Article

Pricing Strategies: A Delicate Balance – Part 1 of a 3-Part Series

By Dan Mitchell, Executive Director of ACE-Net.

Entrepreneurs need to develop an estimate of when their start-up companies would break even on a cash basis – breakeven defined as when the first positive cash flows might occur and when cash flows are positive cumulatively.  To shorten that time, we also recommended that entrepreneurs be careful to price their new products or services as high as possible, while keeping their unit costs as low as possible without compromising quality.  But, how does one do that?  Especially if the product or service is unique?  This article addresses how to determine what price to charge to maximize cash flow. 

The most common approach is to look at what competition is charging.  An ACE-net business plan must always address this issue, even if there is no direct competition, due to the product or service's uniqueness.  The entrepreneur, in this case, must draw on analogy – identifying products and service targeted at the same potential customers he or she is targeting. 

Once he or she has identified competition and pricing, a variety of pricing strategies exist.  The two most common relate to the business goals of the entrepreneur and the type of market in question.  The most common markets ACE-net listed business plans aim at are either consumer or technology markets. 

In general, the major business goal for a consumer product company is to capture maximum market share.  Consumers have so many choices in the US, that they are sensitive to even modest price differences.  These products also tend to be more in the nature of commodities – like minerals and oil, and consumers can be quite fickle if a new entrant to the market offers attractive prices relative to the alternatives.  So, the pricing strategy for an innovative consumer product might be to price below competitors.  Entrepreneurs in these markets should, however, be careful not to price too low below the alternatives – the old saying “You get what you pay for” clearly applies.   Pricing too low below the competition can backfire – putting too tight a squeeze on margins, could put the entrepreneur in the highly dangerous position of not being ever able to “make it up on volume”, as many of the fast food chains have found out.  He or she will just run out of cash all the more quickly.  The entrepreneur needs to be careful not to place too low a value on the innovativeness of the new product or service, even if it is only an incremental value-added to the consumer. 

For technology-based companies, a different pricing strategy applies.  In most cases, the entrepreneur has committed far more resources to investments in research and development (R&D) than a consumer products company.  Pharmaceutical companies spend 30-40% of sales on R&D, whereas consumer products companies are more likely to spend less than 10%.  The business goal of technology companies is to maximize profits, so as to recoup that R&D investment as quickly as possible.  Pricing to maximize profits will also help cash flow.  The suggested strategy for these technology industries is to price above the competition.  If the new product provides a truly value-added element in the eyes of the customer, and if the product is the right product, entering the right markets, at the right time, the customer will gladly pay the premium.  Even if the value-added is only incremental, as long as it is unique, the customer will still gladly pay the premium.

Rather than attempting to put a price tag on the deal, entrepreneurs should focus intently on the issue of when cash flows might become positive and explained the whys and hows of estimating cash flows and the importance of pricing the new service or product at the price the market will bear.