, Costa
• Subscription
  • Fee for continuous access to a service
  • Spotify, Netflix
• Utility and Usage
  • Fee is proportional to the usage of service
  • Virgin Media, Box
• Freemium
  • No fee for access to basic service (intent is to convert to premium customers)
  • Soundcloud, Dropbox etc.

In conclusion, pricing and revenue models are fundamental to the success of entrepreneurial ventures. Understanding customer perceptions and market dynamics is key to determining effective pricing strategies, while choosing the right revenue model can significantly impact the sustainability and growth of your business.

Resources:

• This video will make you more money than anything else on the Internet (opens in a new tab)

References: