Is cost based pricing valid for startups? — Startup 101

Normally, there are two ways to arrive at the price for a service/product in startup phase. This discussion focuesses on cost-based pricing in startups with a fundamental question — is this a valid method of arriving at your price point.

Is cost based pricing valid for startups?

I find the cost based pricing model rather difficult as a startup. The theory behind the cost based pricing model is to add up the costs in product development/service delivery process.

As a startup, the initial focus through the MVP or agile based approach is to get the product out ASAP. If I extend the same logic to fast moving consumer goods, this can be achieved via outsourcing to increase the speed to market and maintain operational flexibility.

The trick with outsourcing however is that the initial ventures will be very expensive and will not provide an accurate measure but can offer you a comparative starting point for the projections.

Tangibles Vs Intangibles

In addition to the direct costs, as a startup — we will need to consider the cost in getting a product / service to market. In this we would need to start thinking about the marketing costs.

• Will these costs remain the same as the startup grows?
• What to do if the costs / prices change? How to transfer this to the customer?
• What about the costs for Intellectual property, time spent in product development etc?

Very quickly, as we answer the above questions, there are a lot of intangibles which surface and we can see how difficult it is to arrive at the initial cost.

How to arrive at the optimal price point?

Even through the above, if we arrive at a price point, an overarching question is — will the customer be willing to pay this for the service / product offered?

What to do if the customer is not willing to pay the suggested price? Add on points to consider are:

• As a startup, it is unlikely to get great deals on prices which economies of scale tend to get. The same applies to outsourced models as well.
• How do you balance the factor of discounts if you are looking into a fast moving consumer goods model? In addition, you will need to consider the holding/inventory costs if these goods don’t move fast enough.

Managing price changes

The moment we realise that the customer is not ready to pay the suggested price — the agile manifesto or the continuous improvement process demands that we reflect and identify if there are to be any changes made in product/service pricing.

The price changes are often reflected through discounts and price cuts. Although price cuts are usually heard of in the startup world, the concept of price increases is often not dealt with welcoming hands.

I have always been on the side which grumbles whenever there is a price increase for the same products I use.

The bottomline however is — if you increase the price of a product

• Be prepared to explain the added value for the change
• Convey the factors leading to increased prices

Price cuts however don’t have an easy answer. It is very hard to say, “Since you did not buy, I have to reduce the price”. As a customer, my response to the above would be that the company was trying to treat me as a fool.

Is cost based pricing the right model for you?

As you can see, there are multiple questions this cost based pricing model throws up in the air. It is a strong strategic driver to have costs right.

For this reason, most companies tend to take the market based approach

• It is easy and customer information acts as the driver so that you are never too far from the buyer
• You can respond swiftly and more flexibly with customer demands
• Availability of statistical information to know what a reasonable price can be
• Choice of comparing the startup with a high/mid or low tier to influence customer perception with pricing.

With the above in mind, as a startup founder, entrepreneur, my preference would be to go via the market based approach.

I can see quite a few challenges in the cost based approach, but I am also very curious about the approach people followed to make this model work.

Please do engage with your thoughts below, I am super excited to know what you think about “Is cost based pricing valid for startups?

Originally published at https://inspire99.com on March 9, 2020.