Per Sjofors, a.k.a. “The Price Whisperer,” founded Sjofors & Partners and is a thought leader on using price for higher growth and profits.
It is clear that Venture Capital funding is drying up. According to Crunchbase, which tracks who gets funded and with how much, VC funding is down by some 44% compared to a year ago. This is despite some substantial investments in the AI field.
The implications of this are pretty straightforward—startup and early-stage companies need to accelerate their quest for profits. And profits eventually drive every company. No profits or further investment often means a fire sale or closing down. Not good for anybody; founders, staff and earlier investors. Not even for potential buyers who could have benefited from the company’s product or service.
A common mistake by companies that bring to market a product or service that is disruptive in some way is to believe they need to price it low to capture market share. But that is not how early markets work.
A disruptive product or service will only appeal to early adopters, who buy for all different reasons, but low price is not one reason. So what, too often, happens is that the company that developed the disruptive product introduces the product at a relatively low price. Sometime after the introduction, the company reviews the sales volume, the bank balance and the revenue they promised investors in their pitch deck.
They find that sales volume is not what they expected, neither is revenue, and the bank balance is getting dangerously low. So they panic and lower the already relatively low prices in an attempt to grow revenue. This rarely works as the company expects, and instead, the best case is the same sales volume but at a lower price; the already low revenue will drop further. So why is this?
The price of a product or service is a message of quality and benefit. It sets an expectation in the mind of the buyer. A too-low price will send a message of inferior quality and benefit, and the potential buyer will decide not to buy.
We have all been there—we find a product or service that we hold in our hands (physically or metaphysically), and we say to ourselves: “I kind of want to buy this, but at this low price, it cannot be any good. It will not meet my expectation of quality and benefit. So I’ll pass.” The lower the price, the larger the portion of an addressable market will conclude that the price is too low to promise adequate quality and benefit.
Furthermore, within the academic field of Behavioral Economics, and especially in the paper by Amos Tversky and Daniel Kahneman from 1992, Advances in Prospect Theory: Cumulative Representation of Uncertainty, the authors established our loss aversion is about 2.25 times more influential for our decision making than the expected gain.
Thus, we don’t want to lose our money buying a product or service that we are unsure will provide sufficient benefit, and a too-low price will highly influence the purchase decision. Kahneman received the Nobel Price in 2002 for their work on human decision making. Tversky sadly died relatively young from cancer but, from my perspective, would otherwise have likely shared the Nobel Prize with Kahneman.
A further issue that can be considered both a threat and an opportunity for a company bringing to market a disruptive product is that all purchase decisions are made in context, with the buyer having one or several references in mind as the purchase decision is made. This is a topic also explored by Tversky and Kahneman and prior by fellow Nobel Prize Laureates Herbert Simon and Richard Thaler.
It is an opportunity because, by definition, for a disruptive product or service to exist, there are no equivalent products on the market the buyer can compare with. This means the seller has an unchallenged opportunity to bring the references to the buyer through value statements. It is a threat in that if said value statements are missing—for example, if the seller provides no context or references—the disruptive product will fail. This is a topic I explored in my previous article in this publication.
Following the discussion above, it then becomes clear that disruptive products or services should be priced high. Not only because early adopters are not price sensitive but also because the company invested significantly in developing the product, training people, and marketing to make the market aware it exists. And consequently need to recoup that investment sooner rather than later, and if no further investment is available, there is only one choice—become profitable as soon as possible.
But why, you may ask, why does a high price for a disruptive product work? Should not the company cut costs instead? Well, any company needs to keep costs under control, but cutting too much cost means that the company will not be able to delight its customers with excellent support and may not have sufficient resources for further product development and go-to-market efforts.
Then there is the fact that pricing affects profits more than cost does. If you do a thought experiment and consider changing price and cost by 1%, for the average company, a cost reduction of 1% will affect profits (EBITDA) by 5.5%. In comparison, a price increase (or reduction of discounting) will affect profits by 11.3%. The calculation for this is simple. Pricing has the highest leverage on profits!
So, in closing, if your company brings out a disruptive product, price it high. The sales volume will be low as the market will consist of early adopters, and they are few, and the company will need every dime of profit it can get!
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