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The art and science of pricing | Madhavan Ramanujam (Monetizing Innovation, Simon-Kucher)

When we talk about pricing many people quickly gravitate to like dollar figures that s just a price point that s a dollar figure but when we think about price we think about it as a measure like you know liter is a measure of volume price is a measure of value and when you think of it this ways it really stands for two people actually want your product and would they actually buy it and that is their whole willingness to pay conversation and entrepreneurs and companies need to do this much earlier so that they can understand you know are they on the right track welcome to lenny s podcast i m lenny and my goal here. Is to help you get better at the craft of building and growing products today my guest is madhavan ramanujam madhavan is the author of monetizing innovation the most widely read book on pricing strategy he s also senior partner at simon kutcher and partners which is the premier consulting agency for companies looking to get help with their pricing and unsurprisingly when i asked people on twitter who the smartest person on pricing is madhavan was by far the most mentioned in this episode we get deep into all manner of pricing strategy especially focusing on five lessons four product teams on thinking about pricing enough talking let s get into it i bring you madhavan ramanujam after a short word from our wonderful sponsors this episode is brought to you by lemon io you ve achieved product market fit you re able to activate engage and retain your customers. 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So i work in our bay area offices and i ve been here with for the last years so i work primarily with tech companies here in the bay area. So that software internet marketplace companies etc so i worked with over companies more than unicorns on you know everything to do with pricing monetization profitable growth and these kind of topics so companies such as you know uber asana doordash many linkedin many come to mind. I think you asked about the book monetizing innovation that i wrote a number of copies. Etc i mean look when we first launched the book i used to track some of these copy sales and everything else and i quickly realized that a book is only good if it actually creates impact and that s also why we wrote the book so the way i measure impact for monetizing innovation is literally there s probably you know someone reaching out on a daily basis saying hey i read the book you know we could make some impact around pricing monetization in our companies and that and to me that s that s real impact and that s what keeps me kind of going because you know when we wrote we wrote the book we didn t want to write any marketing you know fluffy crap we wanted to write something that was more actionable and to see that people find it actionable and can use it monday morning to actually make changes i think that s real impact but of course the book has done well it is in still in top categories in many categories in amazon for instance it s been six years since we wrote the book wow need a second edition soon so that s incredible for a software tech oriented book where they often get really out of date really quickly like i was just reading it. And it s amazing how many things still are very true the topic is it s one that is relevant in i mean in even years to come so i think hopefully it s robust that race. And you talked about the company simon kutcher i l just add that any smart product leader growth person that i talk to they re always talking about how they ve worked with you to figure out their pricing strategies it s like the company that everyone goes to work with the company i like that maybe you should re brand ourselves as the company and my company let s do it let s let s talk about rebranding next how did you get into pricing and pricing.

How Madhavan got into pricing and monetization

Strategy how did you first get into this world and put kind of focus your career around it i actually happened to stumble in it. I mean it s classic fashion i was at stanford graduate school what graduate school of business and the engineering school. And you know we had a lot of startup discussions thinking of like creating starter very classic. And i was this guy who was actually in charge of coming up with the you know pricing monetization strategy in our you know teams when we were actually pitching to vcs. And i remember going and pitching our ideas. And you know and the vc asked me like how do you know you l actually make money on this innovation and i pulled up a spreadsheet i you know i showed him all the assumptions and i said so i m gonna do it. And i still remember this he said you ve labeled them correct those assumptions how do you truly know. And i was like ah i actually don. T i just made stuff up right then and within that same week i got a call from the then managing partner of simon matt johnson. And he said hey there was just you know pricing and growth strategy consulting from you want to come join us you re looking for sanford grads. And i was like whoa i didn t even know you existed i joined because i actually wanted to get to understand these signs behind pricing not just the art and that s kind of what i ve been focusing on you know in the last years and you know also my education in stanford was in quantitative marketing so many of those let s say theoretical models i could bring back into a practical industry relevant sense so it s been a great journey when i think about books.

Why he wrote Monetizing Innovation

People find most useful and sustain are books that are based on people s real experience of doing a thing for like a decade and your book is a great example that what made you decide to actually write a book because i know how hard that is from my wife s experience. Yeah. I think it probably started with some kind of mini frustration because we used to like get calls from like companies saying hey you know we need a pricing strategy we need a price plan and they would have invested like years probably making the innovation and then we would ask them like how long do we have and they re like we needed like yesterday right. I mean so it was like a time and again we witnessed this you know spray and pray approach. And then you know we used to ask this simple question like how do you truly know that people will actually pay for your innovation when you built it did you do any studies did you actually understand whether there s a product market pricing fit and usually the answer was no. And then it had to change i mean when we benchmarked percent of innovations actually fail from a monetization or you know commercial perspective simply because entrepreneurs or companies did not do the check earlier on had they done it. They could have probably you know pivoted the product build things in a different way and build something that was more meaningful. So we wrote monetizing innovation because increasingly you know we were working with companies more early stage in helping them design the right innovations that you know customers need and what are they willing to pay for as opposed to just building a product and slapping on a price. So it was crossing that chasm between knowing maybe hoping that you wouldn t. You know monetize like knowing that you truly will that was the motivation for writing monetizing innovation awesome we re.

Why pricing is a cross-functional discipline, but ultimately a function of product

Going to dive into a lot of these things that you ve shared in the book and things you ve learned one more context setting question before we get into it all which part of the org do you believe pricing strategies should sit in is it product sales finance marketing something else pricing by discipline is like a cross functional discipline i mean you can t talk pricing and isolation of product finance sales. Etc i mean there s always you know touch points. So it s extremely cross functional back in the day probably a decade ago i used to say pricing needs to sit in finance because my view was you know finance would be the counterbalance to sales especially if you have like you know sales coming up with pricing in a b situation i mean you can set all the pricing you want it s a human having a human conversation. So how do you put checks and balance in some of that and my view was you know pricing should sit in finance and it has to report on ultimately to the cfo i have over the last decade i ve been actually advocating that they should sit in the product site and there was also the genesis of monetizing innovation because if we truly believe that we need to build products that you know are simply products that customers need they love their value they re willing to pay for it is a product function because you need to be able to design the product around this kind of information around what customers need what they value and what they re willing to pay for in short around the price if you look at monetizing innovation the subtitle of the book is how you know smart companies design their products around the price so if you take that viewpoint then pricing needs to sit in the product function or you know the founder product and sort of report on to this is my strong health belief one that probably won t.

What “willingness to pay” is, and why founders need to have conversations about it early and often

Listeners of this podcast are product builders and product people that grow product managers founders people that work on cross functional product teams and i was reading a book and i picked five topics that i thought would be especially useful to product leaders to kind of dig into and the first is the willingness to pay conversations which i know is kind of foundational to the way that you think about pricing strategy gm advice that you share with people of how to think about pricing so you just talk about just like what is willingness to pay as a concept and then when should founders focus on these conversations to figure out the willingness to pay. Yeah. Absolutely. So i think look most of your listeners are many you know most product folks they probably understand you know language like product market fit especially made famous from lean startup and other kind of you know literature which is which is awesome. I think that the issue is it s not just about product market fit it is about achieving a product market pricing fit for instance if someone comes and asks me do you like the headset that you re using for this podcast i would say i like it do you like it at the whole conversation is different. So if you didn t put pricing as part of your product market fit validation you re often hearing what you want to hear it is truly about understanding whether you know customers are willing to pay for your innovation and willingness to pay is a proxy for do people actually value your product and you know how badly do they actually want the product the even comes back to like understanding what pricing really is right when we talk about pricing many people quickly gravitate to like dollar figures that s just a price point that s a dollar figure but when we think about price we think about it as a measure like you know liter is a measure of volume price is a measure of value and when you think of it this way it really stands for the people actually want your product and would they actually buy it and that is their whole willingness to pay conversation and entrepreneurs and companies need to do this much earlier so that they can understand you know are they on the right track i mean think of it this way it s like if i have the same sales and marketing conversation that i would have with the customer six months before launch of the product it s the whole value and then ask them a simple question would you pay for this innovation and if someone says no chances are you can put all the perfume you want in the next six months they re gonna say the same thing and if they do say no the most important question to ask is why and you start hearing all kinds of information that you can use to design your product and maybe even pivot your product strategy you know accordingly. So it is it is literally the litmus test of whether people like your product. And so if i were to kind of summarize your main point the ideas have these conversations right as you re thinking about designing the product don t try to just launch it see how people like it build a huge audience and then figure out pricing your advice is start having those conversations early right exactly and the folks at first round summarizes in four words i thought when they wrote a blog article on this. And they call it price before product period. Right. So i think that probably is sucks in but really it s really that right because if frankly lenny as an entrepreneur or a company you actually don t have a choice whether you l have a pricing conversation with your customer the only thing in your control is when you will have it. I mean you can build the most awesome innovation you think is awesome obsess over the engineering the product and everything else. And then you know slap on a price store in the market and hope to monetize or have this conversation much earlier pitch the same sales and you know marketing kind of you know pictures and then try to understand whether people will actually pay for it and then design around this information and you actually know that you will so you re maximizing your chances for success it s simply testing and learning everyone in your probably listener based nurse tests and learn we are talking about testing and learning pricing and willingness to pay why wouldn t you do that.

How Porsche built their SUV around customer feedback and willingness to pay

Products or companies where they have these conversations either way too early way too late or even just like nailed it. But here s the thing there s nothing like way too early for this conversation i mean i even tell people who are like you know early sea stage or just thinking about an idea i would say hey go check so if someone would actually pay for this idea and there s some high level ways to actually check for this and of course it s not about nailing the pricing strategy from like get go three years before a product is launched etc it s about understanding whether there is a willingness to pay and then repeating this exercise as you go along so that you can refine and when you re ready to launch the product you have a much more refined view on what is the willingness to pay and of course then you re you know launching the product with a lot more enthusiasm because you know this is actually going to have a product market pricing fit. So it s about iterating and learning and sort of refining so there s never too early too late i think is most of the companies this is why we wrote monetizing innovation like i told you percent of innovations fail. And we also categorize them into why they fail there are only four paleo types and i ve written about that in the book so i can leave that for readers to actually go and see it but all of those failure types happen because the conversation was just too late and pricing was an afterthought companies that did it. Well maybe you know one or two examples that i can probably take just to like motivate the concept. Right i mean we talk about in the first chapter a tale of two cars and about how porsche actually did this and the example is something like this relevant porsche was really looking for launching a new innovation they came up with an idea you know they said okay it should be launch an suv and even before a blueprint was drawn they basically went and checked with the market you know is there a need for an suv where people value it from porsche are they willing to pay for it and to their surprise they actually found that and then what they did next was more fascinating every single feature that actually went into the car or the benefit that people had was battle tested with customers and no amount of like convincing from product or engineering was you know was enough it had to be battle tested with customers things like for instance you know big cup holder was inside because people loved it needed an suv would pay for it things like six speed manual transmission people didn t need an suvs out of the window right they literally used to bring cars in what is called as car clinics and they would test for this and they would put people through prototypes before anything is even productized anything is in the factory floor where people would actually even drive around the porsche and say okay did they like it would they pay for it. Etc. And then they would fine tune every single thing that goes on. Right so the innovation process is very different from the classic you know spray and pray build something slap on a price throw it out it was really designing the product around customer feedback around willingness to pay you know the outcome of the process could also couldn t have been more different than the traditional approach of spray and pray the you know this was when they launched this suv it was called cayenne which we all know now you know accounts for more than half of purchase profit and literally one of the best roaring successes in automotive history.

How testing helped a marketplace company avoid building something customers don’t value

Right i mean there was this company which take think of this as a two sided marketplace and i and i l just keep the keep it a bit abstract. But i l tell you the details right in two side marketplace think of this as they were already monetizing on the you know sell side and the ceo said okay let s go and build a product for the buy side and that you know people will buy like. So the buy side monetization product strategy so in classic fashion all the product folks product managers. Etc they went off site generated thousands of post it notes design thinking yada everything right. And then they said okay we can t take all of these you know so many ideas to the ceo let s prioritize it somehow and they prioritized it to like ideas. And they took it to the ceo and said this is what we want to build and the ceo has a simple question how do you truly know you would monetize it s the same question that vc asked me like you know back in the day and they simply. Didn t know they were just guessing so what happened next was. They took you know wireframes blueprints they took you know product concepts and they started testing this with their customers and prospects. So you know stuff that they actually thought was exciting often was like way down in the list of priorities right. And if they didn t do these kind of tests they would have probably built the product around this like one to give you an example you know one of the features that they were building was called or other the number one feature that the internal team thought was well you know that was awesome they called it highlight connections from facebook and everyone in the company thought that people would pay for this it s an awesome feature they need it they love it and the thesis was something like this if as a buyer if i m buying a you know this the product from the same seller and someone in my facebook connection has already bought that product from the seller that s credible information in lieu of reviews and everything else and you know people would find it acceptable and pay for this when they went and tested this and pitched the idea they got all kinds of reactions so there was one customer group i remember which said. So. Yeah. You know you say you re telling me that i can t port through hundreds of reviews and make my own determination that s like you know unacceptable like that you know spoils the fun out of like actually doing research on products there was another group of customers who said are you do you like it. Yeah. I like it would you pay for it. Hell. No. And then there was another group which even said i don t even want anyone in my facebook circle to know that i m buying this product because there was some you know like let s say premiumness associated with this and and everything else they could not find a single set of customers or a segment of customers who said i love this feature i would pay for it if they hadn t done this exercise they would have built the entire product around this and it would have been a disaster but because they actually did this they could prioritize what they were building literally i mean for your product folks the number one lesson. And i hope this is the biggest takeaway for your audience you cannot prioritize a product roadmap without having a willingness to pay conversation i mean if you re just prioritizing based on what you think or what you feel or technical resources you re getting it wrong literally you can prioritize what you re building based on what customers need what they value and what they re willing to pay for and you can actually do this test and say what should you be building thing the funny thing that i have actually always seen always across these hundreds of companies that i ve worked of what you build drives of the willingness to pay it s a classic burrito. Right. And if you don t know this you re probably over indexing on like one or the other it s much better to find out what is this so that you can focus on it nail it and focus on all of the you know usability around it and make an awesome product as opposed to like not knowing what drives the willingness to pay and just trying to put everything out there right and at the worst form often what happens then is this is the easiest thing to build and what companies do is they will build it they will throw it out. And they l say there s an mvp give it for free. And then they are trying to chase their tails building you know of stuff that is driving of value so you ve already lost the battle so as a product person or a product builder you need to prioritize your r d roadmap based on willingness to pay conversations exactly like what the two sided marketplace did exactly like what porsche did and this is the crux of everything that we are talking about amazing what s interesting about the second example versus the first is in the porsche example they started with we want to charge this much let s build the car that we can sell for that much in the second case they had like a product they were trying to build. And then they figured out which things to build so exactly it s interesting that this can come kind of along the journey at different places but the main takeaway is do it early and earlier than you think right correct either product ties to a price point and the willingness to pay or at least use willingness to pay as an access to prioritize what you re building either way you l get it right.

Several methods to use to learn willingness to pay

Okay so let s actually talk about how to have these conversations i imagine that s what a lot of people are wondering right now he s. Like yes. I m convinced i will have these conversations. But then you know the classic issue with customers you ask them what they all do. And they never actually you can t trust their stories of what they l actually do so what advice do you have for folks when they have these conversations what questions should they ask what words should they use i know you have a few frameworks that you suggest you sure kind of talked about that. Yeah we can go deep into this and you can pull me back or ask me to go deeper whatever it doesn t. Matter. Right. So as you ve written an entire chapter in the book chapter four it s called how to have the willingness to pay conversation if there s one chapter just read that is. I mean it s quite detailed and goes into how to actually do this but look i mean if you go and ask someone you know how much should i charge for this product you re actually going to get garbage back that s your job. Right i mean no one is supposed to tell you how much to charge and that s the worst way to have the conversation there are some really interesting and nuanced ways of having the conversation where you still tease out what people are willing to pay for without you know directly confronting someone as to like what you should be charging so let me go into like a few methods. And i can pass to see if you have any questions so the first one is you know what we say is frame the question in a more relative manner. Right. And because you know. And sometimes i say tongue in cheek that people are absolutely meaningless relatively super smart you know what i mean by that is if you re gonna ask someone how much should i charge you l get a meaningless answer. But if you actually ask it in a relative way people actually give responses that are meaningful so like for instance if you re a b sas company. Okay. And you re trying to see if your product actually has willingness to pay one way to have that conversation is to say okay hey to your customers you know do you use products like salesforce in your install base. Yeah. I do use okay if salesforce was indexed at in value where do you think we are in terms of like the value that we bring to your let s say day to day business operations that people can answer all day long they might say they might say but depending on whether you re more or less compared to like let s say what a salesforce can do which is an established install base. And then if you say okay if salesforce was indexed at in pricing where do you think we should be that also people can say okay if they say what they re saying is you can be more premium than that. And we would still pay for it at least you ve gotten some information that is meaningful at a very basic level. Right so this is some relative ways of asking these questions are the most basic ways of actually doing it then we have questions where you know we there s some methods where we actually want to understand are there some psychological thresholds or budgets when it comes to like you know willingness to pay so the way to do this is let s you know take your product that you re going to launch pitch the you know value to your customers have that exact sales and marketing conversation that you would have after you launch the product but before and then you ask them what do you think is an acceptable price for this innovation look i mean everyone would like you know would like to lowball they l negotiate with themselves let them give an answer clock it then ask them what do you think is an expensive price and then follow that with what do you think is a prohibitively expensive price and now across thousands of projects that we have done what we have come to realize is acceptable prices the price where people not only love the product but they also love the price if you re in true growth mode maybe you can put it there it s a no brainer price no friction etc the expensive price tends to be the price that is value priced as in you know they don t love you they don t hate you they would pay you. But you know that s a neutral reaction prohibitively expensive tends to be the price that they will laugh you out of the room. Right. And if you do this at scale what you l start seeing is that there are some cliffs in these kind of demand curves where suddenly when you cross from let s say to you know or might say it is expensive or it s expensive it s probably expensive and that s what we look for to see if there are some psychological thresholds that if you actually cross you know you have a perception of being expensive so hiding behind some of these psychological thresholds become important right we rahul vora from superhuman actually read the book. And he s he talked about this in an a about gas he actually used this method to come up with his price point for the superhuman app. And i think that s a quick and dirty way to actually get to you know what is a willingness to pay and what s a psychological threshold. So i think that s a interesting method that you can do monday morning but the key here is to not just ask the question what would you pay but have that sales and marketing conversation tell people where they actually might get the benefits basically exactly everything you would do after launching the product to create you know awareness and showcase the benefits do it and then ask these questions so that you re priming them to the value that your product gets and you re not just having a in a random conversation there are other techniques that go more and more let s say rigorous for instance purchase probability questions so if you ask someone. Okay. Would you buy this product that s like a meaning meaningless question at least if you ground them on a scale and say on a scale of one to five would you buy it one is i m not at all interested five is you know most likely i would buy it or i would buy it for certain and four is like most likely for instance in three years i m neutral what we have actually seen is even if people say five you know they are probably only like to sure about whether they will buy. No. I mean. Yeah. So like you can start and if they say four it s like to percent if they say three and below they re never gonna buy it so you can start if you do this at scale you can start coming up with let s say a demand curve and then say where is the price optimal etc so you can understand purchase probabilities and if someone says let s say three for a certain price point then you can you know lower the price and say okay would they actually move their ratings to a four or five. So i think these are some simple ways to understand purchase probabilities and elasticities two more if i may i think another one is what we call as you know most and these kind of questions and the thesis behind this is if you go and ask people. Okay i give them a list of features let s say. And i say rank them one to ten most people will find that exercise painful horrible because there s always this messy middle where everything is great they all look. The same right. I mean there s a lot of psychological theory that people are very adept at identifying the extremes when it gets in the between that s when things become tougher so what we do is if you have a list of features that we want to understand whether people have willingness to pay for when we are prioritizing the r d roadmap for our clients we would take a subset of let s say six or so features out of those and then they say in this set of features identify the most important for you and the least important and the most important is defined as like you know must have i will pay for it least important is i don t need it i won t pay for it kind of connotation. These people can do all day long because they re just picking the two right. And then we will change the set of six another combination from the and ask that same question so if you do this a few times you would be able to you know prioritize the entire feature set in a relative fashion and truly understand what drives willingness to pay the last method which gets into more advanced methodology is what we call as more trade off exercises so here what we do is we put people through actual buying patterns or actual buying scenarios and say okay if you have this packaging and pricing for instance for your software product you know what would you do which is hack into a real life question like you know you put all the features all the price the number of plans. Etc then we would change that and say okay if you change the features and the price how would you react would you buy any of these products or would you say i won t choose any of these are you know more like shopping scenarios for your products but it s realistic and it s acting to real life based on how they choose these products what we are trying to reveal is the mental models and rules that people use to make decisions so for instance if i add certain amount of features and increase the price people say you know what i m not going to buy anything more what that actually tells you is like the addition of those features people were not willing to pay the addition in terms of price so they would actually opt out of the you know lineup that you actually have for your customers so these kind of things you know you can if you do these kind of exercise you can get more precise on things like price elasticity you know build some simulation models try to understand how the market would react etc and different methods are actually applicable at different stages of a product and different stages of a company you know if you re very early stage let s say just an idea just have the conversation i mean just even asking would you pay for it is a good question because if someone says no then ask why then you l hear a lot of good information if someone says yes ask them why would you pay for it they would articulate back the value that they understood and that should be in your value messaging right. So that s just a simple question if you re somewhere in mill then maybe some of these if you re in the series a or seed stage maybe some of the you know purchase probability questions all of these things can actually be a quick and dirty way to at least get to an answer and a point of view or if you re launching a product and it s in late stage or late stage in the product or the company life cycle and you need to get more precise in terms of like your pricing and packaging strategies and some of the methods around trade off exercises mostly all of these things become incredibly relevant. Sorry it was a long answer. But there s so many methods it s all summarizing chapter four. So just one chapter to read in the book that was perfect thank you amazing you mentioned that you want to ask why a lot and that s something you talk about in your book a bunch. I think something like of your questions should be why after they answer these questions that right that s absolutely right. Yeah. Cool i was tempted to ask you why but that would have not been very relevant nope not in this question.

When and how the willingness-to-pay conversations happen

Can you talk about like logistically how are you asking these questions like is this a meeting specifically you set up with a potential customer to talk about pricing does it come at the end of here i m pitching you on this product or i m trying to get desirability to use research feedback like what s what is that meeting set up for on behalf of the customer it s usually either a one on one conversation with a customer a much early stage you re a founder. And you re having a conversation it s basically you re pitching the idea and trying to understand. Not just product market fit but a product market pricing fit let s say if you re a bit more late stage and you have across functional team this could be a conversation that the sales teams could actually be having along with the product teams to actually understand this that s also what happens in companies like linkedin for instance when they launch a new innovation you know the team has to like book in a credit card or lock in a budget from a customer for pilot pocs and everything else and if they don t they don t necessarily go down the road of productizing it because they didn t. I mean there was no final verdict on whether people would actually pay for these kind of innovations right that s that s kind of how i see it. So it s it depends if it s early stage more like found to lead early conversations if it s more late stage than a cross functional conversation but usually it s it s a one on one with one on one as in with the company it could be multiple decision makers increasingly in b sas for instance it s not just one person deciding on a software budget it s like a team. So it s usually done with the team having that kind of conversation it can also be done in terms of like focus groups where you bring in you know a set of customers and then you sort of mediate and moderate you know answers and trying to get to like what is the right thing to do and often we also do a quantitative version of this where we are doing more test and learn through either you know a b testing or most importantly through controlled surveys that we would actually have you know invite participants to actually participate. And then they would give their opinions on these various concepts that we re actually testing. And then we try to understand you know what is the willingness to pay in the market based on those kind of responses so from a basic qualitative one on one validation all the way to more quantitative testing using other instruments so this is usually a part of a larger customer development product market fit discussion like here s a product we re thinking here s like classic user research yes our ability discussion and at the end you kind of talk about willingness to pay stuff. Yeah. Exactly. I mean i would think of it as i wouldn t say necessarily user research. It s a bit before that i mean user research probably gets more into usability and how people actually use it this is a one step before conversation where you re trying to understand you know testing and learning whether people buy into your idea do they see the value is that an roi and frankly what needs are you actually solving in the market right this people can articulate all day long like you know what is their jobs to be done or what is their needs pain point. What product to build is your job in some way as a product person but when you showcase the product and say okay this is the product that i m building which will actually meet this need you want to see if people s eyes light up and that s also when you need to have the willingness to pay conversation because it s not just about saying but actually meaning what you say and that can only be bought in if you actually use willingness to pay in the conversation otherwise it s a bit of an empty self fulfilling conversation. Often right. So. And then when you actually do this more and more like i said like you know eye trading or refining things then you can bring this into other pieces of the conversation and gets more smarter before you launch the product.

How many customers you should be talking to

Do you have a rule of thumb of how many people you should talk to at least to get a pretty good sense of maybe we ve gotten some. Yeah. I guess question all the time. And i said please talk to one person. Right i mean jokes about because most companies are not even doing that but in terms of willingness to pay conversations. But you know i mean if you re let s say a b c company of course you have scale in terms of reaching customers you might have you know hundred thousands and millions of customers consumers in those kind of situations the more of a quantitative validation might be easier to run so if you get even a thousand two thousand responses that could be statistically significant and easy to do and pull off if you re like a b sas company and you have you know you re focusing on let s say to accounts leading to of your business try to talk to as many of those as possible so like at least you know in the to kind of ballpark and often in these conversations after a point you start hearing stuff repeatedly. I mean if people tell you the idea is horrible it is horrible you can tested all you want. Right. I mean so when you start hearing these kind of things then you pivot and.

When to revisit pricing

Then once you have your initial thought on what pricing should be how often do you suggest folks iterate on their pricing strategy. Yeah usually we say at least every six months pass and think whether you should revisit it within you know to months probably there is time to revisit especially given market dynamics in most you know industry verticals that people are in today and also there are some pivot points where it will make sense to think about this like you re introducing a new plan or you re you know introducing some new features all of those kind of moments in time from a product journey standpoint would necessar having this conversation got it final question on this topic which we ve spent i think half an hour on which is awesome because it s probably the most important to start with but there s going to be a deep episode what s the first thing that a founder or pm should do to go down the route of willingness to pay if they were to start something on monday first of all start educating yourself that there is a science on this topic it s not just an odd get confidence that people have done this before not only just startups but like companies like porsche you know and then read chapter four and do it.

Segmentation strategies

Big deal to you and a core part of the way you think about it in addition to willingness to pay in its segmentation thinking about how to segment your customers and product so can you just talk about broadly why is this so important to think about segmentation when you re thinking about pricing look segmentation is a topic again just like product market fit is a well understood term for many of your listeners like when we go and ask companies you know do you have a segmentation strategy roughly about would say yeah we have it and then when we check it probably of them actually have a meaningful segmentation strategy. Right what i mean by this is most people think of segmentation as a demographic or persona exercise or you know how do i position this product to like different personas and things. And they get it horribly wrong. I mean i l give you this example if you think about a person who s plus years old lives in a castle incredibly wealthy in the united kingdom you probably think about charles but that also fits ozzy osbourne and i would probably raise you that both of them have dramatically different days you know need different things value things differently and are willing to pay for things differently. Right. I mean if you just base things on persona you often get it wrong segmentation needs to be based on what customers need what they value and what are they willing to pay for and how do you productize package to different segments so the key lesson that i want your listeners to take away is you need to be able to productize to segments if you re trying to build a product and try to position it to different segments you ve already lost the battle because segmentation comes down to needs and understanding needs and building products based on those needs and willingness to pay so that you can treat your customers differently because if you build that same product and want to treat everyone similarly and say you have a segmentation strategy you actually don. T have it. Right. I mean take a simple example you know if you think about the water that we drink in a fountain it s free in a bottle is two dollars you put gas in it is cents throw it in a mini bar it s five dollars it s the same damn water. But it s packaged productized differently because people have different needs i mean i m price conscious i wanted to in a fountain i wanted to carry it around i probably take in the bottle i like the taste i take gas in it or i m just simply ultimately lazy and i would pay the five dollars till i get it out of the minibar and not go down the hotel lobby and get it for free because that s my need. Right. I mean if you don t understand these kind of needs you will never be able to productize to those needs so you l just build one product and try to position it to the different needs based segments and you won t get it right for anyone right. And we work with all kinds of industry verticals we have not found a single vertical where you know our customer where their clients needs are homogeneous it is heterogeneous whether you want to accept it or not. And you know if you accept it then you would start getting into the heart of segmentation and say where is that heterogeneity how do the needs differ in the market how does the willingness to pay different in the market and what can i productize to different needs and willingness to pay you know segments so productizing to segments as opposed to building one and positioning it to different segments i mean usually when i walk into these companies they l say we are building a one size fits all i would quickly collect them and say one size fits none so it s a bit of that s why this topic is deep because people get the definition of segmentation wrong so segments are something that people.

Why you need to act differently to your segments that have different needs

Hear often. And i think like you said sort of understand and they to your point they think they ve kind of done segmentation but against your point a lot of times they do it wrong. You have this framework that is really interesting this like one phrase they use you can act differently to help you think about whether a segment makes sense and how to think about segmentation so you just talk about like what s a sign your segmentation is correct versus. Not. And maybe how to think about this framework so the three most important words and what you said is you act differently. So you as in you know your product teams your sales teams your marketing teams your finance teams act as in come up with new products build a business case come up with the product marketing messages sales strategies differently as in there s no point in doing segmentation and having the same reaction or treatment to everyone you need to be able to act differently. So what that means is if i know what you need what you re willing to pay for you know. And what you value then my conversation with you will be different than someone else who needs something else and is willing to pay something else i productize something for any my product is something else for the others and the key here is to understand there is a significant let s say a total available market or size of the market where the needs are similar and they re willing to pay as in let s try to find all the people who would want to drink water in a fountain let s find the people who want to drink it in a bottle let s find the people who want to drink you know have gas would they pay for it. And then when you understand these segments then you can say okay. What do i build for these different segments and then focus on that segment when you launch the product have the marketing message for that segment and target that segment as opposed to just building one thing and hoping that somehow these four groups which sorted sort themselves out into your product and that s the key thing when should.

When to think about segmentation

Early stage founders think about segmentation do you suggest it s like right from the beginning the first product should have multiple segments or does it come later this is also an often asked question in the sense that as a startup as an early stage founder often the excuses like hey we don t have time we re actually like putting stuff out of the wall we need to get something out there it s a time is of the essence. So you know we need to build a product and usually they would say let s build just a product which is like every awesome thing that we are working on and then we come back and revisit whether we want to build other versions. Etc right. And we don t have resources to even build multiple products well that kind of logic makes sense when you don t understand the concept of segmentation if you truly understand the concept of segmentation you would say you know what as a first conversation when you re having that willingness to pay a conversation based on your idea you would say who s actually willing to pay for this innovation you know what do they need how many of them are there can we productize to this first compared to the others then you will start prioritizing not only your r d roadmap but your resourcing to say which segment should i start with and then what segments would i actually add and then your value messaging would be tailored to that segment people will understand the benefits they will say you know your product will be launched and people will get it. And they would actually go for it so having done this exercise early will tell you how many segments are there what is the size of these segments how to prioritize them which one to pick first and which product to build first for that segment and then productize to the other segments later if you re lazy and sloppy you will build the product you l slap on a price you l throw it in the market and say i will attract everyone. You l attract no one amazing so basically understand the segments right from the beginning. Don t necessarily launch products for every segment exactly that s totally acceptable because i mean it s not like everyone has resourcing to like launch up to five products five segments everything else complexity. I mean and plus you don t probably want to be too complex when you re launching your products but focus on the right segment and launch it for that first today s episode is brought to you by miro creating a product especially one that your users can t live without is damn hard. But it s made easier by working closely with your colleagues to capture ideas get feedback and being able to iterate quickly that s where miro comes in miro is an online visual whiteboard that s designed specifically for teams like yours i actually use miro to come up with a plan for this very ad with mira you can build out your product strategy by brainstorming with sticky notes comments library actions voting tools even a timer to keep your team on track you can also bring your whole distributed team together around wireframes where anyone can draw their own ideas with pen tool or put their own images or mock ups right into the mirror board and with one of mira s ready made templates you can go from discovery and research to product roadmaps to customer journey flows to final locks i want to see how i use miro head on over to my mirror board at miro com lenny to see my most popular podcast episodes my favorite miro templates you can also leave feedback on this podcast episode.

Examples of segmentation done well

Are there any examples you sure there s a water example which i love that s really clear by the way you forgot to mention a liquid death which i think is like a dollar water in like a can that just looks really cool. Yeah keep getting these tweets from peter. Yes i love the product actually it s like water packaged as an eight dollar product so it s it s. Great. Right. I mean that s that s a segment that of customers that love that. And oh i love that the vc wants you to include that as an example as you talk about exactly we l do from next time liquid. That eight bucks. Yeah any other examples is kind of the premise of my question i would probably start with like a few obvious and famous examples so that you just remember the point in some way. And then we can drill down you know further if needed but if you look at for instance apple right let s assume the conversational apple was something like this. Hey we need to just you know build one product one iphone because we need to like maximize our market share. And we will throw it out. And you know slap on a price and hope to get the market they wouldn t be the most profitable company in the planet today what did they actually do there is an iphone for all the way to one four nine they have built products to different segments i mean i remember walking into the apple store when iphone x was launched i didn t want to part with you know a thousand bucks. I was checking the phone out. And i looked at the features. I really didn t want the retina features and all these kind of you know benefits. And then i saw that there was a phone without that for and i picked the s and i walked out. Right. I mean so i belong to that segment i was not belonging to the you know. Iphone x. But there s a product that has been productized for different needs segments and if you look deeply apple is not just price their iphones their product ties to different price points and willingness to pay and that s where it gets actually fascinating. So i think that s a great example of understanding differentiation and then sort of you know productize to different needs and i think that s that s a good example another one that comes to mind you know where we work with this was in the pre ipo days you know even bright which is a you know b sas company they used to have a one product that was actually servicing all of their customers. And then we went through an exercise of understanding who are their customer segments and how do we productize two different segment needs and if you look at what they have today they have like three plans you know and because like you know segments behind this and if you look at the plants like there are plants like for instance the entry level plan has something like you can only launch an event with like one ticket type like a general admission. Right okay. And then if you take the middle plan is there unlimited entry type so you can have a general admission a vip admission whatever when you re actually having events it actually makes sense because if you re let s say hosting a you know your local wine club meetup whatever even you probably just need the general admission and that s it. But if you actually are a bit more professional and you needed like you know multiple even types and you re having a event of that nature then there s another product that actually appeals but because of doing this the one that has only one even type that product is cheaper than the other one so there s an essential product and there s a professional product and they have enterprise product so this comes down to truly understanding you know what customers need what they value and what they re willing to pay for and how can we productize towards that right maybe another example that is obvious and in front of us when we you know use our apps like uber is a great example of also segmentation right because you have different car types i mean if they just had one car type then. Okay then that s a very different company very different strategy there s an uber black the uberx we used to even have the uberpool pre pandemic. I don t know if it s back now i think it s back it s back great. And you know they also launched this thing called comfort which is a bit between black and uberx in terms of both price and also the types of cars but it comes with certain features like for instance you can say you know quite preferred on a comfort or a black and that s literally why i take one of these because i m probably working on my over right over. And i like to you know just have the quiet and just work on things. And i m willing to pay for that and that s i belong in a different segment. But of course if i m using you know let s say uber for my you know everyday commute. Sometime. Maybe i do pool i mean. So depending on even my point in time or depending on my situation i might actually belong to different segments and understanding this and then productizing towards that becomes key.

The importance of dynamic segmentation

Been focused with many companies to nowadays is not just doing a static view or segmentation but truly understanding dynamic segmentation and how to offer product and services around the fact that people switch segments so like if i m ordering on a friday night on a food delivery platform maybe i m thinking pizza tuesday afternoon during my office time maybe i m thinking of like a different type of cuisine. So if i know all of these things healthy choices was not when can i productize what then you actually start getting it dynamic views of segmentation and you know and the technology around us actually allows us to take a very dynamic view at segments and that s very fascinating. So the oh age old i mean there are multiple steps first do the segmentation right that s the basic getting at a static view maybe if it s relevant even a dynamic view at this is the next frontier which you.

The three pricing strategies: maximizing, penetrating, and skimming

Should just now remind me of another really interesting framework in your book around pricing strategy and you talk a lot about just like how important it is one to just write down your strategy and why you think this is the right strategy but specifically you have these kind of concepts of either want to be maximizing you want to be penetrating or you want to be skimming and i thought this would be a good time to chat a little bit about that i can just talk about what these three strategies are sure when we talk about pricing strategies you know we hear many buzzwords and it s it s. Irrelevant. I mean so when we take a step back and look at it there s literally only three types of pricing strategies and if you know this then you can follow one of these and you know bill break those access products the first one is gaming strategy which is like your apple you know iphone they launch at a particular price the next generation is probably at a higher price but the previous generation actually goes down so they launched at a higher price. And then they start lowering the price so they re skimming the market. So it s and connotation of these kind of products is also it s a premium product price is a signal of like quality etc if you take penetration that s probably made famous by amazon and amazon you know. I mean they re probably operating at you know much in our margins but they re playing the volume game much more harder game to play because you need to have all of your costs in order supply chain everything else and you re fine tuning towards the volume game often i see entrepreneurs who say let s just price low to like grain gain growth that s a fallacy i mean if you don t have a business model that actually supports this compared to amazon then you probably though shouldn t be in a penetration strategy and even in a company like amazon and aws has a very different strategy compared to their e commerce marketplace. Right. I mean so within even business units you can actually have different you know pricing strategies and the third one is just maximization which is you re neither on these two extremes but a bit in between and you re saying. Okay what can i maximize in the next couple of years i mean in my opinion at least microsoft would probably belong in that kind of category and if i look at apple microsoft amazon i mean companies that reached trillion valuations in our lifetime probably the only three in some way shape or form they have dramatically different pricing strategies the point is not about picking like just picking one. But it s about executing the one that you actually pick and that s also what we write about in the book how to pick one and not just pick one but how to build your products around this executed live and breathe your business model strategy which leads you to your pricing strategy amazing.

How to use bundling and packaging to unlock segmentation

Topic. And then we l get to the next and the rest will be quicker we re spending a lot of time on each which i love you talk a lot about the importance of packaging and bundling and how that alone can help you win a segment versus even the price of the segment you talk about how to think about the importance of that the way to unlock your segmentation is to think about bundling and packaging as in your configuring your product based on what customers need what they value and what they re willing to pay for either you put a bunch of you know benefits that people like and call it packaging and put that out or you re taking multiple products and calling it bundling and putting that out. Right. So it s a question of hey that s the way you unlock segments so you re productizing it s like the iphone x versus the iphone s different products different features. Different packages etc right the way the quick framework to think about packaging bundling you know we call it the leaders fillers and killers exercise or framework. So if you think about the classic let s say bundle you know like a big mac or a happy meal. Right i mean that s the big mac is the need a product that s the in the happy meal right that s what people go for in a when they go to mcdonald s when you look at french fries and coke those are the fillers you can put a burger along with french fries and coke call it a happy meal. And you know most people who wouldn t have bought a french fryer coke. But if you just say for a dollar or two more you know you can actually get this they would say let s get the happy meal so you re actually bundling it in such a way that with you know marginal increase in price you re also able to sell multiple products right which they wouldn t have if you didn t have it the killer is the one where if you put it in the product it just kills the bundle for everyone so like for instance if you put coffee along with french fries and a coke and a burger that s just gonna kill the bundle no one needs a double dose of caffeine and they re having a burger but there are people like me lenny who love to have coffee with their burgers so these are great candidates for selling them as add ons because if i actually i mean i would pay for the add on because i actually want the coffee so i would take the burger stand alone and i would take the coffee stand alone and that s why it s actually listed separately in the menus right if you bundle it what happens is it just depreciates the willingness to pay across the entire customer base to the point where no one actually wants it so you need to find pockets of customers who want it. And then maybe only sell it to them so the rule of thumb that i usually say is you know if to of your customers want something and they really want it badly that s usually an add on that s not that s not something that goes into a package unless you have a advanced package just for them kind of thing and if more than of people want something that s a leader product. Right so if you understand all these leaders fillers and killers then you can configure your product in such a way that you re productizing to segments and you l unlock maximum value your example reminds me i just went in and out yesterday and how i don t think they ve changed their model in ever somehow it just works they nailed it somehow works. I think in and out has that s a story for another day i think it works for different people. Yeah all right. And then the other thought i had while you re talking is understanding who the leaders are and the fillers and the killers comes from these willingness to pay conversations i imagine the stuff that people stack rank at the top it s most likely going to be your leaders. Yes exactly so when you do those most and least kind of questions and you stack rank them the must haves will pay or must have table stakes would be the leader products or leader features or benefits you know the ones that are nice to have and might considering might consider being or nice to have those kind of features are probably the fillers and that don t need other killers awesome don t need i will not pay got it interesting when i saw you write about killers i always thought it was like things that it needs to have that would kill the deal if they don t but that makes a lot more sense that who kills the deal if it includes it interesting. It includes it exactly maybe we should change the language in the next sequence monetizing information but don t change anything all right good all right third topic around your pricing model this something that you.

Why how you charge is more important than how much

Talk a lot about that people think too much about how much to charge and not enough about how to actually charge the pricing model so can you just talk about maybe what that is and why people maybe don t think about it as much as they should we usually say how you charge is way more important than how much you charge you know take a quick example and then bring the point home. And then we can talk about why this is actually essential so like taking a non sas or software example if you think about michelin which is like you know tire company probably one of the most price sensitive let s say markets because i mean think about it you actually go into a tire store you see all of these things look similar but they somehow price differently how are you supposed to make a decision i mean it s very hard when you need to understand what you re paying for and they came up with this new tire which was supposed to last longer was a true innovation in the industry and these were tires that were used for like moving trucks from you know as a moving trucks from point a to point b. Right. So. And when they thought about it they said okay if we go and ask for a premium there s no chance they would get it because it s a price sensitive market right if they don t ask it the tires are going to overrun and they re going to cannibalize of their business so what they actually did was they changed their pricing model or monetization model. And they said okay we are going to charge based on the number of miles that a person would drive the truckers actually love this model right not just because it was pay as you go. And you know they could pay when they actually use the tires and how and everything else if that was obvious reason. But then now they could also invoice their end customers and say okay. My you know journey was kilometers or miles and that s the amount of tire costs and they could pass it through because it became a variable cost and they people love this kind of model and of course you know tires lasted long michelin recoup that more but more people jumped into the michelin bandwagon because now they could actually you know buy a tires on a pay as you go basis now this is if a tire could be actually with i mean the age old model for tires is on a per tire basis if a tire could actually be sold on the pay as you go kind of consumption model i mean then obviously most products can actually explore this kind of route especially in a software setting but the key lesson here is the how you charge was the most important question was not how much the how much came about because of the how you charge another sas example that is probably top of mind for me is b sas s segment this was before they went it to twilio they used to price based on apis. So like the number of apis that you actually have with segment that used to dictate which plan you would be and how much you would pay for it but increasingly they were also shifting gears towards selling to different personas within companies and what is an api is a debate probably a marketing person does not necessarily understand exactly what an api is and the how you charge question became very critical and what they actually did was we worked with them and we kind of identified that monthly tracked users were was a much better metric into how customers perceive value and that was the more fairer metric for customers like if you re tracking more users in segment you re probably willing to pay more compared if you re tracking less so the packaging was changed to like a monthly track user instead of apis this literally exactly the same michelin per mile kind of models on a you know b status month number of monthly tracked users. Right so that was a different examples so the how you charge question is super important way more important than how much if you don t focus on it and just rush to one or the other often you re sub optimizing like crazy.

Subscription vs. usage

Interesting that both your examples are usage based models winning and it feels like in general usage basis kind of where people are trying to go more and more or maybe not so maybe two questions do you feel like that s the future of sas pricing generally and roughly do you feel like that should be a default way of approaching when you re building say a b sas company or is it still seat based i would say this is like most b sas companies follow what is actually in work at that present point in time you know if subscription is invoked then they say oh subscription is the best strategy if usage is you know made famous by snowflake and others they would say usage. Right. I mean so i think usage is obviously let s say invoke right now i think it comes down to really understanding based on your business situation does subscription makes sense or should you be usage or pay as you go if you re a sas company. Right i mean there are different markers which actually identify this if customers demand let s say predictable bills or usage is very similar month over month as in if you re subscribing for tight pods for instance not like you want to watch more clothes one month versus the other the usage is the same month over month or you know when the usage is highly variable which is you know changing quite a lot between month over month and if you price based on pay as you go then your bills are also going to be dramatically different month one versus month two was month three so you re gonna have a very tough conversation with your customers in all of these kind of situations a subscription actually makes a lot more sense or it could also be like you know usage is intermittent but the value delivered is ongoing right. I mean like lifelock is a great example it s a product that you probably have to protect your identity theft protection the value is ongoing the usage of the product is only episodic when your identity theft gets compromised i mean if they say okay i m gonna price based on usage i would be automatically wrong pricing model. Right. I mean so in those kind of cases subscription makes sense or simplifying the pricing conversation is your advantage you know let s say the spotify is a good example right if everyone wants to listen everyone used to listen on a per song basis but having a subscription actually made sense it simplified the pricing conversation same as netflix all of those kind of situations so don t don t just rush to something like usage just because understanding that is key usage makes sense when people want low commit or less friction so like making it easier to buy like an aws kind of thing you know you re on board people and then you grow over the product and i think those kind of situations make sense or when customers would demand transparency and fairness not please note that don t mix transferency and fairness with being predictable those are very different things transparency and fairness just means that you charge for the product right for instance if you don t use a subscription for a few months is it fair that you re being charged for those months that s fairness that s nothing to do with being predictable. But if they re demanding fairness and transparency often a usage based pricing model could make sense or alternatively you know usage is intermittent or episodic and the value delivered is also episodic and not ongoing like you for instance book the movie theater ticket or you book the flight it s also intermittent usage intermittent value so the pay as you go kind of makes sense or maybe there s even some underlying costs that scales with usage like an aws pay as you go can make sense or even probably lastly if there s some a most important thing for psg colony is you need to have clear metrics that you can actually track and identify an attribute value and your customers would agree to that value generation then pay as you go would make sense if you can t track what you re charging on often it s a really bad idea and then of course you can also be more hybrid sometimes and that s also a winning model like for instance if you take hubspot it s a hybrid model between a pay as you go and a subscription and it actually works well for them because there s a certain component on a fixed monthly basis and then if you exceed those kind of codas and limits then you actually get into a pay as you go model. So i would urge the readers not to rush into one versus the other based on what is in style at the given point in time but give it a deep thought and say you know what is your business how are your customers how are they situated what are you servicing and what makes sense between the two models awesome on.

Pricing options and structures

The on the point of being able to even track usage i ve seen like five startup decks of startups that help companies with this because it s so kind complicated to know what to charge what is that what to charge on usage based models where they basically plug into your systems to help you figure out how much every company owns owes you maybe a couple more questions on this topic one is just like what s like a simple way of thinking about the options say a b sales company there s like seat based pricing there s flat based annual contract pricing there s usage based you can lock on freemium to make a free version of it is that the four what s kind of like a way to think about your options for b sas i think those are probably the options i mean you need a subscription pay as you go freemium these kind of things and of course the price metric that you actually pick like what measure are you charging on and then how do you structure the price structure that you pick is important because for instance are you flat for a certain amount of time and then it becomes variable that s a structure. Right. I mean and then the or for instance can you be two dimensional in your structure on two metrics so like the more people actually use your product and take actions that benefit you the better price you get i mean this is something we call as a value matrix for instance i mean in b sas companies that actually want to achieve like wall to wall adoption i mean it in many companies is still a pipe dream i mean it s it s. Just. Yeah you can talk product like growth but if your pricing model is actually instant devices product like growth that s a whole different conversation so what we would do is like for instance on one axis you have seats and on the other axis could be the number of departments that the product is being used at departments is. Hr legal etc right. And then the more users and the more departments you get a better per user price so you ve automatically built an incentive to actually say if you want the better price sure you drive the right behaviors which is get more people on the product and put it in the hands of more departments so people can self govern their pricing as opposed to just you know you come up with a price and you re just negotiating right. So when you think about pricing models you have to think about first picking pay as you go subscription premium then thinking about the metric big and then thinking about the price structure. Awesome and maybe one more example say marketplaces basically if you re taking a fee in almost every case and it s a question of how much you take. And then there s maybe a subscription piece on top of it is that. Roughly right. Yeah that. Absolutely so you could take a break on the transaction and there s probably a platform fee or a subscription fee so that comes down to again a hybrid or a structure so there is a portion that is predictable and then there s a portion that is the usage base it s a bit it s not a rig based model but similar to the hubspot model in principle.

How to run tests to see which pricing model works best

This topic so you want to test different models say your say seat base. And you want to try usage base so you wanna your usage base you want to give seat is that possible if so how do you do that it s definitely possible there are ways to test this it s a science i mean this is also what we do with many of our clients for a living. But maybe the easy monday morning thing that i can actually ask your listeners to do is what we call as a break even exercises so let s assume that for instance let s let s take a marketplace let s say you re selling a dollar a hundred item and i mean as in your customer is selling it if you ask them you know what should the pricing model be three percent transaction fee on the hundred dollar item or one and a half percent transaction and dollar fifty cents or three dollars or are you indifferent this is a basic question because if you do the math all of those numbers are the same so an economic human being rational everything that business school taught us would say okay people will pick the indifferent option i mean i ve done this thousands of times i ve never seen the you know indifferent actually win it s always people who pick one or the other. So then you actually start understanding what kind of model might make sense i mean same thing with b sas companies you would say let s say you have seats and i would charge you let s say a thousand dollars and ten dollars per seat or i would charge you two thousand dollars flat or i would charge you know five hundred dollars and the rest in the seed based amount that are equal to it s all the same people would say i mean i like the lower platform fee and the variable or they l say i like the fakes or so the indifferent never wins that s the easy way to like test you know pricing models what makes sense awesome that brings us to our fourth topic and i.

Focusing on benefits vs. features

Think this is something that everyone listening is going to be like. Oh no. I got this i m doing this great. I don t need to learn about this. But your point is that it s almost always wrong which is focusing on benefits versus features when you re talking about your product so maybe as a first question just what s a sign that you re probably focusing too much on the features of your product when you re pitching it versus the benefits which is to your point much more powerful i think i see some you know markers or pattern recognition as to when people are talking more features as opposed to benefits i mean first of all just to set the nomenclature right what you build as a product person is features what people actually get out of it is the benefits as like what do the features actually do and that s the benefit that a customer gets and you need to pitch benefits if you pitch features you re not talking value and if you re not talking value no one is going to get it. Right. So if you are super excited about the product and passionate about every single thing that the product is doing most likely you re talking features and not benefits because you re showcasing how cool your product is and you know how the different bells and whistles actually work as opposed to focusing on what is the actual benefit for the customer there probably also other signs like for instance if you if you don t see market fraction for what you actually build it is i mean either what you built is off base but in the in the good outcome of this could be that people actually don t understand what they re getting and then actually then changing the you know speak to being more benefits is key to take an example for instance you know smug mug which is a ridiculously awesome company they used to actually publish their pricing plans which was like you had to scroll literally three or four pages. And then you would see the price it s all the features everything else that the company did they changed it to benefits based communication so like a very simple thing like for instance the ability to sell photos online is a benefit there are probably features that behind is behind that actually enables that stuff but then focusing on the benefits they had a double digit improvement in revenue no changes in products right we show the before and after also in monetizing innovation if someone is interested in so like what it was what they actually did so if you don t see in a fraction that could be a marker coming back to your question or it could it could just be that if you re too passionate about your products then your chances are as a product person you re talking features is there any other examples of companies that you think do this super well to make it even more concrete to take a let s say non sas example my favorite i l come back to like porsche again because their value communication is to me a legendary like when they launched taken which is the electric car their value communication or something like this i m trying to remember it. But it was something like take on is not your most affordable electric vehicle but that was never porsche s goal porsche s goal was to actually build a car that was first and foremost a porsche that kind of value save you know statement. What they actually built totally resonates with those you know their audience taking a maybe sas example shopify is one of my favorites in terms of like looking at the plants in terms of their benefit like what do they actually put out all of the plans emphasize benefits and less features like for instance the number of locations that you can track inventory is a benefit because if you actually have a more complicated supply chain it s different from a lot so there are plants which actually you know have different number of inventory locations which is a benefit that i mean if i can track more or not but behind this there could be like many features that actually enable this so if you look at the you know the plans that shopify has i think that s a that s a great example and also they have a lot of good value communication in there i remember something like the tagline for shopify plus was fair pricing unfair advantage and you know just things that actually make bloody sense then you see it what you re actually getting so i think that s a great example that listeners can go maybe it s a takeaway folks should probably look at their website browse through their pages and just look or am i pitching features or am i pitching benefits to the reader correct awesome correct exactly that.

What behavioral pricing is and why it’s important

Brings us to our very final topic which is behavioral pricing you have all chapter on this concept of behavioral pricing and it s super interesting. And it s interesting because it you can you don t have to rethink your price you could just sell at a higher rate by just thinking through this lens of behavioral pricing so just to set context what is behavioral pricing and why is it important the behavioral pricing basically is you know tapping into the irrational modes of our decision making and not just rational i think that when i talked about the break even exercise if you take a very rational view indifferent would always win. But like i said it i have never seen it so there s always a you know irrational side of our brain that actually makes decisions and understanding this as a product person would lend yourself to like building products and also positioning or framing the product conversation in such a way that appeals to both sides of the brain the you know predictably irrational was a great book from then i really made i mean that made the concept very famous we built on top of that where we actually talk about product and pricing strategies that actually you know you need to take care of when you think about the you know irrational side that s what we call as behavioral pricing to take a concrete example and he may be you know. I remember walking into a company. And they had three products and i remember asking the ceo you know why you have three products. And he said i learned that good better best is a great strategy in business school. So i m like. Okay that sounds great. But when you actually look at what was going on they were giving the farm away on their entry level product so they had three products and that was price points and what they actually were doing is they gave a lot of features for the so they were giving the farm away so to of people were taking the product not many are actually opting to the others what they did was actually super interesting they just reframed the argument and they found out that between to the pricing was inelastic and there s a threshold at not at it is the same exercise that i talked about in the acceptable and expensive price. Etc so they moved the price from to and they moved the price of the to like because of the same kind of reasoning and then what they actually did is they built another product at which was simply a decoy to make the product look attractive. Right. So if i put a product that looks awesome next to a product it looks even more attractive i mean god bless the two percent that even take the product right. But what you actually see is the mix shifted more people took the product because the pricing made sense it was respecting the psychological thresholds and next to a decoy it actually made more sense to pick that product. Right. I mean so let s just reframing the conversation and it was a plus percent increase in you know mrr and arpu right after they actually did this change no changes in products no changes in features just in terms of how they reframe the conversation i mean these kind of things are around us and we need to like understand these like for instance if you go to a movie theater you l see a small popcorn for seven dollars an extra large popcorn with butter on it huge one is eight dollars most people say for one dollar i m getting this extra large one let me buy it but that seven dollar popcorn is a decoy i mean if that was not there most people would be scratching their heads saying why am i paying eight dollars for popcorn in the first place. Right. I mean so this kind of behavioral framing and nudging becomes important it s not about you know deceiving your customers. Etc. But it s just about framing the products in such a way that it also appeals to the irrational side of the brain as much as a rational side the example that i talked about in the sas product on the three products and compromising to the rather than going for the early product is simply product discipline don t give too much away in your entry level product don t give the farm away your entry level product you know sort of at least preserve something for the product so if you build the packaging correctly you can emphasize a compromise effect and this is a well known behavioral theory where people avoid the extremes if you are quality conscious you go to the right if you re budget conscious you l go to the left but most people will compromise in between if you actually see your you know packaging mix is like this. And it s not the normal distribution as in most people actually prefer the entry level product you re giving of you re giving the farm away maybe you should think about how to change your features and benefits so that you can actually steer more outcomes towards you know middle package compared to the entry level one and also then you know charge based on the value that you re actually bringing to the table so we have talked about many behavioral pricing strategies in the book dedicated an entire chapter to this did you.

Tactics for behavioral pricing

Actually share a few of them just like some of these tactics that you find i don t know if you have them in your head sure. Yeah anything that you could share you can talk about these topics all day long and i m probably gonna keep telling you what i know but tell me when you re bored. But you re bored. So that there are a few right i mean the compromise effect is the good better best that we talked about the next one is what we call as like let s say you know pennies. A day effect or like how you actually frame your pricing so like for instance if i tell you a per month price it s very different from one dollar per day like the way you actually you frame your price if you can actually showcase some kind of bargain like aws does this really well the price that you actually see is so less because also the units and consumption is so less but of course the bills stack up if you use it a lot but the price if that you know started with like a higher price point compared to a lower price point that could have been different you know sort of situations similarly instance you know when you take like let s say you have a monthly subscription in your sas business and you also have an annual subscription you need to showcase your annual subscription as a monthly price like if it s like for instance it is if you actually take an annual subscription but it s bucks a month if you actually do monthly subscription but you re still messaging the price as a monthly price because if you actually just do the computation and say okay instead of saying a month i would end up saying it s a year that price could actually look like a higher price but if you reframe it looks like a more attractive price so that s a penny today kind of effect i think that kind of makes sense on a product side if you re what you re building is products and consumables then things like the razor razer blade model actually makes a lot of sense most famous made famous with razer blades. Right. I mean if you think about the jealous stick that you are buying it s probably cheap but the razor blades add up very quickly so that initial pricing or investment is less but then you re making money on the consumables right like the hp print cartridges same thing the printer is cheaper but then the cartridge is added for a sas product it s very similar if you actually have a product that s a base platform. But then you have like consumables then you might want to make the platform price at practice so that people onboard themselves on the platform and then they are paying for you know chunks of like usage or things like this which is a razor you know razer blade model which is much more attractive for people typically because there s a lot of scrutiny on the upfront cost that people are actually paying as opposed to doing an entire tcv calculation i mean like at all cost of ownership calculation most people don t do that they re looking at what they re actually going to pay so if you are more attractive up front that could be a different way to reframe your you know product or price maybe an advanced version of like a behavioral tactic that i would probably talk about from product site is what we call as a panini effect the thesis for this is like when we were kids or for those of your listeners who have kids at home one of the most repetitive exercises that we all went through as kids was to like build puzzles or like fit different things together. Right. I mean i mean i used to do that i thought i grew out of it so happens that you never grow out of this from a psychology standpoint right people love to fill puzzles and have a compulsion because they just started with most of this in their childhood so is a panini effect comes from the sticker book album that we actually used to you know collect when we have kids are building you know puzzles five or pieces whatever all of these kind of things so when you actually build a product and even in the most some of the most complex sas industries like financial services when we have tested this with our clients if you list the products usually of people will buy more than one product or they will attach themselves to more than one product because most of them are just buying one like you have a real estate product like let s say you have a you know brokerage product you have like a different investment product etc right you just list all the product. But if you show it as a puzzle and you actually say hey these are the six products that we offer and if you complete it you complete the puzzle you have actually finished checking a few of these and these are empty and that s like the first thing literally people actually see when they come into the product we actually see the attached rates going crazily up like to of people suddenly start taking more products because there s a compulsion to say yeah if i didn t finish this one even in a b sasted but of course if you re a b c customer like say you re a food delivery platform or you re you know ride hailing for instance if you say okay this is your weekly puzzle and if you like take a ride every day or you take a ride during evenings or if you if you give people a task or a puzzle and show them the puzzle and show them that you have done this. But then these are the other things that you have not done people change their behaviors because they actually feel a compulsion to finish it starbucks actually launched a bingo card which is the same principle. Right so the panini effect is a nice way to actually think about how to showcase your products in such a way that you create compulsion for people to like buy multiple products i mean if there s show notes in your podcast i m happy to give you some visuals that you know you l see it is absolutely please send we will include them i don t get why it s called the panini effect it makes me think of linkedin and their whole you know little completion percentage. But it s a panini because you make a thing and you call it something. No i think the spanini effect it comes from the panini sticker books or whatever like all the things that we used to use not the sandwich i mean.

Determining pricing thresholds

There s something else you touched on that might be worth doubling clicking on is this price threshold psychological trick is there like heuristics or just rules of thumb of like here s thresholds people generally have or is it generally like very accustomed to the product if you look across b sas or consumer products you l find some thresholds that often make sense like for instance if you are looking at twenty nine dollars most people would say equate that to a dollar a day and say that thirty dollars is a threshold so you see some of these things you know beyond this you need to test for your own products and categories because the anchors are also referenced based on other competitive alternates you know what their perception of value is and so on so doing the exercise like i described earlier the acceptable expensive and probably extensive would give you psychological thresholds and by the way that s also a behavioral pricing thing because you re saying if you cross to like there s a steep drop in the demand curve and if you didn t know this you can do all the quant you want you re gonna probably optimize your prices somewhere. But you know at the end of the day people are also looking at pricing from a you know psychological standpoint and often we are able to validate this statistically and significantly as to what are the different thresholds for your products in the market and this also gets a bit more quickly complex and that s why the testing is important because it s not just about the product but what happens when you have add ons what happens to the thresholds when you have price structures or what happens to the thresholds when let s say you have a plan platform plus a usage strategy so then the testing and learning becomes inevitable and there s no rule of thumb that you can just apply but of course there are certain things like bucks a month or whatever that s a usual threshold that we see or famously you know made famous by all the subscriptions that we probably use awesome.

Tips for pricing in a depressed market

Well to start closing our chat just a few more questions that i wanted to get through one is the market is slower the economy has slowed purchasing seems to have slowed do you have any advice for founders when they re product managers or anyone thinking about pricing in this kind of market that we re in now. Yeah. I think it s a great question because we need to prepare for it. But of course you know be proactive i would say three things that founders can keep in mind when it comes to product pricing if there is a downturn especially the first thing to think about is you know building a lesser expensive alternate compared to what you actually have and keep it in your back pocket so like for instance if you have a product a sas product i would think of like what can i do feature from this product and then create a lesser expensive alternate that i keep in my back pocket to like reduce churn so if someone says you know what i can t afford this anymore it s a downturn give them the lesser the lesser expensive alternate keep them in the system i suppose them going away if you just discounted price guess what s gonna happen six months later that s gonna be your new price so before you price discount think about what value can you exchange to actually justify that price discount so you re taking value away in a d featured product and hence you can discount it s having that kind of price integrity is super important with your customers so don t just rush to like dropping price that l be the absolute worst thing you can do to yourself at that moment and also in future so like having these kind of less expensive alternates second one i usually say which is in line with not dropping the price is to think about three non pricing actions that you can do when you know when this actually happens like for instance do i give more product to preserve the price that s a non pricing action so like i give more value. Say. Hey you know times are tough take the best product professional you re being a great customer on the loyalty. But when you know times are great you re probably gonna renew the pricing at let s say a higher price because you just gave them a product for one year at a the same price that they re actually paying right. So i think that s a non pricing alternate or it could be change the contract terms like you know say that okay take a three year contract or two year contract and then think about that as an alternative as opposed to like reducing price or things like for instance payment terms like okay if you say it s difficult i l change it from days to days and live with the payment terms as opposed to like changing price. Right. So like three non pricing actions we need to write about some of these also in the book and the last one i would probably say you know is think about changing your business model a pricing model like it s a you talked about usage based pricing frankly an outcome based or attribution based pricing frankly this is the best time to actually think about these things like if you know if people are not using the product changing it to a usage base people would say that s great because you know there s a downturn we re not using the product and you they would opt into a usage based pricing because they are going to pay lesser because they re not using but when times are good again they re gonna use it. And basically what you did is you just lodged in a usage based pricing easily compared to like trying to do that when the times are good and people are saying oh i actually want fake star i want you know. I don t want the usage and things like this you actually just took that as an opportunity to change i mean one extreme example that was interesting during the pandemic is a software company that was actually you know providing a software to like hair salons. Right i mean just as an example like hair salons and this come i mean it used to be a perceived model i mean it just used to make sense but they want to think about usage during the pandemic no one for instance went to a haircut they were all taking this at home so they said okay let s you know change it to like a per hacket basis but of course when things are back again that kind of model can recoup a lot more compared to a perceived model because that s really where the value is actually getting derived. Right. I mean just as an example but so see things again one is you know thinking about changing your pricing model three non pricing actions that you can take and then how can you de feature something and keep it in your back pocket so that you can have a proper pricing conversation and not just drop a price that is some killer advice thank.

Madhavan’s new book

You for sharing all that thank you something else is during our chat preparing for this call you mentioned that you re maybe working on a new book can yes we talk about what it s going to be about and anything else sure i will try to see what i can talk about without you know getting too detailed but the thesis of the book is that the title of the book is called unlocking growth that is profitable meta etc so unlocking growth and the subtitle is breakthrough strategies for acquisition monetization and retention of customers. So this is a bit like where monetizing innovation stopped and this book picks up from that i mean you let s assume you built a great product you know based on what customers need what they value what they re willing to pay for now what you need to acquire customers you need to monetize them you need to retain them so this book actually gets into all of those dimensions and the key pattern that we have seen lenny or nor again is now most companies would have teams and people dedicated to these three functions i mean acquisition monetization and retention that s the you know if you unlock these three you re getting to profitable growth. Right i mean that s literally the three things you have to focus on but what ends up happening is most people don t understand the interaction effects across these or they in the worst case they even treat it as silos so the acquisition team works on something but the monetization team is not looking at the interaction of what they actually do for instance of customers or you know people who we meet who claim to have a land and expand strategy are only landing they re not expanding because they gave their farm away in the land. So how do you actually think about a land and expand strategy in such a way that you can acquire monetize and retain customers so this book actually goes into breakthrough strategies to balance the trade off between acquisition monetization and retention and build the right products and come up with the right pricing strategy you re going to have incredibly strong product market fit with this audience is this something anyone can pre order yet sign up to get notified when it s out i think the pre order probably is still open in amazon. So i think that s something you can check i will check lately but you can follow me on twitter at madhaven sf that s m a d h a v a n s. F i usually tweet about this book and in general or follow me on linkedin or add me on linkedin. I think those are probably some good ways to keep in touch the book is supposed to be out in key you do like q to q time frames so watch out for it amazing. So it s called unlocking growth they can search on amazon. Right. Yeah. Absolutely if you look for an unlocking growth and even bookmark it you re going to have it in your list of books that you want to buy all right i m going to pre order it immediately any other good resources that you recommend for folks that want to learn more about pricing and just all the things that we talked about other than your book there are a number of resources our founder herman simon of the simon of simon culture has a lot of books particularly i like one which is called confessions of the pricing man i mean he started this business years ago and literally out of university and academia and we have grown to where we are today but it talks about some of the lessons that he has learned i find it fascinating. And it s probably the better book competitive monetizing innovation. So i think i would actually just definitely read that the other book that probably we also put out which is topical right now is one of my you know partner colleagues adam actor anne hermann wrote a book on pricing during inflation and inflationary times. So i think that s a very topical book that i think your readers can pick this is within our simon kutcher assets of like you know people who have actually written books another resource to probably look at is kyle poyer from openview he puts out some really good stuff on product like growth pricing. Etc i mean he s an alumni assignment coaches. So we are proud about our alumni but you know he it s some fantastic work that he has done he has also written some sas pricing guides. Etc. So i would highly encourage you to check kyle s work i think that s fascinating. And i also feel the folks at first round are pretty good at putting some good content on pricing product. Etc amazing we will link to all of that in the show notes madhavan this was everything i hoped it would be this is probably the record for the longest podcast we ve done and that s no better no better topic to spend a lot of time on thank you again so much for joining me two final questions you answered most of them but just in case there s anything else where can folks find you online and learn more and how can listeners be useful to you online. I mentioned linkedin. So madhavan ramana gym so that s on linkedin and madhavan sf on twitter that s probably where you can find me online or even at the salmoncouture com and you can search for you know leadership. And you l probably see my name there what can listeners do i think i l probably say that the fundamental level if you can you know talk about this topic actively share what you have learned you know if there are sections of the book for instance that you like talk about it. You know the biggest thing that we can all do is to educate each other and everyone that there s a science behind all of this and it s not just an art and if that you know if that s relevant. Then i think message accomplished that s also why we wrote monetizing innovation what a beautiful way to end it thank you again for being here thanks. Lily thank you so much for listening if you found this valuable you can subscribe to the show on apple podcast spotify or your favorite podcast app also please consider giving us a rating or leaving a review as that really helps other listeners find the podcast you can find all past episodes or learn more about the show at lennyspodcast com see you in the next episode.

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