What do you charge for a service that you just made up?

We all would like to believe there is nothing like our product or service. After all we are innovators and our vision is to change the way people do things. The investor pitch deck from a startup, Everest, sums up this attitude

Let us take all such claims at face value and treat every one of these products and services as new. Then we face the key monetization question
What do we charge for a service that we just made up?

To make this question more meaningful let us use a simple yet real life case study instead of talking about hypothetical product. The case study comes to us from NPR Planet Money, (Don’t read the full story yet, I will take you to the middle of the story to set up the case)

Two guys offer visa form printing services in front of the New York Chinese consulate.Visa applicants, turned away at the visa counter for filling they wrong forms, come to these guys who have computer and printer in a RV parked right outside the consulate. No such service existed before. They just made this up. How do you think they should price this innovative service?

As I wrote in the past, there are two places to start to answer the pricing question – even for something we’re building just now, Product or Customers. My recommended starting point is, Customers.

Even if the product is innovative and what you are building doesn’t exist yet, the needs are not.  The needs are why the customers are hiring your products for (Christensen). If needs indeed exist then they are currently addressed by different customers differently.

In general there are always different customer segments. For some  the needs may go unaddressed for others the needs may be addressed through alternatives, however sub-optimal they may be. There may not be a competitor product but there are always incumbents. In some sense, doing nothing is an alternative too (for Intuit’s TurboTax, they defined their incumbent as paper and pencil).

In the Chinese visa case the alternative is walking to the closest internet cafe and paying for printing or coming back another day (like those with low opportunity cost for their time).

You can’t serve all segments, at least not initially. You need to choose your segments, those that offer the best return with your limited resources. After all strategy is about making choices.

Say you choose the segment that used to walk to nearest internet cafe.  By choosing this segment you already know they are willing to pay for printing the forms at the internet cafe and they incur additional pain to make the round trip.

Your next step  is to position the product in the minds of the target segment. Positioning your product is not about how innovative it is but about what job you want them to hire it for and why your product is better than anything else that customers hire now. If you can’t position your product you can’t control its pricing.

Once you perfect the positioning, pricing is the next logical step. Hiring your product over the alternative adds incremental value to customers (like avoiding round-trip walk) and you price your service to capture your share of the value created.

How do you quantify the value created and how do you know your right share that customer will willingly part with? Some customers know, some don’t. It is up to you to do the value creation math and show it to them. Then you rely on quantitative methods, pricing experiments and signaling to find your fair share – the price customer is willing to pay without pain.

In general,  cases where you have repeat customers it is important to get the first pricing correct. Choose too low, you forgo profits. Choose two high and continue to drop prices, you lose credibility. That said, if you have done the Segmentation right, Targeting right and Positioning right, the pricing can’t be far from right.

Let us come back to the case study. They had no repeat customers. They chose to experiment. They charged $10, the same price charged by internet cafe and found the demand overwhelming. Next they went to $40 and found drop in sales. Now they charge $20.

Be it a software product,  magical delivery service or Visa form printing service – you need to worry about monetization. Otherwise why do it, however innovative the service is?

So what do you charge for a service that you just made up?


Readings:

  1. NPR Planet Money Story http://www.npr.org/blogs/money/2012/01/04/144636898/a-man-a-van-a-surprising-business-plan
  2. Segmentation
  3. Startups and Segmentation
  4. An entrepreneur will not always succeed in positioning his latest innovation the next “new thing.” http://www.chicagobooth.edu/capideas/oct09/5.aspx

Note 1: Note that the pricing for the service did not take into account the cost to rent the van, opportunity cost of the two guys operating it, or the cost of printing. Pricing comes before costing. If you cannot deliver the service profitably at the price customer is willing to pay you need to explore options.

Note 2: The price $10 set by internet cafe is the reference price in the minds of customers. Even if that price is wrong (cost based) you are stuck with it unless you can shift the reference.

4 thoughts on “What do you charge for a service that you just made up?

  1. Thanks for your article. You never want to undercharge for your services yet if you are too expensive, people will not want to purchase from you. It is important to position it correctly with the price right from the start.

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