Recently a promoter who had been working on a launching a B2B start-up was discussing the issue of pricing and gross profit with me. It was clear that the decision around pricing was coming late-ish in the proposition development plan. The promoter was largely influenced by what competitors were charging and, assuming her customers would compare her pricing to her competitors, she was anxious to make the customer’s decision to buy her product as easy as possible. She was coming close to choosing a price that would be 10% less than who she thought was her nearest competitor.
What was interesting was the promoter had spent so much time doing minimal viable product testing around customer needs and demand, betas, pilots and competitor analysis etc that she had never really invested time or brain matter in justifying her pricing assumptions. In fact she had very little logic to the pricing other than referencing what she perceived her competitors were at. Funnily enough – the competition were not large companies, they were similarly start-ups, but were out of the blocks a year ahead of this promoter’s business.
Pricing is of massive importance in a business plan. Pricing is not only a core driver of revenue and profitability – it signals the positioning of the company in the eyes of its customers and competitors.
In the same way that you could write a different business plan nearly for each different category of customer you hope to sell to – you could write a different business plan depending on each pricing strategy you choose.
– What is the price per unit?
– What will be the revenue per customer?
It is amazing how little thought goes into the latter question, and the implications for the sales plan, scalability and investability of the business.
Here are a few pricing/profit pitfalls I have seen in business plans.
a. Anchoring your pricing to your competitors.
Are you new and different, or more of the same….. The majority of start-ups I have come across often try to price themselves timidly, at less than competitors (so that they are “affordable” and don’t scare off the customer). The problem here for a start-up is at launch they have a golden chance to differentiate themselves from the pack, to demonstrate they have something significant to offer the world, and they blow it by pricing only relative to competition. Often buying from a new customer is a risk for personnel inside a large organisation – failure of the start-up to deliver can often cost the customer (and their staff) a lot more than the mere price-tag. If the value proposition of what the start-up is selling is so compelling for the customer – then pricing relative to competitors may be self defeating for the start-up. The start-up often leaves more than money on the table – they leave the chance to position themselves in a different league or category to the alternatives available to their customers (although not a start-up, think of Apple’s pricing strategy…).Not sure I get the point in brackets?
How to mitigate this…..If you are a B2B company, find sufficient justification through a RoI (return on investment) study with your friendly customers that you could charge a lot more than the alternatives/competitors – and then do it. So many beta/pilot studies focus on demonstrating functional efficacy and not on proving both the value delivered and the acceptable pricing level.
b. Price/Revenue per customer and implications for direct/indirect sales
When listening to an investment pitch, a venture investor very early on wants to understand the numbers. So how big is your market – let’s say the entrepreneur can “prove” it is >€1 bn per year.
Then the investor wants to know what the unit price is, or the per-customer spend is. Why? To get a feel for how many units the start-up will have to sell, or how many customers it will need to reach, to put a real dent in the market and become a leader in it.
For many investors (looking at enterprise businesses where sales are not acquired via online purchases) they will use a rule of thumb about whether a business can sustain a direct sales channel or need rapidly to scale via reseller partners. That rule of thumb may be that if initial sales consideration or lifetime value (or lifetime contribution) of a customer is >€100k, then a start-up should consider growing via direct sales. But if such consideration levels are <€100k, then a strategy of reseller/bundling channels may well need to be pursued. The level of €100k or €500k or €50k may change per market – but it is worth understanding how the pricing/revenue per customer would impact on the route to market. For a lot of enterprise sales, the process and lead time for customer acquisition is not very different for items of €20k as for €200k in terms of start-up resources – and limitations as to how many customers a small sales team can reach and manage. A start-up may get more bang for its buck in the early days if it is focused on closing €600k worth of deals via 3x €200k deals with a prospect list of 20 target customers and (?)may be easier and more probable than trying to close 30x €20k deals with a prospect list of 200 target customers.
If indirect sales is the way to go (i.e. via a reseller channel) then the entrepreneur needs to start work early on in the planning stage to justify as compelling a value proposition for the channel/reseller as the end user. This could be the amount of actual share of sales they will get. As opposed to margin % (e.g. reseller gets 30% of the sales price) make sure the upside potential is real and relevant for the reseller. Perhaps the additional value for the reseller is not the additional revenues from their share of your product revenues, but the fact that having your product in their portfolio positions them better than their competitors and enables them to retain high value customers. If the start-up cannot make a case for a compelling value proposition for your channel – then the sales model may be seen as too capital intensive (i.e. needs lots of money) for venture investors. So the pricing level may have implications for the sales model and the attractiveness of the proposition to investors.
How to mitigate this……if indirect sales is considered the most likely a way to scale, start work early on how to justify as compelling a value proposition for the channel/reseller as the end user.
c. Low pricing → low gross profit → lower profitability.
Profitability – as in the propensity to make a profit – is always a fairly useful objective for any start-up company. If the start-up can demonstrate that customers will pay a price that supports a high gross profit margin (well over 50%), this is a very important objective for a start-up selling into the B2B space. As a signal – it can be indicative of premium and/or scarce offering (perhaps proprietary IP) that a market is allowing appear to support a high margin from day one when the start-up is launched and initial sales are direct (can you re-word as I don’t understand this?). A lower price/gross profit signals a commoditized market and possibly one that a start-up entrepreneur should consider carefully before entering. Low pricing by a start-up may make it easy for their competitors to convince potential customers that the start-up offering is “cheap”, or in the short term they can match the start-up’s pricing and put them out of business (if lower pricing was the start-ups major differentiator).
Finally high gross profit results in nice additional contribution to the other overheads of the business (R&D, sales and marketing etc) – in other words higher per unit (particularly ¬higher per customer gross profit) delivers more cash to fund the business. The converse of low gross profit per customer and low cash contribution (for the effort of customer acquisition) means additional cash/capital demands on the business as it aims to grow. Demonstrating a high gross profit margin makes the company more attractive to large acquirers – a large company can acquire a small company target in order to market the highly profitable products of the small company target to the large customer base of the acquirer.
How to mitigate the low price/low margin value death spiral……. launch with as high a gross profit margin, and as high a gross profit contribution per customer as you can. It leaves room for both competition to eat at pricing levels in the future (assume there will be some competitive reaction) and channels to eat at margin levels – yet still leave the company with potential for decent gross margin. For these reasons, it makes the business a more attractive investment proposition for an early stage investor.