in Pricing, SAAS, Sales, Scaling, Startups

Your Price Does not Equal Your Cost

Its economics 101 that when you increase the price of something the demand goes down (The Law of Demand). Unfortunately, like most 101 courses, this is a partial truth that needs either further study or practical experience to be useful and as the old adage goes – ‘a little bit of knowledge is a dangerous thing’.

No doubt you’ve all seen the law of demand used to justify low prices. It is particularly dangerous to a startup as it can be used as logical proof to an emotional decision to have rock bottom prices. We all fear rejection and we emotionally want to do everything we can to minimise our chances of it. So we tend to lower our price to a level where it can no longer be an issue.  

However for startups your price, no matter what you set it at, is almost never the issue. The problem is your total cost to the customer and price is just one small element of this.  Your total cost is a long list but for most startups the largest cost to the customer is the personal risk to their career of doing business with an startup as opposed a known quantity.

“Nobody ever got fired for buying IBM’. While obnoxious, this 1980’s slogan this hit upon a core business truth – not only are we, as sellers, ruled by emotion (fear of rejection) so is the buyer (fear that their purchasing decision will be perceived as a failure). If the project fails because they chose a startup rather than an established player, even if vastly more expensive, their choice will look unjustified and unnecessarily risky to their boss (and everyone has a boss).

There are many other costs that go into the total cost born by the customer and I won’t go into them at length, but they include evaluation, training, support, change control, hardware etc.. For IT solutions these costs can frequently outweigh the actual price 10 to 1.  A 50% reduction in your price may only represent a 5% reduction in the total cost of ownership. Similarly a 50% increase in your price may only represent a 5% increase in the customer’s total cost.

Remember, as a startup, if you are going to be rejected, it is almost a certainty that it’s not your price that’s the problem – it’s your cost. Even if you are told by the lost customer that its your price, it still probably isn’t. Most people shy away from hard conversations and a potential customer telling you that you are rejected is a hard conversation. In these circumstances people tend to use the easiest way to end the conversation quickly – saying your price is too high is nearly always the easiest.

A final thought: unless you are a commodity, you either have a lot of value or no value. Unless you have a lot of value, your solution will never overcome the other costs that have to be borne by the customer, and you effectively have no value. It’s not a linear scale, its binary.

Next Blog Post I’ll explore how high pricing can increase demand rather than reducing it.

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