Ryan Lawler

2 March 2020

3 min read

This video is a part of our ClassroomX educational series on the nuts and bolts of building a startup today. From defining your business model to growth, product strategy, and building your community, these 15 lessons by domain experts aim to equip young founders with crucial insights to transform their early-stage products into viable businesses.

How to move from cost-based to value-driven pricing

Pricing is one of those awkward subjects many founders would prefer not to have to think about. But it's actually an important lever for unlocking value for your startup.

What you'll learn from this lesson:

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About Maor Gordon-Guterman

Maor facilitates data-driven clarity and empowers founders to tackle their startup's biggest obstacles to growth. As the director of innovation and strategy at NUMA New York, he helps startups scale in the U.S. through key partnerships with corporations, investors, mentors, and experts.

Cost-based pricing leaves money on the table

According to Maor, startups generally have three pricing strategies. They can choose from cost-based, competitor-based, or value-based pricing strategies.

A cost-based pricing strategy involves charging for your own costs, plus a small markup. This is the easiest option, but it risks leaving money on the table, Maor says. For example, he points to the recent failure of J.C. Penney's new pricing strategy.

Previously, the department store chain was known for regularly running sales where it would slash the retail price by 50 percent or more. Then, in came a new CEO who decided to stop all discounts, sales, and coupons, and switching to a cost-plus-markup model all the time. Lowering the regular retail price caused customers to actually value the products less.

Another example is a study commissioned a few years ago by a grocery chain operating around the D.C .and Atlanta metro areas. This chain charged roughly 10 percent less than the market average, but because it looked like an upscale grocer, customers perceived that they were paying more than they actually were.

The problem with this type of cost-based strategy, Maor says, is that price doesn't just define the value of your product; your product also defines the price. In the case of this grocery business, the company would have been better off raising prices because people already thought they were paying a premium.

"It's quite important to recognize the value you're giving, which in the case of that grocery store was an upscale experience and not low-cost groceries," he says.

Why value-based pricing is more efficient

About 75 percent of startups that participate in NUMA's accelerator program charge similarly to their competitors. Unless you have a product that is totally unique, then a competitor-based pricing strategy makes sense, Maor says, "but it is still not the most efficient way of pricing."

The biggest mistake Maor observes in NUMA participants is that they set prices in a "vacuum." By this, he means these startups are too fixated on competitors' prices and don't go to the trouble of testing how much their own customers actually value their product.

To demonstrate the benefits of value-based pricing, Maor points to one of its most famous exponents: Starbucks. "Starbucks knows that its customers really care about the strength of their coffee, and that their cups look boutique and nice. So, Starbucks can price above competitors like Dunkin' Donuts or other coffee brands in the market."

Value-based pricing is about understanding what your customers value and then pricing accordingly. NUMA, for example, recently worked with a startup marketing an AI-based supply chain platform that promises cost savings. The startup's founders understood that what their customers valued the most was guaranteed efficiency. So they adopted a performance-based pricing model which stipulated that for every dollar the platform saved the customer, they would charge X percent.

This pricing model reduced the risk for clients and also guaranteed the startup a sustainable revenue stream that did not leave any money on the table, Maor says.

Once you have identified value, the only thing left to do is communicate that value to clients. This means training your team to sell value, not price, Maor says. "Setting a price is one thing," he adds, "but communicating the value is more important than actually having a price that's correct."