The ABC of value based pricing

Value based pricing

Last week Casper Mønsted from Incentive gave a really interesting talk on pricing and offered 1:1 coaching on pricing issues for the participants in Danish Tech Challenge.

  

Here’s what I took with me from his talk:

You need to consider four aspects when pricing your product or service.

1.     The pricing strategy (which is the overall price model)

2.     Optimizing the price (basing the price on experienced value, price differentiation, price regulation and estimating the experienced value for customers)

3.     The pricing processes (control and monitoring, definition of roles and responsibilities)

4.     Realizing the price (mapping and optimization of discounts and discount policies)

There are three basic ways of determining your pricing:

	Cost based	Competition based	Value based
Pros	Easy to calculate Avoids loss on products	Easy to estimate Secures competitive prices	Maximizes profit
Cons	Doesn’t leverage knowledge about the customer Doesn’t leverage knowledge about competitors Doesn’t maximize profit	Doesn’t leverage knowledge about the customer Doesn’t maximize profit	Can be complex

According to Casper Mønsted value based pricing should always be preferred. Otherwise you risk cheating yourself. The value you provide might be much greater than the price you take and the cost of production.

To base your price on value you have to understand the value you are creating for your customers. And your customers might be diverse and experience different value from your product, which is why you should consider differentiating your pricing.

Compared to cost based pricing where the price is calculated on the basis of the cost of production value based pricing is calculated from the perspective of the experienced value of the customer.

Price differentiation: Can you put a price on water?

A simple example is the price of water which varies dramatically when comparing tab water, water bought at a super market (AquAdor) as opposed to 7-eleven (Kildevæld) or a five star restaurant (bling H2O).

Another illustrative example of price differentiation is Microsofts office package which are sold in three different packagings with different prices (home&student, home&office, professional) but with the same costs of production. The experienced value is different because many companies can’t do without the office package but private persons can.

A small feature change can mean a significant value leap that some customers are willing to pay for. A good example for this is the Weber charcoal grill which can be bought in two versions the budget model without ash tray and premium model with ash tray. This is a small difference in cost of production, which creates a value difference that makes tangible price differentiation possible ($100 vs. $150).

The ABC of value based pricing

1.     Identify the advantages of your product from the customers perspective.

2.     Estimate the value of the advantages.

3.     Set the price so that the value of the advanteges exceeds the price.

4.     Repeat 1-3 for different customer segments.

What you need to do to master value based pricing:

·         Map out what your customers are willing to pay

·         Ask your customers in surveys

·         Know the value drivers of your product and map the value creation

Are the value drivers of your product delivery time, quick service after purchase, warranty, service and support prior to purchase, high reliability, low noise level, product aesthetics (visual design), the possibility to buy add-on service, low energy consumption size and dimensions?

·         Calculate the cost reductions your product makes possible

·         Analyze sales data

·         Ask distributors or industry experts

As yourself the following questions:

·         What’s my product? (remember service), know the value drivers, remember the entire package (incl. service)

·         Who are my competitors? How’s your product different from theirs, how do they price their products? How will they respond to your pricing?

·         Who are my customers? Does your product deliver different value to different customer segments? Can this be used for price differentiation?

·         Will my price be experienced as fair? Can you explain your pricing? Which reference price do your customers have?

Price differentiation 

	Premium	Standard	Budget
Characteristics	All inclusive Few people buy this, but the package exists as an anchor and benchmark for the price you actually want people to pay.	The typical package The package you want people to buy Has to have the most important features	Low fidelity There are good reasons to choose the standard model
Price ratio	15	5	3

When differentiating price always create the reference for comparison yourself, otherwise your customers will find one themselves, and that one you can’t control. And make sure that the price your customers see first is the premium price, so that becomes the anchor and benchmark for your lower prices.

Pricing is important for any business. Give it the consideration it deserves and price it smart!

The fallacy of secrecy

Excerpt from Founder Institute blogpost by Joe Garza on 9/24 2014  

While it is common among founders to be hesitant about divulging their startup secrets, the truth of the matter is that your company can benefit greatly from telling people what your idea is about and what you hope to achieve. Read on to find out why.

In this exclusive video, Adeo Ressi, Founder and CEO of the Founder Institute, explains why "Nobody is Going to Steal Your Stupid Startup Idea".

Myth #1: “I Should Save My Startup Idea Until It’s Refined”

Reality: You should share your idea with everyone you meet. If you plan on pitching your idea to potential investors, why not practice beforehand? By sharing your idea with as many people as possible, you can get feedback early on to prevent wasting time on an idea that won’t sell. In a Courtney Seiter-penned article titled Why No One Will Steal Your Startup Idea, Buffer CEO and Co-Founder Joel Gascoigne says:

When you build a startup, you’re basically creating something that doesn't exist already. In order to figure out if your idea is actually going to work, it’s essential that you share it with people. You’re going to have to do it sooner or later. The longer you leave it, the more risk there is that you spend a long time working on it, and then eventually you put it out there and find out it’s not something that resonates.

Myth #2: “My Startup Idea Is Too Unique To Be Shared”

Reality: No, it’s not. Just look at the countless companies that offer the same product. If you have an idea for a startup, there’s a very good chance that there are a multitude of other entrepreneurs working on the exact same concept. But don’t let that deter you, as you should focus less on the idea itself and more on how you plan to execute it. Here’s what Cory Levy, Co-Founder at One, Inc., has to say in a Linkedin article titled Startup Secrets: Should I Hide My Business Idea?:

Ideas are a dime a dozen; it’s the execution that will set you apart from the rest. Chances are that there are people developing the same thing that you’re working on now. We plan to compete not by keeping our idea secret, but by building the best possible team and by creating the best solution to the problem we are solving.

Myth #3: “People Will Steal My Startup Idea If I Tell Them What It Is”

Reality: Most likely not. The chances of someone stealing your idea are pretty slim. In fact, sharing your idea with others is a great way to drum up interest in your company and makes getting help easier. Still not convinced? Here’s what serial entrepreneur Alexander Muse has to say in a Startup Muse article titled Should you share your idea?:

If you keep your ideas a secret it will be impossible for anyone to actually help you. Could someone steal your idea? Of course, but as I’ve said before your potential competitors are more likely to become partners. You’re far more passionate about your idea that anyone else – and most people want to partner with people with passion.

If you’re still reticent about sharing your idea with others, take into account the multitude of opportunities that your company can benefit from by simply divulging what it is you do and how you’re going to do it. And remember:

If someone does take your idea, they will never have the passion you have for it because they didn’t come up with it.” - Joel Gascoigne

Our Dangerous Obsession With The MVP

TechCrunch blog post March 1, 2014 by Bill Aulet (@BillAulet)

Editor’s note: Bill Aulet is the managing director of the Martin Trust Center for MIT Entrepreneurship and a senior lecturer at the MIT Sloan School of Management. He is the author of the recently released book, Disciplined Entrepreneurship: 24 Steps to a Successful Startup.

Building stuff does not make you a startup.

“But don’t we need to build stuff and iterate quickly?” I get asked a lot.

Well, sure. Once upon a time, when companies used the “old-school” waterfall model to develop products, pushing entrepreneurs to think in terms of building a minimum viable product as quickly as possible made sense. It substantially accelerated the development process. By narrowing the product scope to core features, you start the customer feedback loop quicker and you can more rapidly iterate based on that feedback.

But the pendulum has swung too far toward building stuff and away from spending some time getting to know your customer first. And the result is that more startups are building blindly, without focus, as well as falling victim to the “IKEA effect.”

The IKEA effect, coined by Michael Norton, Daniel Mochon, and Dan Ariely, is that when you make something yourself, you value it way more than you should. The trio did tests showing that amateur origami makers valued their creations as equal to those made by experts – even though the expert-created pieces were objectively of a much higher quality. The phrase is named after the well-known Swedish furniture chain where “some assembly required” is an understatement. As a result, as soon as we build something, we all tend to move increasingly from inquiry mode to advocacy mode at the very time where the former is needed and the latter can blind us.

As soon as we build something, we all tend to move increasingly from inquiry mode to advocacy mode at the very time where the former is needed and the latter can blind us.

One of our recent alumni teams, who will remain nameless for reasons you’ll quickly see, is absolutely in love with the technology they have created. They have developed some impressive award-winning technology which has the promise to significantly improve the Human Computer Interface. They have built a demo that is in high demand, and each time someone expresses interest in a piece of their technology, they get excited and add some more to address the interested party’s desire. With their demo and impressive technological skills, they have gotten money from business plan competitions and investors, which I think is possibly the worst thing that could have happened to them.

Neither the “someone” watching their demo at a conference nor the business plan judges nor the investors are paying customers. What the team calls an “MVP” is simply a sexy proof of concept. They say they are testing hypotheses, but the hypotheses they are testing relate to technological feasibility. They claim they are “pivoting” – which means they have run out of business ideas but not money – on a regular basis. And as a result, they’re not making progress.

Why are they devoting all their time and money to building when, as a startup, they have precious few resources? Because they built it themselves, and they love it, and they’ll be darned if you tell them their MVP isn’t attracting any paying customers and that they should instead focus on an honest dialogue about customer needs. They are too beholden to the IKEA effect. They claim to be in inquiry mode but really are much more in advocacy mode for what they have developed.

Compare this to another recent alumni team, FINsix. The company won recognition and a slew of awards last month at CES for its product, a miniature laptop power adapter that is a quarter the size of today’s power bricks.

But when they first showed up in my class, they only had a promising technology from the labs. I’m sure that power supply geeks will be impressed by Very High Frequency (VHF) switching that is 1000x faster and with a 10x reduction in converter size. “The elimination of heavy components, like magnetic core transformers, enables superior resistance to mechanical shock and vibration,” according to their website, which sounds like a good thing, too.

However, none of that helps a well-defined group of customers address a pain that they’re willing to pay money to address. FINsix recognized that, and so rather than build, build, build, they took some time to learn about customer needs.

“We were able to test the [VHF switching] concept with many different markets using an electronic brochure and extensive surveying to determine our beachhead market of laptop power suppliers,” co-founder and CEO Vanessa Green told me. A brochure.

There is a lot less emotional investment in an electronic brochure than an MVP that the engineers build. And their analysis allowed them to consider a range of markets, from cell phones to LED lighting, before determining that laptop power adapters were the best way to gain a core group of paying customers that would sustain the company so that it can develop more products.

You can’t develop the right product for your customer if you fall in love with a prototype that nobody wants to buy.

Had they fallen in love with their technology, or the first prototype they built, they may never have gotten to the point of selling a consumer laptop charger. Think that app makers are immune to the dangers of an MVP? Sure, an app has less initial investment required, but otherwise, a business is a business. It’s easier to spin the roulette wheel when you don’t need as much upfront or sustaining capital, but that doesn’t mean you have a solid startup.

You can’t build great products in the dark, without a well-defined customer. And you can’t develop the right product for your customer if you fall in love with a prototype that nobody wants to buy.

So unless your end game is hoping that before the money runs out a competitor will buy you for your engineers or technology, you need to stop obsessively building, and start an honest dialogue with potential customers about their needs. It may not be as fun as tinkering with a “product,” but it is far less stressful than playing the acquisition lottery. That is what we call “disciplined entrepreneurship” where you can have both great technology and great marketing, leading to epic products. It is a false dichotomy to think you can only have great technology or great marketing, as some commenters have recently claimed in a myopic comparison of Stanford and MIT graduates.

Think I’m a conservative East Coast entrepreneurship instructor who’s behind the times? Last week when I was in San Francisco and chatted with David Bergeron of T3 Advisors and Cory Sistrunk and Ed Hall of Rapt Studio, they were right on the same page. “The MVP mentality has unintentionally taken us away from ‘user-centered design’ and a focus on the customer,” they told me. “We have to focus on the WHY before we can focus on the HOW and WHAT.”

For the entrepreneur, stop obsessing about your MVP.  Your first question, before HOW and WHAT, has to be “FOR WHOM?”

Bootstrap with a service before launching your product

Excerpt from a Havard Business Review blog postby Sramana Mitra | 11:00 AM February 3, 2014

Raising funding for startups in Silicon Valley is a low probability game. Fewer than 1% who try actually succeed.

Outside the Valley, the startup eco-systems are mostly immature, and the probability gets even lower.

The bar to raise seed funding is getting higher and higher. Seed investors are mostly operating as growth investors, expecting that the entrepreneur will somehow manage to bridge the gap and bring a concept to realization. In fact, what these investors really want is to invest in businesses that have traction, not just validation.

In short, they want to come to the rescue of victory.

As an entrepreneur, how do you go from concept to traction? How do you bridge the seed capital gap? What do you do if you are full of dreams, but stuck in the gap between concept and seed?

 

Offering a service is one of the best ways to bootstrap
This remains a controversial point of view. Most industry observers take the position that companies get distracted if they try to bootstrap a product with a service. But from where I sit, bootstrapping products with services is a tried and true method.

In our incubation methodology at 1M/1M, we actively encourage entrepreneurs to engage in services businesses. In particular, we encourage them to immerse themselves with customers, learn their problems, and do some services projects that not only generate cash, but also generate customer intimacy and trust. Through these kinds of dialogues, entrepreneurs diagnose real pain-points in customers, and end up building products that customers are willing to pay for.

A couple of examples:
AgilOne, a company that provides cloud-based predictive customer analytics, was founded by Omer Artun in 2006. Initially, the company relied entirely on services to get close to customers, understand and address their problems, and in the process generate revenues. Today, AgilOne’s product is a software-as-a-service platform. Much of what the company learned about its customers in the services mode has been developed into its product, although a good percentage of revenues still comes from services.

Andy Chou, a PhD student at Stanford, also bootstrapped his company, Coverity, using services. Andy’s research was financed by DARPA at the university. The technology allows automated cleaning up of large code-bases, and was licensed back to the company by Stanford.

Andy recounts his funding story: “We talked to all of the VCs and told them that if they wanted to invest in us, we would only consider certain types of deals. We presented them with our range of acceptable terms and indicated that if we did not receive offers in those ranges, we were content to continue bootstrapping the company as we had a solid clientele. We were in a sweet position where we had revenues and did not need to receive additional investments to succeed. As a result, we got a good deal from Benchmark Capital. They invested $22.3 million in us in 2007.”

Both of these companies bootstrapped to profitability via services. Not only is this a viable method of getting your startup off the ground, it’s a proven method of reaching profitability, as well. In some cases, it can take you to the enviable position of having VCs like Sequoia or Benchmark knock on your door. In other cases, you could even have investment bankers come calling, wanting to take you public, and a whole slew of late-stage investors wanting to shower you with funds. All those are desirable outcomes.

For other ways to bootstrap find inspiration in this blog post: How to bootstrap your startup by George Deeb

A world of experience in the form of advice

Whether you're engaged in a startup or a maturing company, you most likely often find yourself operating in circumstances characterized by extreme uncertainty regardless if your challenges concern acquiring new customers, refining your value proposition, attracting capital etc.

A skillful way to deal with uncertainty is to plan for fast learning and systematically test your assumptions in order to either validate or change them. A simple and extremely useful way to do this is to talk to those whom you expect to be your primary customers. 

Another powerful way to accelerate learning is to establish a relationship to accomplished individuals who are willing to lend their experience and insight to the venture you are undertaking. That is; entering a mentor relationship. If you manage to build trustful relations to mentors they will apply the world of their experience to your venture in the form of valuable advice.

However good mentor relationships don’t just evolve by themselves. So what do you need to consider to build such relationships? Here are 10 basic principles formulated by Martin Zwilling on his Startup Professionals blog for both the mentor and mentee to remember to get the most out of any mentoring relationship:

1. Good mentoring requires building a relationship first. A positive business or personal relationship between two people normally requires a high degree of shared values, common interests, and mutual respect. Remember that good relationships take some time to develop, so don’t assume that your first discussion will seal the deal.
2. Agree on specific objectives and time frames. Mentoring that consists of random discussions is not very satisfying for either side. I recommend one or more early discussions of mutual objectives, with a written summary of goals and expectations from the mentee to the mentor, with timeframes and milestones.
3. Make efficient use of time for both parties. This means being respectful and diligent about scheduling and keeping appointments, and returning emails and phone calls. Don’t attempt to multitask, or allow constant interruptions, during meetings. Book follow-up sessions, with an agenda, rather than fill time with random discussions.
4. Identify strengths and weaknesses early. Both the mentor and mentee should put their cards on the table, to avoid surprises later. Then both should look for opportunities to leverage strengths, and shore up weaknesses. This avoids wasted time and speculation, and provides the motivation to bring in other experts or mentors as required.
5. Mentor feedback must be thoughtful, specific, timely, and constructive. An important aspect of a mentoring relationship is how the mentor provides feedback to the mentee. Formulate negative feedback in a constructive fashion. Using open-ended questions that start with “how” or “what” help the mentee to arrive at their own solution.
6. Mentees should avoid any defensive reaction to feedback. The right response to most mentor feedback is a thoughtful question for clarification. Immediately responding with “reasons and rationale” to every feedback will be read as insincerity, and will likely end the mentoring relationship quickly.
7. Practice two-way communication and candid feedback. Mentoring is not a series of monologues and lectures, from either side. But candid feedback means not pulling punches when they are deserved. Both sides need to practice active listening and thoughtful questions. Constructive conflict is good.
8. Agree to deal with unforeseen challenges openly. The most common challenges involve time and accessibility demands on either side, or the level of help expected. Both sides need to honor business boundaries, and not stray into personal relationship issues. Agree up front on how to end the relationship if other unforeseen circumstances arise.
9. Celebrate successes, and deal openly with failures. This will help the learning process and build the mentee’s confidence. With patience and time, the partners should develop a good rapport and become more comfortable with openly and freely conversing with each other.
10. Evaluate mentoring requirements on a regular basis. The mentee, as primary beneficiary, should be proactive in making sure the review process occurs on a regular basis, perhaps quarterly. This allows for frank discussion of unanticipated changes, and the potential for discontinuing the process and declaring success.

Martin concludes:

“The end of a mentoring relationship should be seen as an opportunity to review what did and didn’t work, and more importantly, to reflect on the results, so that every lesson that can be learned from the relationship is recognized.

 
Both the mentor and mentee should celebrate the successes, review the learning from failures, and conclude the relationship with positive feelings. To bring it full circle, mentees should now consider passing on their new knowledge and skills by entering a new mentoring relationship – as a mentor. That’s the ultimate satisfaction.”

A secret sauce for running Lean?

By Thomas Klem Andersen, Published on January 20th 2014

Last week the Copenhagen Lean Startup Circle and Silicon Vikings co-hosted yet another interesting event on the Lean Startup concept. This time at Copenhagen School of Entrepreneurship (CSE) headlining Ash Maurya who has authored the Lean Startup methodology book Running Lean.

 Ash is a serial entrepreneur and a keen ambassador for the Lean Startup movement, which is sweeping the startup world at the moment. He is the creator of the Lean Canvas (start your own here), author of the books Running Lean and the Customer Factory (in process). Back in December 2013, he headlined the Lean Startup Conference in San Francisco and he is behind one of the most read startup blogs in the world: www.practicetrumpstheory.com.

In his own words his Lean journey started when confronted with the works on Customer Development and Lean Startup pioneered by Steve Blank and Eric Ries. He joined in on the conversation and started applying and testing the principles on his own ventures all the while sharing his learnings on his blog mentioned above. The blog eventually turned into the Running Lean book aimed at helping entrepreneurs raise their odds of success.

At CSE Ash shared some of the insights from his book. Here I will share what I took with me from the event:

The myth about the perfect idea and the visionary entrepreneur

Entrepreneurial success is not so much about starting with the perfect idea. Rather it is a question of arriving at a plan that works before you run out of resources. For this you need to be willing to learn and you need to be ready to do it fast. In contrast to the glamour picture of the entrepreneurial genius, most successes are based on a lot of failures and learnings along the way.

Some principles of Running Lean

-       Plan for systematic learning

To be a systematic learner you need to find ways to test your assumptions and visions. You also need to be aware of the fact that entrepreneurs often fail to see the entire business potential of initial and even mature ideas.

-       Listen to customers

A simple way to design for fast learning, which is key to the lean startup concept is talking and genuinely listening to customers. By doing so you can learn about their problems and start figuring out how to solve them. The most important entrepreneurial mantra in this context is: You don't need to build a solution to validate if you've found a problem worth solving! Simply ask your customers. This practice can save you a lot of time and a lot of wasted resources and thus get you running Lean.

-       Test to learn

Document your plan. Knowing what you are doing and how you are doing it, while measuring for progress will let you test the plan in order to change it for the better. This includes testing solution and product feasibility, testing customer demand and testing business model repeatability etc.

-       De-risk your business model

Identify the riskiest parts of your plan and work systematically on de-risking your product and business model

-       ‘Canvas’ your plan

An easy way to do this is to work with the Lean canvas which condenses a business plan to one sheet and brakes it down into workable elements.

There’s no secret sauce and no silver bullet

There's no guarantee for success but living by the Lean principles will raise the odds of it. However as Ash put it: You should never take the Lean principles on faith. You have to go test them out for yourself! Running Lean is not a theory, it is build on experience and requires hard work, strong intention and an attitude supportive of learning, focus and speed. Thus Ash supports Steve Blank’s urging mantra for entrepreneurs to get out of the building which is clearly emphasized by the title of his blog: Practice trumps theory!