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Pricing Is Imperative to Driving Profitability

The question I hear most frequently from entrepreneurs is “How do I price my product?”

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Some companies are better suited than others to go public. In June, Slack garnered press for doing so via a direct listing rather than taking the traditional route of an initial public offering. Because it had a profitable business model with a strong customer base, Slack executed this strategy effectively.

WeWork’s failed IPO is the flip side of that coin. The startup’s parent company, We Co., had planned a launch earlier this year. But after strong investor pushback, We Co. withdrew its IPO. The company grew quickly, but it struggled with profitability. Investors did not trust the high-value, high-risk company’s hype, and its bankers were not in a position to take the company public after seeing its valuation plummet from $47 billion at its last funding raise in January to $15 billion in September.

The contrast between these IPO outcomes illustrates the importance of creating a road map to profitability. One company had it, while the other did not. And what is central to profitability? Pricing. Recognizing how it could ultimately impact your future success on the stock exchange is crucial.

Is There a Silver Bullet?

The question I hear most frequently from entrepreneurs is “How do I price my product?” Pricing can be extremely difficult, especially because startups are creating new products and solutions while trying to steal market share from established players.

The key is to quantify the value that you provide your customers, which can be difficult without a baseline. If you face a strong competitor, you might have to price aggressively to entice customers to try your product and then increase your price as your targets begin to recognize its value. This can be accomplished through promotional pricing, free trials, and freemium models.

So what is the pricing silver bullet? Unfortunately, there is none. You have to consider each component of the calculation. If you price too low, you will be unprofitable. But if you price too high, you run the risk of turning away future customers who will eventually drive profits.

Emerging companies need to continuously adjust to strike the right balance between attracting customers and generating profits. If investors do not see a path to profitability, they will invest elsewhere. Uber, for example, priced its IPO at $45 per share but opened at only $42 per share and continued dropping. Uber raised more than $8 billion by going public but finished well short of the $100 billion it had expected. To change this trend, the market needs to understand how Uber will become profitable.

Incorporating pricing upfront in your business strategy is the best way forward. Below are three strategies to help you do so:

1. Establish high-level pricing objectives.

It is imperative that you understand what level of pricing is appropriate for your current business stage. This can range from rock-bottom “survival” pricing to top-tier “harvesting” pricing. Knowing this shows investors that you have thought beyond product-market fit.

  • Survival: This approach to pricing is generally used to buy time to build a consumer base when the marginal cost is low. It is also useful in correcting a weak competitive position.
  • Growth: Growth pricing is a low-cost business strategy. This can be a good option if your target customers are sensitive to price, as production and distribution costs decrease with increased volume.
  • Skimming: This pricing level is generally appropriate for firms with limited capacity, small markets, or high barriers to entry. It allows you to attract new segments with a reduced price (e.g., off-season travel, peak load pricing, or clothing markdowns).
  • Differentiation: Firms can generally price at this level when they are in a growth or maturity stage. They have high costs, high-quality perception, and customers who are insensitive to price. A higher pricing model is required to sustain the advertising necessary to maintain their perceived image.
  • Harvesting: Products in late maturity or decline would typically be leveraged in a harvesting pricing strategy. The end goal is to create a cash cow to fund other product markets.

2. Take control of price sensitivity.

Start by understanding your price ceiling (what people are willing to pay) and floor (company cost). To maximize your profits, take advantage of various tactics to influence price sensitivity.

One tactic is leveraging customers’ willingness to pay. Typically, people are willing to pay more when the price is a small percentage of their income or the total cost of the end product. They are also willing to pay a higher price when a cost is borne by another party, such as you might see with health insurance or expense accounts, or if your product enhances the value of a previous investment.

3. Conduct a thorough competitive analysis.

You need to understand where you stack up next to the competition across multiple dimensions. Consider what the competition is selling and how much it is selling it for, including positioning and merchandising. Continuously check the market so you do not fall behind when the landscape changes, and be thoughtful about whether you are pricing below, with, or above your competition.

Proper pricing is imperative for the success of your business, so it is vital that you understand your pricing objectives, your customers’ willingness to pay, and your competitive landscape. As Slack and WeWork showed us, having a road map to profitability is paramount to successfully go public. While pricing can be a challenge for entrepreneurs, it is not only crucial for profitability, but also for their potential of future success on the stock exchange.

Christine Alemany is the CEO at TBGA. She has a passion for helping early- to midstage companies grow and scale. Christine has more than 19 years of experience reinvigorating brands, building demand generation programs, and launching products for startups and Fortune 500 companies. In addition to her work at TBGA, she advises startups through Columbia Business School’s Entrepreneurial Sounding Board and is a teaching fellow at the NASDAQ Entrepreneurial Center.

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