In his premier film appearance in the blaxploitation send-up “I’m Gonna Git You Sucka,” Chris Rock inadvertently illustrates a key pricing issue faced by most entrepreneurs when they initially launch a new product or service.
Watch this 93-second clip and see if you can identify the pricing pitfall addressed in this humorous clip. Caution: the clip contains a bit of profanity. It is Chris Rock, after all.
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A recurring entrepreneurial challenge is to determine the optimal price of a new product, especially absent a directly competitive alternative. This issue is often further complicated by users who request that individual features be unbundled so they can limit their purchase to a portion of the overall solution.
The questionable “logic” of such requests is, “I only need a fraction of the features offered, so I should only pay for the features I will use.” This is analogous to asking Bill Gates for a discount because you, “never use the mail merge features in Microsoft Word.” At Citrix, GoToAssist customers would occasionally ask if they could just purchase our screen-sharing functionality because they did not intend to use the features it was bundled with, such as reporting, session recording, agent monitoring, etc.
Resist the temptation to accommodate unbundling requests, which essentially are veiled attempts to obtain a price discount. The value of your solution is in its totality, not its individual features. Once you unbundle most solutions, you bring into question the “value” of each of the individual components, which could result in price erosion, as customers pick and choose individual features.
Ironically, similar to Chris Rock’s character, who clearly can afford more than a single rib and a handful of coke, most of the GoToAssist customers who requested that we unbundled our solution could also readily afford, and, in most instances, make use of GoToAssist’s additional features.
Price = Value
The value of your solution will vary by customer, based on the utility they derive from your product. Ideally, discriminatory pricing laws aside, you would charge a different price to each of your customers, based on their willingness to pay. Starting with this ideal and applying it to the pragmatic reality of the markets you serve, attempt to match your pricing with the value delivered to each market segment you serve. Your costs should only be considered in light of the value you deliver. To the extent you can achieve sustainable gross margins, these factors should not influence your pricing decisions.
For instance, at Citrix we offered our GoToAssist customers the option to brand the customer-facing web pages of our solution with their logo, colors and general look and feel. The process to implement this branding involved minimal effort and thus cost us very little. However, the value to our customers was significant. If we had utilized a “cost-based” pricing model, we would have charged a few hundred dollars for this option. However, using a value-based approach, we derived a fairly substantial price (much to the chagrin of some of our engineers), which our customers were happy to pay.
When we initially launched GoToMyPC, the price of the annual plan equated to $9.95 per month. Our Marketing Department championed this relatively low price, as they had received numerous emails from would-be customers who indicated they would purchase GoToMyPC “if the price were lower.” Their concern was that we were forgoing revenue that we could otherwise capture if we decreased our price.
As I was responsible for driving GoToMyPC’s revenue, I was highly motivated to test its price elasticity. To this end, we gathered two very important pieces of data: (i) the large majority of our customers were reimbursed by their employers, and (ii) our customers used GoToMyPC an average of over four hours per month. At the time, our customer demographic was white-collar professionals, whom we conservatively assumed were compensated at the relatively modest rate of $35 dollars an hour, which equates to approximately $140 (4 hours x $35/hour) of “value” delivered by GoToMyPC each month.
Given GoToMyPC’s significant value, I championed a 50% price increase, from $9.95 to $14.95. Although there was significant internal resistance to such a large price increase, the company agreed to test the new pricing, based on the compelling empirical evidence that substantiated the significant value GoToMyPC delivered to our users (and their employers) each month.
Fortunately, our analysis was sound. Even this relatively large-percentage price increase had no impact on our sales. In fact, our overall revenue increased across all our market segments and marketing channels. Although we could never prove it, we suspected that the price increase enhanced the legitimacy of GoToMyPC in the eyes of corporate customers who might have otherwise been concerned that a $9.95 price could not support a sufficiently professional, secure or reliable corporate service.
Too often, entrepreneurs attempt to widen the appeal of their solutions by dropping their prices to attract a larger number of prospects. Although the appeal of this strategy is obvious, it is illusory. Focus on a value-based price that balances gross margin profitability with capturing the largest possible addressable market.
Avoid The End-Of-The-Quarter Trou Drop
Many corporate customers have become conditioned to delay major acquisitions until the end of a calendar quarter. These customers are accustomed to companies discounting their products as a quarter-end nears, in order to achieve their sales targets. As described in Private Means Private, one advantage of a private company is that it is not slavishly bound to monthly and quarterly financial objectives. As such, ignore the temptation to reduce your price at the end of a calendar quarter, simply to attain your internal sales projections.
Avoid end-of-quarter price erosion expectations by firmly communicating to each prospect early in the sales process that your company is private, focused on its long-term growth and thus not subject to quarterly sales pressures. Let your Bro Foe know that you strongly desire to close the sale as soon as possible, but you are also willing to re-initiate your discussions at the start of the upcoming quarter (after the prospective customer is done beating up all their other vendors). Once your prospects realize that you are not subject to the quarterly sales pressure, they will be less likely to withhold their order in order to extort a price discount.
That There Be One Slippery Slope
Discounting is a slippery slope. However, if you never offer price discounts to anyone, it is easier to resist such requests by deferring to your company “policy.” Clearly declaring your non-discount policy is a strong negotiating position. If you selectively compromise this position, your potential and current customers may become alienated, and feel betrayed that they were not the beneficiaries of a discount.
Steadfastly refuse to discount your product based on price. If a customer is serious about acquiring your solution, it is always possible to devise creative, non-price alternatives to deliver customers additional value without eroding your price.
Eliminating the possibility of price reductions removes a crutch which is often employed by mediocre sales people. If your sales team knows that you will approve deals with price discounts, they will be inclined to give away this relatively expensive allowance in order to close the sale and secure their commission.
Price reductions have a dollar-for-dollar impact on your gross margins and ultimately reduce the amount of cash available to reinvest in your adVenture. As such, force your sales team to seek non-price alternatives to price reductions. If you reward your sales team for maintaining gross margin targets, they will be motivated to craft non-price deal sweeteners that can be delivered at minimal cost. To the extent that such non-price incentives have a smaller impact on your margins than a price discount, your adVenture will be well served. Some non-price methods of enhancing your overall value proposition include:
Support – If you provide various tiers of support, offer an enhanced level at no additional cost. For instance, you might provide phone support to a demanding customer, rather than lower-touch and less timely email or chat.
Volume – Offer per-unit price relief in exchange for a larger overall purchase. For instance, if you are selling ten concurrent seats of a software program, consider reducing the cost per user if the customer agrees to purchase an aggregate number of user seats which results in a larger overall sale than you would otherwise garner without the cost-per-seat discount. This strategy obviously is most effective when your product entails low variable costs.
Cash – As noted in Frugal Is As Frugal Does, cash at a startup is king, queen, duke and prince. If you offer a subscription product or a similar solution that is purchased over time (e.g., software as a service), require discount-oriented customers to pre-pay a substantial portion of the fees upfront. For capital goods that may traditionally involve extended payment plans, demand more timely payments.
Duration – Extend the duration of the purchase agreement such that the overall revenue generated exceeds that of a shorter, undiscounted sale. For instance, to the extent it is applicable, require a customer to agree to a longer-term commitment in exchange for a lower per-year or per-month price. If you are selling a product with a one-time sale, such as capital equipment or legacy software, require customers to sign an extended service or warranty agreement.
Protection – Consider offering “pricing protection” to users who are particularly price-conscious. Rather than reducing your price upfront, contractually limit future price increases. Clearly, caution must be deployed when utilizing this tactic, in order to reduce your downside exposure in the event your costs unexpectedly increase.
Transparency – Some customers will value understanding, and potentially influencing, your product roadmap. As long as such customers abide by your confidentiality covenants, your competitive exposure will be minimal. However, never allow such transparency to result in a customer exerting de facto control on your product development process.
Professional Services – Your Professional Services team can be invaluable. When properly managed and motivated, they are akin to spies who cross enemy lines and become trusted members of the opposing side, providing you with invaluable intelligence regarding your customers’ wants, needs and plans.
Your Professional Services team should also be compensated to drive incremental revenue. By solving customer issues beyond the scope of your solution’s current deployment, you deliver more value, become more ensconced within your customers’ organizations and generate additional profits. For all of these reasons, generously allocate discounted Professional Services resources to demanding customers, especially with respect to the installation and implementation stages, when ensuring a satisfied customer experience is of profound importance.
Expensive Chits
Never discounting is an ideal strategy. However, if for strategic reasons you decide to grant price allowances, tie them to one or more non-price deal points as a means of making the discount relatively expensive. A few suggestions of such “quid pro quo” provisions include:
- PR Goodies – Secure the use of a customer’s logo, testimonials, inclusion of the customer’s name in press release boilerplate text, joint press release, etc., as described more fully in Thrill The Messenger.
- Referenceable – The customer agrees to field a reasonable number of reference phone calls from future, prospective customers. Note: As a buyer, I usually agreed to this provision, as it ensured that the seller would do everything in its power to make me happy and keep me satisfied.
- White Paper – The customer agrees to participate in the creation of a marketing document which details its successful use of your solution; ensure you have access to the raw data, such as cost savings, usage, productivity enhancements, return on investment, etc.
As noted in Kiss Of Death, rebuff customers’ requests for Most Favored Nations (MFN) status. Such a provision dictates that the MFN customer is guaranteed the “best” deal that you offer to any future or current customers. MFN covenants are difficult to administer and they amplify the financial impact of any price concessions you are forced to make with any customer.
For instance, if you grant a new customer a deep discount in order to close a strategic deal, a MFN clause will require you to offer an identical discount to all MFN customers. However, if the discount is accompanied by one or more meaningful quid pro quo provisions discussed above, the discounts will only apply to MFN customers who also agree to abide by the favorable provisions.
The Customer Is Not Always King
The essence of Chris Rock’s cameo in “I’m Gonna Git You Sucka” became a watchword at Citrix. Whenever we encountered a prospect who attempted to nickel-and-dime us with an unreasonable request, we referred to them as “wanting a rib.” In other words, they were a prospect that was unlikely to become a profitable customer.
As Chris Rock runs from the ribjoint, chased by Isaac Hayes, actor Bernie Casey enters the scene and admonishes Isaac Hayes’s character by saying, “Don’t do it. The customer is always king.” Experienced entrepreneurs know this is simply not true. Some would-be customers, such as those who are unwilling to pay an equitable price for your solutions, should be sent fleeing, just like Chris Rock’s character. If they are not, it just may be you who is gonna get it, sucka.
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John Greathouse has held a number of senior executive positions with successful startups during the past fifteen years, spearheading transactions which generated more than $350 million of shareholder value, including an IPO and a multi-hundred-million-dollar acquisition.
John is a CPA and holds an M.B.A. from the Wharton School. He is a member of the University of California at Santa Barbara’s Faculty where he teaches several entrepreneurial courses. He is also the author of an award-winning entrepreneurial blog infoChachkie.com. You can learn more about his experiences at johngreathouse.com
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