Step-by-Step Instructions

Click to open worksheet

Problems it Solves

1. Avoid Common Pricing Mistakes

There are some prevalent pitfalls founders fall into when setting their price. This chapter will help you avoid them.

2. Set the Foundation for Price Testing

This chapter will present the fundamental principles when setting your price so that when you test your price, you'll be acting from a strong base of pricing fundamentals.

The 4 Pricing Principles

Principle #1: Costs Don't Determine Price

I know that when I first started, I wondered if "price" came from some calculation based on my costs to build the product. This makes sense logically, but it turns out to be completely wrong.

Costs have nothing to do with price.

It turns out that price has everything to do with how much your customers are willing to pay. In other words, your costs do not determine price, your customers do.

It is true that costs have some role: costs will determine if it is feasible to build the product you would like to build. If the price customers are willing to pay is less than the cost of building the product, obviously it is not feasible to proceed. However, beyond that, price is an entirely different question.

Your customer will always be the one to determine your price.

Steps 1 & 2

Take out your Science of Pricing worksheet. Fill in your customer and the problem they have. This should be the same as you've completed on other worksheets.

Principle #2: Humans Can't Infer Prices

Humans have a very hard time looking at something and determining its value. For example, take a look at the picture at the vehicle here.

Unless you have a lot of background knowledge on this particular item, you have no way of determining if its value today is $500, $5000, $5 million...it is impossible for you to know without some additional information.

That additional information we use to determine a product's value is how it is priced compared to other products.

For example, in the vehicle scenario, you would make a decision about the value of this vehicle based on how much it sold for most recently or how much a similar vehicle sold for.

This happens all the time. The price of a house, for example, is literally based on "comparables."

Comparisons are also the reason why sales work: if you look at the sales tag in the picture here, you will see that the original price is listed there. As customers we perceive the value of a sale based on its comparison to the original price.

Knowing that customers use comparisons to make decisions about value, leads to a fundamental concept that drives almost all pricing decisions: Anchor Pricing.

An anchor price is the price your customer will use to compare the price you're asking for your product. "Anchors" can come in many forms:

• What the customer paid for a similar product
• Prices the customer has seen while shopping for similar solutions
• The "original asking price" of your product before you put it on sale
• A more comprehensive version of your product offering can serve as an anchor for a lower priced version

Note that sometimes you determine the anchor, and sometimes the greater market does. Either way, your customer will determine the value of your Offer using these anchors.

Now, on the worksheet, you'll explore your customers' possible "anchors."

Step 3

Here list all possible "anchors" your customers could reference when thinking about the value of your Offer. These need not be direct competitors, but rather any solution that your customer may consider trying to solve their problem.

In my case, I wrote in some of the comparable products to this workbook series including other books, online courses, startup accelerators, etc.

For each "anchor", list Low and High prices that your customer may find for each solution.

For example, there are many books out there for entrepreneurs who are not sure what to test or how to test it, and these range in price from free to around $30. In another example, there are in-person programs that may cost the founder anywhere from $700 - $1,200. You can see my other examples in the image.

Write in yours, and don't worry if the prices range all over the map.

Principle #3: Price Implies Quality

There are a few different ways that customers assess the quality of a product before buying. Often times these include some form of social proof like: testimonials, a recommendation from a friend, ratings on Yelp, and so forth.

In addition to social proof, customers use other "proxies" to determine the relative quality of a product. One proxy might be the design or aesthetics of a product. If something looks designed well on the outside, it's easy to imagine the same holds for the "inside"; and vice versa.

Of course, the other quality proxy customers often use, is the price of the product.

The price of a product implies it's quality.

You may have experienced this with drinking a bottle of expensive wine. A bottle of expensive wine simply feels like it should taste better than a bottle of cheap wine.

The same goes with cars: a luxury car has the allure of being higher quality even if the actual mechanics are of equal of a less expensive quality to a less costly car. A haircut is another example of where price may lead the consumer to feel like he is getting a better product: getting a cut at SuperCuts feels differently than a haircut at a high end salon.

In all of these cases, the higher price does not necessarily mean that the item is actually a higher quality. It is simply that price implies the quality.

It's also true that perceived increases in quality, increases sales. As perceived quality increases, so too can sales - to a point.

Let's take a look at how quality perception and price interact.

It is generally perceived that demand follows a simple path: as price increases, the number of sales decreases. The idea here is that the cheaper something is, the more people will buy it. The more expensive it is, the fewer will buy it.

This is the idea behind the generally accepted demand curve, which it turns out, is wrong.

Professor Min Ding of Pennsylvania State University published research in 2010 in the Journal of Retailing stating that price is an indicator of quality and that indicator of quality can increase sales.

Professor Ding conducted tests where he presented the same product at different price points to see what effect price had on the number of sales. Over and over again, he found that the price was a sign of quality, and to a point, higher prices actually increased sales.

Based on these findings, Professor Min Ding found that the demand curve looks more like this:

In this curve, you can see that at a very low price, often free, a large number of products are sold. Humans like free things.

At a slightly higher price, sales drop pretty dramatically.

However, at an even higher price point, sales actually start to increase.

Of course, there is always a limit. At some point the price is too high and sales begin to decrease again.

The "bump" in the middle is what I am calling the quality hump.  It should be your goal to identify at what price your quality hump is highest so you not only maximize sales, but maximize total revenue.

Almost universally, early stage founders undercharge for their product. Founders are so scared of losing customers based on too high of a price point that they vastly under price their products.

This is not a demonstration of founder altruism. By pricing your product too low, you are making a statement about the quality of your product. If you price too low, you are saying you have a low quality product, and you will sell less.

Absent other trust indicators, pricing your product low implies a low quality product.

In the next few steps, you are going to learn how to avoid this mistake and identify your "quality hump."

Steps 4 - 6

First, look at your Anchors chart and cross out the LOW column. You don't want your customer associating your product with low cost and low quality alternatives.

Next, circle the two most comparable solutions. These are the two solutions that are most like the solution that you are proposing to build. In my case, that means other books that are out there on start-ups, and workshops that are available for founders. The price points for these two are $30 and $300 respectively.

In step 6, you will pick a price in between these two that seems reasonable. For my case, I started with $49.

Side note: Study after study has shown that prices that end in a "9" have a higher conversion rate. So, if you think $100 is your best price, drop it to $99.

Principle #4: Low Prices Are Not a Business Model

You cannot start a new business based on price as your key differentiator. Low prices are not a business model for an innovative product.

For innovative products, low prices are a scaling strategy - not a business model.

Low prices are what you use if you have already have an established company or customer base, and you would like to grow. Low prices won't help you bring an innovative solution to market.

Why is this the case?

Your Early Adopters care more about solving their problem than they care about a discount.

As a reminder, your Early Adopters are the customers who have a problem, know they have a problem, and are actively trying to solve it. These people are not necessarily looking for the best "deal", they are looking for the best solution.

Approaching someone who is willing to pay for a solution to a problem and then offering them discount, is like saying:

"I'm 80% sure I can solve your problem. Let me give you a 20% discount so I can make up for the rest."

No one wants 80% of a solution, so don't offer your product at 80% of it's price. Your Early Adopters want a 100% solution, so sell it to them at 100% of the price.

This is why you want to avoid lower prices, especially to your Early Adopters. As you move on to your Late Majority you'll encounter customers not actively looking for a solution, so price may enter in as a deciding factor and a discount may be helpful.

In the meantime, keeping your price higher is a clear message to your Early Adopters that you have a high quality product that will be able to solve their problem.

Steps 7 & 8

Keeping in mind that price implies quality and quality increases sales, I want you to take your price from Step 6 and double it. Adjust this new number so that it ends in a "9". Write the new price in Step 7.

Now, in Step 8, I want you to double it again, also adjusting to end in a "9".

Congratulations - you now have the three prices that you are going to test in the next chapter, Price Testing. You are likely to be surprised by the data you get for each of these products - I'm constantly amazed by how higher prices almost always generate more revenue than lower ones.

What's Next

You now are equipped to avoid the most common pricing mistakes that most founders make! You also know the founding principles that will guide your future pricing decisions.

Most importantly, you know that your price is an indicator of the quality of your product, and that perception of quality is a large part of what will ultimately drive your sales.

Next, you will learn how to test your price to find your optimal price point, without losing customers.