Lesson: Revenue Relationships with Steve Blank

Step #8 Pricing: Pricing is a tactic within your revenue model

In summary, revenue streams might take the form of a whole series of potential strategies, but what's interesting is inside of each revenue stream, you may have different pricing tactics. Let me say that again, we just talked about revenue streams, if you think about it, we didn't talk about how much to charge, we talked about the potential ways to charge. Licensing, intermediation and direct sales etcetera. How do you think about pricing itself? How do you set prices? Let's take a look.

Pricing is kind of tactics, first thing is you have to figure out, what's the revenue stream I'm going to use for the customer segment, but there are two types of pricing. One is fixed pricing, fixed pricing is just like it sounds, there's no haggling, here's how it is it's a fixed price. Fixed price, you can decide, how do I set that price? I'm going to take the cost of what it takes me to build the product, and I'm going to add some fixed markup, whatever I think my profit should be, and it's very simple, its cost plus markup.

This get's me to the minimum price of the market. You know what? I might know something that my competitors don't know. I've been out talking to these customers for weeks or months and I know that they actually value my feature set, my value preposition more than my competitors. In the existing market I know something no one knows; I know exactly how much they value one able offer. Instead of pricing based on cost, I can actually price on specific customer's segment or on features I know they need.

There's a third type of fixed pricing, and that's called volume pricing. It might be that you want to encourage high volume because you have economies of scale, and so you might price the product if you're buying quantities of 1 to 10, its $1,000. But if you buy in quantities of 10 to 100 its $900, therefore you can keep stepping up the discount, but boy if you're buying hundreds of thousands or millions instead of a thousand dollars, we'll charge you $99. You know who does that? Go talk to Intel on a semi-conductor manufacturers, they want to encourage high volume purchases, and so they have stepped pricing that is oriented to create volume. Cost plus markup, value pricing and volume price are all examples of fixed pricing tactics.

There's another type of pricing, that's dynamic pricing, and dynamic pricing is exactly what it sounds like. Dynamic means it moves. Well how can you have prices that move? I thought all pricing is written down on a piece of paper and never changes? Well if you think about it, pricing that you negotiate. Yeah we kind of have this price on paper, but that's just the starting point of a conversation. Negotiated prices are a dynamic price.

Airlines are now a great example of another type of dynamic pricing and that's called yield management. If you think about it once an airplane takes off, they can no longer sell those seats, so a month before the flight, those seats might be $500, a week before those seats might actually go up to $600, an hour before, those seats might drop down to $99 because that plane's leaving and if we have empty seats we're not getting any revenue. Yield management is actually pretty interesting based on experience, on time, etcetera. There are software programs and industries, like airlines and car rentals etcetera that have perishable seats or time, actually are quite good at doing this.

Another type of dynamic pricing or real time markets, stock market is a real time market, and then auctions like eBay, another example of dynamic pricing. So again, two types of pricing models, fixed and dynamic. How do you know which one to use? You've been out talking to customers, how do they currently buy and what's the revenue stream that's associated with this kind of pricing tactics?

You need to be constantly thinking, what's the right revenue stream for the right segment? And within that, what's the right pricing model, is it fixed or is it dynamic and which one are you going to pick? Couple of mistakes right on tactics I just want to remind you about, I mentioned them earlier but a common startup error on day one is, "Let’s price on cost." We know how much it takes to build our product, we'll just add a markup that is a profit, and therefore, we have a price. How hard can that be? This is typically not a strategic way to price. You might end up here, but boy there's a lot more moves on the table.

What you really want to think about is not just your internal economics, but the customer insight that you actually have. So I want you to think about, pricing and cost is maybe the first place we start, but are we leaving a ton of money on the table? Because the alternative to pricing on cost is pricing on value. As we said earlier, you now know, your customer segments perception of the value of your value prop, is it about time saved, new efficiency created?

Remember we talked earlier about pains and gains for this customer segment. What is it that they value, why are you saving them a ton of money? Customers don't necessarily feel that they want to pay this way, but smart marketeers and smart startup executives can convince customers that instead of paying on cost, they really ought to be thinking about that your company is unique in providing the most value, not just the cheapest product.