Pricing Your Start-Up Because It’s a Company-as-a-Product
March 3, 2011
There are always two products for a start-up: one is the product sold to the end user and the other is the company itself. Many start-ups struggle with fund raising today, not that locating start-up funding is ever as easy as it is written about but it’s definitely more difficult today. If a start-up itself can be considered one of the products then the investor is one type of customer and the investment is what needs a pricing strategy.
Recently, Rafi Mohammed wrote a book “The 1% Windfall – How Successful Companies Use Price to Profit and Grow”. This book discusses how companies can capture a greater number of customers and can maximize profits by implementing a Price Blossom Strategy. What if his insights are applied to the Company-as-a-Product, and not just the product consumed by the customer?
What Rafi points out in his book is the most effective pricing strategies are value-based, but the most common method of pricing is based upon costs, mark-ups, and margins. Value-based pricing is derived by considering the customer’s next best alternative because it is a viable option.
Value and the Next Best Alternative
Knowing how your product differs from the next best alternative is important. If we look at this approach from the viewpoint of a start-up, potential investors are presented with many investment proposals – far more than they could ever invest in. They weigh the merits of each and select the best ones. But many start-ups don’t consider other start-ups to be their competitors because their end products address different markets, industries or customers. When it comes to funding, every other start-up is a competitor, and not just other start-ups, every other investment vehicle as well.
I know a venture capital firm that is closing because over the firm has only doubled the value of the investor’s money and is unable to raise money for another fund. In 1997, when the VC fund was created, the DJIA closed for the first time above 7,000. Last month, the DJIA closed above 12,000. From the viewpoint of investors in this VC fund, they could have put their money into an index fund with publicly traded companies and have had a similar return with far less risk.
Start-ups are privately-held companies, Rafi points out that the regional next best alternative needs consideration too and there are premium players in some regions. This is particularly true of the high tech centers where venture capitalists and angel investors flourish. Many investors prefer to invest locally. There are now super angels in Silicon Valley who are targeting investments outside of the valley because competition for quality start-ups is highly competitive locally.
Pricing for Subjective Versus Objective Value
Every company needs to survey how customers choose products in various pricing scenarios so that the company can gain insight into the key attributes that customers’ value and hence are willing to pay for. The challenge in setting a price is each customer values a product’s unique characteristics differently. It’s difficult for a company to understand what every individual customer values, and so the Price Blossom Strategy recommends setting value-based pricing, but then adding many ways for the customer to obtain the product: versioning, pick-a-plan, and differential pricing. Customers are unique in their subjective and objective valuations of a product. Personal tastes are keys to the different valuations, and this translates into a different willingness to pay.
Back to the company as the product and the investor as the customer view, a start-up wants to maximize its fund raising results. What do investors value? What are the different avenues of obtaining funding? How can start-ups offer different investment types to different types of investors?
Pricing for Uncertainty
Start-ups always have a questionable outcome. Much can happen in the years before investors can realize any return from their funding. As Rafi discusses in his book, customers don’t like uncertainty when purchasing a product and companies need to look for ways to alleviate these customer concerns. There are some firms now that recognize this issue with investors and are offering ways to provide liquidity to stakeholders before the end result is achieved.
The book concludes a combination of strategies is needed to maximize results. This is definitely truism about today’s start-ups. In this book, Rafi outlines core forces affecting value, as well as characteristics to consider when evaluating the next best alternative. Too many entrepreneurs and start-ups pursue only one course of action before considering others, instead of pursuing many.
Filed under: Management,Start Up Funding
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