Successful Startups Almost Never Compete On Price

09 MAR 2010

by Doug Richard, founder of School for Startups

I have counseled and supported many thousands of entrepreneurs over the years, and something that never ceases to amaze me is how many initially enter the market with the intent of competing on price. Since I have an extensive background in sales and marketing, and since I’ve managed more than my fare share of sales teams, the idea of maximizing the number of low margin sales a business makes just seems completely insane.  Startups rarely have the returns to scale or the marketing and sales efficiency to do large volumes of business profitably at a low price.

I believe this problem is caused by a fundamental misunderstanding about how prices are set, a lack of insight into why people buy what they buy, and no formal education on what other meaningful qualities products can compete on.  This article reviews some fundamentals that every entrepreneur needs to know.

The Process of Perfect Pricing

Prices are insanely slippery numbers.  They are defined by what one person will pay another for a given product or service.  They are not defined by what a product cost to produce or what profit margin a producer would like to have.

For example, all the ingredients in a litre bottle of Coca Cola, the bottle itself, and all the branding painted on it, costs less than 10 pence. The Coca Cola company feels no need at all to price its products at a few pence per bottle. Sometimes this truth is explained away by pointing out how much the company spends on advertisements, maintaining its brand, etc.  But the truth is that if customers decided they were only going to pay 15 pence a bottle, Coca Cola would change its branding and all other elements of its business model to keep profits high while meeting that requirement or they would stop producing the product.

The price people are willing to pay for a product or service can be derived from many factors. Which factors people use to make their decision will vary from person to person and from day to day. A man trapped in the rain on the way to a business meeting will spend quite a bit for an umbrella.  Someone who buys airplane tickets online will almost always want to spend less than someone who buys tickets from a travel agent.

Factors people may take into account when figuring out how much they will pay for something include:

-    The cost of the problem a product or service solves
-    The revenue owning or using a product or service can generate
-    The status derived from owning or using a product or service
-    The improved perception of self derived from owning or using a product or service
-    The cost of the crisis a product or service prevents
-    The price of substitute products and services
-    The price people pay for related products and services
-    The location where the product or service is being provided
-    Who will be using the product or service
-    Customer service provided post sale
-    Pre-sales support leading to a better solution for the customer.

Sales and marketing professionals can choose to target customers based on any of these characteristics. They can target their marketing materials and their marketing efforts on customers who do relatively little in the way of comparison shopping. In many cases this will require the business to adjust the products and services they offer to address the needs of these less “price sensitive” customers.

For example, the price of a tow truck to pick up a car may be just £20.  But a service that guarantees they will rescue a stranded daughter in the middle of the night on a dark road may be worth £80. If your objective is to sell tow truck services,  you should obviously consider modifying your business model to provide the more profitable solution.  After all, many people purchase towing service plans but few use them even once a year.  In fact, this is a demonstration that sometimes the number of people willing to pay more for a service is much higher than those willing to pay less.

Good pricing requires good market research. You must look for and find people who are ideal customers for your product.  You must come to understand them well and you must give them what they need.  When you can do that, you won’t need to compete on price.  You’ll be able to compete on everything else.

Update: Watch Doug’s exclusive video “Prices Are Discovered“.

Looking for More Help?

School for Startups offers support and practical instruction for UK entrepreneurs through online events and face to face courses.  For more information, please visit www.schoolforstartups.co.uk or follow us on twitter at @s4startups.

 

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