AL #010: Use pricing to drive product decisions

A non-conventional way to think about strategy, user feedback and offer design.

Early stage crypto companies often avoid thinking about pricing. They think that…

• …pricing will restrict their ability to raise following capital

• …pricing is irrelevant (opting to make money from a token launch instead)

• …it's too early to charge (for strategic reasons)

• …the product is useful but we simply don't know the business model yet.

This is a mistake.

Pricing is the most high-leverage driver in any business

My first project as a McKinsey consultant was a pricing project.

The first thing I was taught is that pricing is unreasonably effective.

Assume you charge $20 per user per month in subscriptions and it costs you $10 per user per month to fulfill the subscription.

The profit is $20 - 10 = $10 per user per month.

Now increase the price by 50% to $30. The profit becomes $30 - 10 = $20, a 100% increase.

If the number of users stays the same, each 1% increase in price increases profit by more than 1%.

Since prices are cheap to change, this makes pricing one of the most impactful levers to improve in any business.

You can't think about pricing too early

Not every company should charge prices for their products immediately.

But thinking about pricing early helps companies make better product decisions and prevents them from investing in the wrong direction.

You could be building a product that is hard to charge for.

You could be focusing on the wrong metrics that won't drive profitability.

You could be prioritizing features that customers won't pay extra for.

All these risks can be mitigated by upfront pricing/business model research.

Here's how to go about this.

1. Think about the value you're adding to the user

The ability to charge prices requires users to perceive that you're adding value.

Would an average Instagram user pay for a subscription to browse other people's photos? Probably not.

Instead, Instagram charges advertisers who can make promoted content. In this case the value is clear – Instagram redirects user attention and the advertiser pays for it.

This doesn't mean that Instagram is not valuable to its users. But the money Instagram could extract from paying users is likely less than it can from advertisers.

And charging both would actually reduce profits for advertisers by reducing the number of users on the platform.

Two ways to think about user value in numerical terms:

• How much monetary value are you creating or what is the value of time you're saving?

• What is the value of your offering compared to the customer's best alternative?

2. Figure out your pricing structure and business model

The next step is to define your pricing structure and eventual business model.

There are 2 schools of thought.

The “value school”. Use value-based pricing to capture customer surplus

Patrick Campbell has talked a lot about how companies that charge based on value grow faster:

Value pricing is a mathematical inevitability as long as it is informed by competitive price analysis.

For example, if a competitor is charging $100 for a product that delivers $500 of value for the customer, that’s $400 of customer surplus.

Let’s assume your product would deliver $1000 of value for the customer. This means you can't charge $800.

If you did, you would only have a $200 value surplus. Your higher value does allow you to comfortably charge $400 and deliver a $600 value surplus, well in excess of your competitor's $400 surplus.

The “dominance school”. Use cost-based pricing to win the market

A more hypermodern idea promoted by Jesse Beyroutey is that the most user-friendly pricing will win in the long run. I recommend reading the Divinations article for more detail.

A return to cost-based pricing may seem controversial but from a game theoretical point of view it makes sense.

Both methods are actually compatible.

I see Jesse’s argument as saying that value-based prices converges to cost-based prices in the long run in any competitive market.

If you understand the interplay between these concepts and think from first principles, you're well on your way to finding a disruptive pricing model.

3. Align your metrics with pricing

In this step, you’ll use your hypothetical business model to define priorities for development.

For example, if you're building an asset management product that will eventually charge a fee, you’ll want to focus on:

• Assets under Management (which could be monetized through a management fee or a withdrawal fee)

• Performance (which could be monetized through a profit fee).

Instead, if you're building a product that will lean on advertising, you’ll focus on:

• Dwell time (how long users spend in your product)

• Your ability to attract high-value audiences (advertisers pay more for high-value targeting).

4. Determine how different features would contribute to pricing

You may already have done steps 1-3 especially if competing in a product category with a fairly established pricing model.

But step 4 is often missed.

Once you've figured out pricing, you have a lens through which to evaluate customer feedback.

Features that everybody wants and would pay extra for are differentiating features for your product.

Features that some people would pay a lot for are potential add-ons.

And features that everyone expects to be there are “core” features.

You shouldn't be building anything that doesn't fall in these categories.

Yes, that includes dark mode.