Pricing is one of the riskiest assumptions on the Lean Canvas (Revenue Stream).
Ironically, most founders defer pricing to later. They wait to define/build their product, understand their cost structure, then set and test pricing with customers.
This is backward.
Pricing should determine your product and not the other way around.
Here’s why:
Price is part of your product
Suppose I place two bottles of water in front of you and tell you that one costs 50 cents and the other costs 2 dollars. Even though you couldn’t tell them apart in a blind taste test (because the products are similar enough), you might be inclined to believe (or at least wonder whether) the more expensive water is of higher quality. Here, price has the power to change your perception of the product.
A product (MVP) without pricing is like a two-legged stool.
Price defines your customers
More interestingly, the bottled water you pick determines your customer segment. From the existing market for bottled water, we know there is a viable business for bottled water at both price segments. What you charge signals your positioning on which customers you want to attract.
Pricing drives business model viability.
Getting paid is the first form of validation
Getting a customer to give you money is one of the hardest actions you can ask them to take, and it’s what separates users from customers.
You don’t need lots of users. Just enough good customers.
There is no business in your business model without revenue.
In today’s issue, I’ll outline when and how to set pricing for your product. It’s a lot sooner than you think.
Forget Cost-based Pricing
Pricing against your product (solution) is cost-based pricing. It’s backward because customers don’t care about your solution or cost structure but their problems and outcomes.
When buying a new iPhone, do you justify pricing by slapping a fair margin on Apple’s unit costs? No. You justify pricing based on your perceived value of what the iPhone lets you do compared to other smartphones.
Value-based Pricing is Better, But Not Enough
A better approach is value-based pricing. This is where you anchor your pricing against your unique value proposition (UVP) and the cost of existing alternatives.
Your product’s fair price sits somewhere between these two anchors.
But even this may not be enough.
It’s possible to set fair pricing for your product but still fail to build a viable business model.
This is why I advocate setting business-model-based pricing before value-based pricing.
How to Set Business-Model-Based Pricing
Using business-model-based pricing is a 3-step process:
- Outline the ways to achieve your business model goal
- Shortlist possible business model (customer-problem-solution) variants
- Pick your primary business model (one customer-problem-solution)
Let’s walk through the steps.
1. Outline the ways to achieve your business model goal
Avoid starting with your product or idea. Instead, determine the business model outcome (minimum success criteria) you’re trying to achieve that would deem any project you undertake a success.
Then outline the ways to achieve this outcome.
For example, if my goal is to build a $1m ARR (annual recurring revenue) business, I would need to achieve one of the following:
- Acquire 100,000 customers paying you $10/year
- Acquire 10,000 customers paying you $100/year
- Acquire 1,000 customers paying you $1,000/year
- Acquire 100 customers paying you $10,000/year
- Acquire 10 customers paying you $100,000/year
Notice that this approach is customer/problem/solution-agnostic or idea-agnostic.
It’s goal-oriented.
When you start thinking this way, you quickly realize there are only a finite number of ways to build any business.
2. Shortlist possible business model (customer-problem-solution) variants
Only after you’ve outlined the ways to achieve your goal do you identify, define, or refine your customer segment (early adopters), problems, and solutions (product).
I’ll illustrate with a personal example.
In 2010, I first introduced the Lean Canvas template in a blog post, which quickly became my most popular post.
How could I build a $1m ARR product around Lean Canvas?
- I could sell 100,000 ebooks per year for $10
- I could build a SaaS product and charge 10,000 entrepreneurs $100/yr ($9/mo)
- I could sell an online course for $1,000 to 1,000 students/year
- I could sell a mastermind coaching program to 100 people/year for $10,000
- I could build an innovation platform and charge $10,000/yr to 100 enterprises
- I could offer private consulting to 10 big clients per year for $100,000
- and so on…
Some of these ideas are more feasible than others. Others are more fitting to the kind of company I want to build. Finding fit here is what I call Founder-Business-Model Fit.
For instance,
- Selling 100,000 ebooks at a 1-10% conversion rate would require building a 1-10 million reader top-of-the-funnel. Feasible?
- Being impact and purpose-driven, I didn’t want to limit my expertise to just 10 clients a year. Doesn’t fit with the founder’s mission.
- Being a technical founder, I wanted to leverage software versus people or time. Product-type constraint.
Shortlist your most promising variants by picking a big enough market you want to serve.
3. Pick your primary business model (one customer-problem-solution)
While it’s perfectly okay and even advisable to test your top 3-5 variant business models in parallel for a little while, you’ll need to make one variant your primary business model (by problem/solution fit) and stay razor-focused on driving that variant to product/market fit (PMF).
This is probably the step that most founders struggle with (myself included) because it’s so tempting to say yes to someone that wants to pay you.
But having five ways of making money at five different price points across several customer segments when pre-PMF is a recipe for spreading your limited resources too thin.
Embracing a singular product, singular price point, singular beachhead customer focus is key until PMF.
When to Apply Business-Model-Based Pricing?
The ideal time to apply business-model-based pricing is at the outset of a new project. The next best time is now.
If you haven’t already administered the Rapid Viability Test on your product, this simple 5-minute exercise could save you months of wasted effort and drive a renewed focus on your beachhead customer-problem-solution.
