A strong pricing strategy is an elusive target which companies find only through a determined effort — one which respects the complexity of the issue.
Unfortunately, a big part of the world has decided that there’s only one price strategy: Cheap. In fact, within tech inspired venture capital funded startups it seems that cheap is the only price that matters.
The Strange Mass Market Venture Pricing Path
Every new venture endeavor, especially targeting consumers, seems to launch with a dramatic announcement of low prices.
Low prices by themselves, though, aren’t a serious problem. Things get bad when each of these tech endeavors promise to deliver a premium product or service at a discount price.
Sometimes the premiums are hidden because we don’t think about the “work” the company took on for us. For example, Blue Apron searches for recipes on your behalf, shops for the ingredients, and carefully repackages the makings of an entire meal before finally delivering the whole package to your door.
Many Well Known Companies Continue to Deliver Premium Product for Discount Prices
- Amazon’s retail-style online sales: Anything you’d buy in a store for a cheaper price and delivered to your door (same afternoon or even overnight).
- Uber/Lyft: Compared with Taxi’s, better car, better reservation system, faster arrival, tracking, better payment, serving a wider area, and better tracking of history — all for a cheaper price (except amid some surge pricing).
- MoviePass: Up to 30 movies a month for the price of 1. (MoviePass is now bankrupt and gone.)
- Dollar Shave: A better razor at a fraction of the price. How? Claims big bad razor companies just charge too much. (Of course, Dollar Shave has never charged enough to make a profit.)
- WeWork: Office space in small bits and on demand with full services and all kinds of benefits — all for not much more than you’d pay committing to a long term lease and without the benefits.
- Casper: Mattress delivered to your door. The mattress price itself is price reasonably, but they’re throwing in free shipping and free returns. In other words, a premium service.
- Blue Apron: Meals prepared for you to cook in your home all at a pretty good price. They take on all the planning, shopping, recipe searching and deliver it to your door. All you do is follow their cook directions.
- Spotify: Low monthly charge (less than buying a single CD) for you to listen to anything in their extensive library.
- Netflix: Low monthly charge (about 1/2 the cost of buying a movie on DVD) and you can see anything in the extensive library — including an aggressively growing library of original productions made just for you.
- StitchFix and other clothing subscriptions. These efforts choose your clothes for you, ship multiples, let you return what you don’t want for free, and sometimes are pure rental plays.
The Mind Boggling Result: Premium Products, Low Prices, A Rush to Invest, Yet Not a Stich of Profit to be Found
Ok. I exaggerated the profit statement. But it’s damn close. Netflix has a profit. Spotify has turned a profit a few quarters. Amazon is profitable but only through selling premium services at a premium price (AWS primarily but also devices and content). Uber and Lyft have stunningly massive losses. WeWork is falling apart as we speak. Dollar Shave was bought by threatening existing razor makers — not because they were profitable. And the list goes on.
Yet, who is going to complain? Not consumers. They love getting something for less than they’d have to pay if it was priced honestly. But society should complain. Dollar Shave was a flavor of “Digital Dumping” as defined by my friend Shahin Khan. WeWork turned out to be a scam. Casper can’t make money in mattresses — one of my retail connections Tweeted that this is an incredible thought because it’s hard to lose money in the mattress business. Etc…
I have no problem when tech truly eliminates significant costs and passes those to consumers.
- Digital photography eliminated the cost of buying, developing, and printing film and we received convenience/flexibility in return (while giving up several long term values).
- Newspapers suffered subscription loss when the internet offered consumers a way to get their classified ads (Craigslist) or movie times (Flister, Fandango, websites) easier online and for no cost. This was a premium service enabled by technology for nearly no cost.
Yet none of the “premium at a discount” companies in my list are in a position to dramatically reduce costs.
Three Main Reasons Startups Adopt This Price Strategy
Three reasons — yet none of the reasons stands on its own. This is a classic complexity situation. Each of the reasons affects the others — with an interdependence so thick it’s not clear where companies can break the chain. (I’m sure I’m missing other important reasons and look forward to discussion which points those out.)
1. A Need to Claim Disruption
Whether it’s their headline or a subtext, each of the above efforts claims to be “disrupting” a stodgy, out of date market filled with dinosaurs. That’s their claim. There are problems with the claim — like they don’t understand disruption.
Disruption does NOT provide a premium product at a low price. When Christensen defined disruption in his book The Innovator’s Dilemma he explicitly noted that it happens as follows:
- The opportunity exists when “stodgy dinosaurs” have overloaded their offering with expensive premium features which aren’t valued by customers. (So the premium problem is on the end of those about to be disrupted.)
- Smart, nimble new entrants reduce features and offer a discounted product as a result. Done smartly, these new entrants take considerable business from the overburdened historical market players.
- Note clearly: The new entrants are not providing premium products at a discount. They are providing discounted products which are at that discount because they’ve made the economically viable step of REDUCING un-needed and unimportant premium features.
2. A Need to Claim to Scale
Each of the efforts noted above hit the market with exaggerated claims of how big and popular they’d be. This desperate need to scale has become core to the market of venture backed consumer efforts.
As a result, these companies have a desperate need to get vast numbers of consumers and get them fast. So, rather than building a company that is economically profitable then growing it naturally through the smart paths which are available, they grab onto the truth that consumers, not CFOs, love the idea they’re getting premium products at low prices. So the company rushes forward.
Truth is that they tend to get very large numbers of customers quite fast. Unfortunately, none of those customers are profitable.
3. Investors Demand It
In order to attract investment, companies need to promise huge returns. It appears many attempt to do that by claiming to disrupt a market and claiming that their innovation will scale beyond belief. Without those claims, the returns on starting these kinds of companies don’t justify high returns for the venture capital investment.
As a result, claims of disruption and scale have become more and more exaggerated. Even worse, when the absurdity of the premium via discount approach is challenged, these companies become superb magicians of the unusual analytics — inventing ways to claim their model works.
One common thread I hear is that “we could be profitable if we wanted.” Of course, none of the companies who says that ever becomes profitable. Another claim, is that once they are big enough, economies of scale will solve all their profit problems. Incredibly, this argument was still present in a recent Amazon annual filing — claiming that shipping costs will come down once…Amazon is big enough!!! At the time of the report, Amazon was spending over $26B annual on shipping. Tell me again, when do they become big enough? (My guess is the statement is boiler plate left over from all their years inventing ways to claim future profitability.)
On the investor side, while investing in startups is tough business there are also dysfunctions built into the process. For example, the investor’s primary goal is a highly profitable exit — whether a strong company is built is secondary. That’s a critical conflict of goals. Also, note the investment process tends to conflate revenue growth with value — after all revenue growth is sometimes enough to have a successful exit. Regardless, it’s clearly not the best path to value. (Thanks to @AndrewEverett for suggesting this path of discussion.)
There is no single prescriptive approach to pricing no matter what consultants tell you. There are also no magic equations which determine best pricing nor the elasticity you have when introducing a new product. Equations may come later when you are optimizing an already successful product line.
Price is a field of subtle complexity. The key to smarter pricing is that age old discipline called “management.” Pricing management should be led by a marketer with strong support from CFO, product development, manufacturing, and the CEO. One of the first questions this team must ask is whether they are in that unique position where their technology will allow them to offer a premium product at a discount price.
This team needs to be filled with “steely-eyed missile men and women” who work without the hyper-active tech “SciFi/Fantasy” imaginations that seem to drive too many companies. IF the decision is that your technology makes that dramatic offering possible, then challenge your belief in it. Are you being honest or are you hoping to succeed by making massive promises based on thin threads of hope and prestidigitation? (Think Theranos here…)
This management team must also be skeptical of taking on massive ‘decision debt’ by promising investors that which can never be delivered — specifically promising strong profits by delivering a premium product at a discount price.
Done right, your price strategy becomes a strong support to building a strong company. Done poorly (as in many of the examples above), your management team ends up stumbling from light post to light post hoping to find a key which might lead to a stable business — all as you pay for the massive debt due on promises made to close your funding.
I know which type of company I prefer to work with.
©2020 Doug Garnett — All Rights Reserved
Through my company Protonik LLC based in Portland Oregon, I consult with companies on their efforts around new and innovative products. This work has also led me to focus on what marketers need to learn from the field of complexity science. In addition to teaching marketing, consumer behavior, and advertising at Portland State University, I advise a select group of new product clients as well as work with clients attempting to bring new life to Shelf Potatoes or taking existing products to new markets. You can read more about these services and my unusual background (math, aerospace, supercomputers, consumer goods & national TV ads) at www.Protonik.net.