Why You Shouldn’t Underprice
The topic of pricing, or underpricing more specifically, has come up a number of times in the past week in my conversations with both portfolio companies and perspective investments. This has made me realize that many entrepreneurs start with the assumption that all startup products should be priced lower than the competition. But this thinking is flat out wrong. The conversations typically go something like this this (dummy numbers used):
“Our product is awesome. It’s the best on the market and it is disruptive. We’re pricing it at $1,000 while most of our competitors are $2,000 and our closest competitor is $1,500.”
My response to this is that you’re either underpricing or your product is NOT always better to all customers. I’ll take each one of these two possibilities in turn. First, you are underpricing. Startups often assume that they should price lower than the established competition to gain market share. My problem with this is that in reality businesses and consumers often (unlike they teach you in school) infer quality from price among other factors. This problem is particularly pronounced in opaque products that are new or complex—and startups tend to launch new to the world and opaque products pretty damed frequently! Once you underprice your buyers will this lump your product into comparisons with whatever is in the same price band. This can be damaging to your brand if you’re trying to build a premium brand. It can also be damaging to your brand because your product is making awesome product claims—“It can do X and Y!” but is underpriced, which makes the buyers doubt it can actually do X and Y. Buyers have been trained to be skeptical! This makes your branding inconsistent. Thus, if your product is better, price it accordingly. As counterintuitive as this may sound, my experience shows that this will actually help your sales and marketing efforts.
The second reason you might be underpricing is that your product is not really as good as the competition. Sounds crummy right? Hard to stomach that thought? It shouldn’t be! Truly disruptive technologies start out cheaper AND “worse.” Think Salesforce.com. At first it was cheaper than traditional CRM solutions, but it was also much less functional. Sure it had certain advantages we can all see now, but it has come a long way since then. Over time these disruptive technologies improve and take price too as their products go upstream. So sometimes when it comes to pricing the most important thing to do is to be honest with yourself and your team. Is your product really all around better than the competition or is it “worse” (ie less functional in certain ways) but potentially disruptive for one reason or another? Network effects and externalities are another subtlety to consider in pricing, particularly for consumer products. Network effects are why Facebook and Foursquare are free for consumers. However, while almost every entrepreneur I’ve met assumes their product has “incredibly powerful network effects,” in reality I think they are more rare than we lead ourselves to believe. Be honest with yourself, does your product really have hugely powerful network effects that justify underpricing the product to gain market share? Once you have market share how then will you monetize it?
If your product is better and you’re building a premium brand, price at a premium. If your product has limited functionality but the potential to improve over time and disrupt incumbents, consider under-cutting the competition—but don’t assume this is always the way to go!
Key takeaway: Startup pricing is not one size fits all and I think startups are more prone to underprice their products than overprice. And if you need a good visual to remind you that putting things on sale is not always great for your brand, I’ll leave you with this:
