BOGO. Gift with purchase. Free to download. Get the first 30 days free (just enter your credit card… you won’t be charged unless you decide to continue). We’ve all received offers like this, all with varying degrees of impact. Promotions have become a way of life, setting a precedent for how we engage, buy and even value a product.
While promotional strategies have become ubiquitous in day-to-day life, what we don’t realize is that promotional logic embeds itself in our heads and influences the way we view things. It’s so prominent that the majority of startups I talk to show up with a promotional strategy in hand, even if their pricing strategy isn’t totally baked. Why? Because we are focused on the immediacy of the sale. Whether or not it’s profitable, proves product-market fit or illustrates traction, entrepreneurs often focus on the rush to revenue, not fully understanding the implications of their decisions in valuing their solution.
One of my favorite examples of this is a situation that happened a few years ago. I was introduced to a company that was targeting a very niche industry—so niche that there were only 1.5 million total potential buyers in the US. To further complicate this rather small addressable market was the added dynamic of minuscule operating budgets and lack of discretionary capital. To drive adoption and show traction, the founders decided that they would use a Freemium model to drive stickiness, choosing to focus on upselling in the platform via premium features with a total price tag of $10 a month. They painted a cogent argument on the what and the why, up until the point when we started poking at the numbers.
Let me illustrate:
- 1.5 million total market
- 33% market adoption = 495,000 companies using the “free version” of the product
- 15% conversion from Freemium to Premium = 74,250 companies paying for solution
- At $10 per company, that is $742,000 in monthly recurring revenue (MRR), or just shy of $9 million a year at maximum adoption target.
While $9 million is not a paltry sum, it’s by no means the venturable business the founders were extolling. Additionally, the conversion metrics were ambitious, and when factoring down for smaller market adoption, it wasn’t enough to justify the cost to build, sell and support the product. Since the founders were developing an enterprise support model using transactional pricing, there was no way for them to be right-side-up and illustrate the growth they wanted without completely rethinking their approach.
Why does all of this matter? It’s actually a pretty easy answer, but one that requires you to step back and think about the big picture.
In the example I cite above, the founders priced their product based on their cost to build. Simply stated, they summed up all the labor and associated support costs, factored a margin based on best practices and put together a pricing and promotion strategy to get to that number. This approach to pricing is called “cost-to-price,” and while it’s the easiest way to get to a sales number, it sets you on a hamster wheel of selling. You are always chasing the target, knowing that if you sell X amount at Y price, you will hit your target.
Instead of taking this approach, I encouraged the founders to back up and think about what the incentive is for the customer to buy. This is not a promotion, but rather the value proposition, features and functionality that address a specific pain point. By identifying the value, the cost savings and aspirational benefit become the justification to act. This allows you to get out of margin pricing (e.g. a 25% markup) and get to a pricing strategy that affirms what issues a product can solve, and its value to the acquirer. It also keeps promotional motions that can erode the value or conversion to a minimum, and helps you quickly establish value to act.
One of the things you’ll see in your interactions with the team at JumpStart is a heavy emphasis on validation and research. This is a great downstream illustration of why that is important. Market sizing, competitive landscape, pricing and validation of willingness to pay are all key pieces of upfront work that help feed your pricing strategy which will ultimately help you build toward price-to-value as opposed to cost-to-price. A lot of times that upfront work feels like easy to skip efforts, but in the long run, it’s that heavy lifting that allows you to frame out a meaningful pricing strategy and ensure that all your efforts aren’t for naught.
For more useful tips on getting your venture started the right way, check out JumpStart’s Entrepreneur Roadmap, which includes an in-depth Go-To-Market Strategy Tool and Go-To-Market Strategy Worksheet.