This is the second of a series of three articles on startup pricing strategies. In the previous piece, I raised the notion of a ‘fair’ pricing strategy and the importance making the question of ‘what do we charge’ one of the first questions to ask about your startup – not a late afterthought. Click to read.
And, in response to readers questions, this article is I’m focused on
Dynamic, Pandemic and Special Startup Pricing strategies.
So, what are Dynamic, Pandemic and Special Prices?
Firstly, the question raised was – what is happening to pricing when a landlord decides to forego rent – as happened to commercial and a lot of retail property – during the early days of the pandemic?
My best answer is that this is an example of a price driven market in which the market collapses. It is similar to the rare days when trading on a stock market is suspended – usually during massive crashes – because the ‘market makers’ can’t make a market!
What does that mean? Simply, any ‘traded’ market requires a broker to balance the demand to buy vs the desire to sell – and find a price which establishes an equilibrium. However, when a market is in shock, there is no price at which buy and sell demand can be balanced. Hence, it is price-less!
Let me explain:
If 100 people want to buy a gallon of orange juice each and 1 person wants to sell 1 gallon, then the price rises until the volume on both sides of the equation are equal. Obviously, as the price rises, fewer people will want to buy or they may wish to buy less, but the number of people willing to sell (or the volume they are willing to sell) will rise.
Hence, if price €x entices 30 people to buy 2/3 of a gallon each (so 20 gallons in total), AND, 5 people are willing to sell 10, 5, 3 and 2 gallons each (total 20 gallons) then we have reached price equilibrium – or established a price; namely €x.
And, if more people want to sell more gallons, then the price will go down unless more people want to buy more gallons, in which case the price will go up.
The ‘price’ of a gallon of orange juice is set when the two sides – buy and sell volumes – are equal or reach equilibrium.
This is dynamic pricing – the price changes but the commodity – a gallon of orange juice – always remains the same.
(This is different from when I buy oranges at my local Spanish market – early season, they are expansive and rare, in season they are plentiful and quite cheap, late season they are good for juicing only and dirt cheap. Here, the product – the orange – materially changes and the price changes reflect these differences).
During the pandemic, we saw sellers giving their services away for free – so, landlords forewent rent on their shops, accountants and agencies didn’t charge for some of their work – or extended payment terms etc.
This isn’t really dynamic pricing – as the price remains the same – whatever was agreed when you signed the contract – but the seller decides – for exceptional reasons – either to not charge or to allow you longer to pay the debt.
This reflects the decision by banks in the 2008/9 financial crisis not to foreclose on people’s housing debt in Europe (US was different) because, forcing people to meet (and therefore, fail to meet) their monthly mortgage back in the 1990s property crash, resulted in ‘jingle mail’ – that is, the sound of keys landing on the door mat when posted back to the bank! And banks didn’t want that.
That’s because people walking away from homes and their mortgages then reduces the resell value of both the home that the bank has just repossessed- but also, it reduces the value of the homes in the same neighbourhood. Hence, neighbours who were just about paying the mortgage and ‘hanging on’ saw the ‘equity’ in their homes disappear and hence, they too would post back their keys! They’d give up. And so the whole neighbourhood and some whole towns face collapse.
All in all, a pointless exercise if you are the bank! And not good for anyone else, either.
Hence, by 2008/9 banks did all they could to extend mortgages and allow payment holidays to stave off the risk of jingle mail and subsequent contagion. This happened more in Europe than in the US.
What we saw during the 2020 pandemic was a similar tolerance designed to allow the market to recover.
There is no point in enforcing your pricing such that you halve your future market! Far better to delay payment or even, let your customers off for a few months, than to permanently reduce your market size and value.
Special Startup Pricing Strategies
Note, neither of these two above examples include ‘special offers’.
A ‘special offer’ requires an established and stable price. In the orange juice example above – ie on a trading platform – there is no ‘special’ price – there is only price equilibrium or a ‘correct’ price. However, when you get to the supermarket and you see that your favourite 35ml orange juice carton has a BOGOF (buy one, get one free) – then for you, today, it is effectively half price.
In fact, BOGOF is a highly effective way of making your product feel half price – and it doesn’t devalue your product – because the price for ‘one’ item is the same as it has always been. The customer pays the same amount – they just get more product.
Hence, the use of ‘free’ – such as buy two and get one free – is a powerful way to reinforce your single unit price whilst giving away – what feels like – a large discount. Of course, in this example, your volume of sales will go up (we hope!) and therefore, your total revenue may increase – and hence, despite the higher product costs (all those 2nd or 3rd items given away for free) you make bigger profits!
A quick note here: traditional forms of discount are often less effective. Let me ask you a question:
Well, if the item in question was €10 (reduced to €5) then 2/3 of people would make the trip.
If the item in question was €100 (reduced to €95) then 2/3 of people would not!
Note: in both cases, you save €5! (that’s right – people are not rational when it comes to price)
Hence, for some items, BOGOFs or Deal Packs (buy two, get one free) or ‘added value – get a free sticker-book with every purchase’ are be more effective. But if you can offer ‘70% off’ you will divert the traffic!
What we see here is that rather than discount your price, you can often add extra value! This is a mechanism that SaaS businesses can use!
Typically, a service is bought at a basic, pro or advanced level – and there is a pricing structure to encourage the customer to buy a ‘higher’ level of service. In this case, it is possible to offer all ‘basic’ subscribers a free ‘upgrade’ to pro for the rest of their subscription – and then, the default could be to renew at the new ‘pro’ level.
This is a great way to allow ‘freemium’ whilst your customers pay! Magazines which launched special newsletters would often use this technique (yeah, I used to do this back in the 90s).
Note: to achieve this, the service needs to be designed to allow this from the outset – which is why pricing needs to rise to the top of your startup agenda.
(Even more notes: SaaS businesses can also offer additional accounts at a reduced price – so, buy two accounts – get a third free).
More dynamic pricing – auctioning!
However, let me bring the conversation back to other versions of dynamic pricing which go beyond the classic orange juice trading example above.
Think of how google or facebook or any social media sells adverts – the price is dynamic – driven by demand for the keywords or customer eyeballs you are seeking to reach. This is a particularly effective pricing strategy for startups as it allows you to begin very cheap – when demand is low – and as you build dominance in a space, then the network effect of ‘everyone using’ your product or service means that all the advertisers need to congregate on your platform – and then they need to pay more and more as the demand grows.
This is a smart way of allowing your price to be appropriate for the stage of growth you have achieved so far – and, equally, it is a powerfully argument for why €XYZ trillion of venture capital money will deliver the VCs a great return. Effectively, as you dominate the market then the value of your product goes up and up.
In effect, you are auctioning your inventory on an ongoing basis
The old fashioned way to do this was to take a commission or a percentage of a deal. This is the old banking method – and I recall being told ‘the only way to make money is to take a % of a deal‘ – but, as we look at Fintechs, this whole model is breaking down. For instance, instead of me paying a % to convert £ to € or vice versa (yes, I do this a lot) I now pay an annual subscription to a fintech bank and the conversion cost is free (practically).
Hence, this is an example of moving back from dynamic to fixed pricing!
Traditionally, auctions were used for old furniture and unsellable houses – but now there is a detailed literature on how to auction anything – from adverts to mobile 5G licences! In fact, the first established internet enabled platform – eBay – began as an auction site but rapidly recognised it needed to allow fixed price selling too!
Not dynamic – but usage pricing!
One last pricing model to mention is the usage model. So, there is a café in Manchester where they tested charging by the hour to ‘keep a seat’ rather than charging you for what you consume (ie your coffee). This seems like a good idea when your customers arrive at 9am, buy a coffee and nurse that coffee until 5pm and then go home!
Airport lounges use a similar model – or did – where they charge per one off use – not for what you consume. That’s why using airport lounges always made me put on weight. Like Sunday afternoon all-you-can-eat buffets at local Indian restaurants!
In the airport example it works well – because when your flight is called, you leave – allowing the lounge to sell the (calm and empty) space again. I’m not sure it really works like that with cafes!
Other examples of usage pricing include Rolls Royce who give airplanes engines for ‘free’ but charge per mile flown (which includes the servicing too).
What is dynamic here is not the price but the usage – albeit, there will be a scale – the more you use, the lower the unit price.
Nevertheless, this is a great way of allowing customers to ‘use’ the product without upfront capital investment. Similarly, Swedish startup Klarna, have made this method of ‘buy now, pay later’ available to other startups via their platform.
Car, too, are sold with ‘monthly’ finance – which treads a similar path.
Okay, so this month we’ve looked at Dynamic, Pandemic and Special Pricing – which including auction pricing and usage pricing.
How to put this into action: ask this question:
How would our business change if we adopted different pricing strategies?
Perhaps this would lead you to start a coffee subscription service – like the Dollar Shave Club?
Either way, sectors and markets often settled for a given pricing model – so, at the supermarket I pay cash – which means there is an opportunity for a disruptive price model to break into an established market. For instance, when I was in the UK, we bought a box of home delivered vegetables, I pay a fixed subscription fee and allow the contents to vary each week.
I hope you are enjoying these pieces on pricing? They are a bit complex, but hopefully they are stimulating and you can share them with your team?
In the third and final article of this series, I write about the ultimate goal – how to use pricing strategy to demonstrate the power (and value) of your startup brand (and the value of your business for future investors or acquirers). Click to read it.