Have you ever asked your paying customers how much your product is worth to them?
I do this a lot, and it's not as scary as it might seem. Often, the majority say the product is worth more than what they're paying for it. This is a good problem to have, right?
Well, yes and no. On the one hand, it proves my product offers a lot of value. But it also shows that I'm leaving money on the table.
Undervaluing a product is a common pricing mistake. Once I understood why I kept making that mistake, I was able to break the pattern and make the shift to scale the company.
So let's talk about why we entrepreneurs constantly sell ourselves--and our products--short, using the four pricing rules I run all new entrepreneurs through.
1. Don't price on the basis of your competition.
Establishing a price model and setting proper pricing is one of the most difficult parts of developing a new product. And when it comes to difficult business concepts, entrepreneurs tend to learn a lot of those concepts by osmosis. They analyze how established companies do things, and then they copy those things.
So when it comes to pricing a new product, one of the mistakes I see a lot--especially with early startups--is basing their initial price on their competition's pricing.
Yes, some early startups overreach and expect a much higher price point than they'll ever get in any realistic sense. I make it a point not to advise those startups. But, in my experience, the majority of startups launching new products undermine their pricing by about 10 to 50 percent.
This is usually a losing strategy, because it also undermines the unique value of your solution. So when you're deciding what to price on, always choose value. You're not selling software or widgets or services, you're selling value.
I get this pushback a lot on Spiffy, the mobile vehicle-care company where I'm head of product: "How can you expect people to pay $59 for a car wash?" The answer is about value. We're not selling a clean car. We're selling time. When you add up the customer's travel time, waiting time, and labor time, our $59 wash packs a lot of value.
2. Break the psychological pattern.
I still suffer from this, but I've learned how to get past it. It's that nagging voice in the back of my brain saying: "This is just something I created. It can't be worth that much." But then I remember that every billion-dollar company essentially started with someone's stupid idea.
So why not my stupid idea?
When it comes to pricing, what you think doesn't matter. It's what the market tells you that matters. These days, I'd rather be shocked and surprised by a paying customer base that thinks my product is worth much more than I do.
Don't add internal pressures to your pricing, because the external pressures will be hard enough to handle.
3. Err on the high side.
I love to tell the story about a colleague of mine who got caught up in a drop-ship side hustle. He made $2 million in revenue in his first year. He spent $1,999,000 to get there.
That's the perpetual struggle of a low-margin business. A $2 million run rate might be a reachable number, but it may take $20 million or more before the business becomes valuable.
What's more, your business needs high margins, because you need to protect yourself against price wars. A lot of first-time entrepreneurs have a one-sentence business model: Undercut the competition. But your competitors have been around longer, they probably have a larger war chest, and they can undercut you back until your business fails.
Don't forget, once you win those price wars, there will be a new pack of upstarts coming after your now-established business.
Finally, a higher margin allows for all sorts of avenues to discount. But do this only with caution. The owner of a local baseball team gave me some great advice about discounting. He will discount everything except the price of the ticket itself, because once he does that, he devalues the product.
4. Ask your customers about both price and value.
Obviously, it's a great idea to ask customers and potential customers how much they would pay for your product. The only issue here is that they'll undercut you on price as well. We're all negotiators at heart, so even if I would pay $100 for your product, I will tell you $75.
It's a better idea to ask about value. I always ask my paying customers: "How much value do you get out of the product?" And I give them options:
More than the price?
Exactly the price?
More than half the price?
Less than half the price?
Now, when you ask about value, your expectations should be the reverse of when you ask about price. Customers tend to avoid confrontation, and they don't like to admit mistakes. This means that they usually respond with a higher value than they actually believe. Thus, the majority of your customers should answer, "More than the price."
Ultimately, the key to correctly pricing a new product is to stop thinking like a founder. Break that psychological tendency to undersell yourself. Then start thinking like your customers, and let them lead you to higher margins.