When developing a new business, pricing the offer is challenging. The business has no reference customers or brand equity.
One strategy is to lead with pricing.
The problems with this approach are many. When the offer is priced artificially low, curious but uninspired customers may accept the deal. The customer trial numbers grow, but the data is corrupted with false positives.
As the customer success team surveys these early adopters, it becomes clear that many of the trials are failing. The logical step is to discover why. Unfortunately the answers can come at a high cost. Many of the failed conversions should be attributed to the fact that the customers are not qualified. Those results should be discarded. Unfortunately, this rarely happens. Instead, the corrupted surveys are considered, leading to faulty recommendations on product, features and pricing issues. The product and development teams end up wasting valuable time on the wrong priorities. The updated product goes live, but the uptake on the new features go wanting. The product team is puzzled with the discouraging results.
Let’s rewind and start over.
This time, the team prices the offer at a premium level. The pricing is such that only the most viable customers are attracted to the offer. Although the trial size is small, the true voice of the target customer is represented. The team can reliably focus on the critical product enhancements using customer feedback. Additionally, the premium cost of the pricing creates a “sunk cost” and cost justification dynamic that further benefits the business.
What is sunk cost?
Sunk cost is a phenomenon that affects otherwise rational humans. When someone makes an investment, losses incurred from that purchase are troubling. This is the phenomenon that causes gamblers to double down in order to get back to even. In a similar vein, a customer will go out of their way to use a product or service till they believe they have achieved a fair value. This skin in the game provides a symbiotic customer-to-vendor relationship with a shared goal of creating a winning customer value proposition.
What is cost justification?
When a brand sells a premium product, many customers are attracted to the allure of the premium offer. When asked why they choose to pay a premium over a less-costly alternative, a cost justification argument takes place in the customer’s head. This is valuable to the brand. The customer will often attach positive feelings towards the brand through this process.
The product need not deliver immediately
If a product is hopelessly short of promise, the sunk cost and cost justification dynamics won’t hold the customer. However, the brand may survive an inauspicious trial if the product shows a modicum of promise. High-quality customer support and rapid product updates can keep a customer from abandoning the trial.
The first line of defense is customer service. The new product is likely to be buggy and immature. The customer service team needs to work closely with the QA and development team to report bugs and communicate with customers on solutions to the most critical issues. Customers who are treated as partners in the product enhancement process often become vocal advocates for the brand. The role of customer service in building this positive customer-vendor relationship should not be underestimated.
The second line of defense is the development team. Sharing upcoming product releases plans can keep at-risk customers from abandoning the trial. The faster the development cycles, the more likely the early adopter will persevere through the beta product and eventually convert into a loyal, active customer.
Branding, development speed and elite customer service is not free
In the example above, the customer churn is averted due to the company’s development and customer service excellence. This communication from early adopters to customer success to development and back creates a powerful feedback loop. A product can rapidly mature using this engagement model.
Marketing a winning product
Once the product delivers on its intended value proposition, the company can begin marketing the offer. With low churn and high customer satisfaction, the brand can invest, experiment, and optimize the branding and customer acquisition strategy.
Crossing the chasm
Once a winning brand and marketing process is discovered, the company can target a broader audience. At this stage, the price question is revisited. Does a more cost-effective entry-level product and pricing strategy make sense for the brand? Will a downstream offer damage the premium reputation the brand has so carefully fostered?
A list of representative premium brands include Tesla, Apple, Adobe, Intuit, Cisco, Coach, Starbucks, Lulu Lemon, and Microsoft. These brands have demonstrated tremendous pricing discipline through all the phases of their brand growth.
Exercise: Consider the industries where the above brands dominate. Now consider their low-c0st competitor. Which company is more valuable?
Summarizing the premium advantage
At the inception phase:
- Premium pricing allows the business to focus on passionate early adopters.
- The premium pricing offers compelling unit economics. The business can invest in customer service to reduce churn, and product specialists to accelerate development cycles.
At the scaling phase:
3. The investment in innovation and customer service creates brand equity which leads to more efficient customer acquisition campaigns.
4. The higher per customer revenues allows the business to further invest in marketing and branding, thus creating a virtuous growth cycle.
Crossing the chasm:
5. The premium pricing provides brand allure as an aspirational brand.
6. The brand can extend the product offering to appeal to a larger customer base.
Investing in new markets:
7. At scale, the premium pricing provides a war chest that allows the brand to explore blue ocean markets. With its loyal customer base and valuable brand, the company can leverage these advantages when entering fast-growing new markets.
In summary, early decisions on pricing should be made carefully. Building a premium brand is a difficult task. Businesses who have succeeded have proven resilient in competitive markets and difficult macro-economic environments. With increased globalizal competition, fast-followers from foreign competitors are making the low-cost, economies-of-scale strategy risky and difficult to defend.
