By Edward Lee, Founder and CEO of HelloAdvisr
As a kid, I was a collector. My passion was baseball cards.
Baseball cards were a way to connect with my favorite players and teams, especially when I couldn’t see the teams play live or on TV.
I also quickly learned there was value to baseball cards that went beyond fandom.
Since I had limited resources (read: I was a kid with no money) there was a finite amount of new cards I could get. So this is where card trading helped fill the gap.
I would trade cards with friends and kids in the neighborhood. Looking back, these trades were a hustle. The savvy traders knew the value of these cards. So when a kid would come with valuable cards, but didn’t know the true value or didn’t know enough to defend the value, you saw one bad trade after another.
It almost wasn’t fair.
This situation is one that startups face daily — trying to figure out how to create a fair exchange of the value delivered for the value received (read: setting your price).
When startups set a price that is less than their product is worth, they run the risk of value debt, where your startup is getting less value than it’s giving. Most struggle to get out. It is great for customers — who are getting a product at a low price — but for far too many startups, this can be the start of a slow death.
Value debt is avoidable and manageable, but it starts by figuring out if you’re doing things that increase your risk.
Founders set out to solve problems, and they build products and services as a result. Building a company, business and pricing models was often not part of the equation. As a result, many founders are laser-focused on creating a solution valuable to customers.
The trouble is that too often, founders don’t make the connection between product and pricing value.
A good example is the free trial. A free trial is designed to reduce friction for the customers so they can enjoy all the benefits of the product without the headaches of commitment. Seems simple enough, right?
The trouble starts with how the trial is designed. The right value elements must be clearly exploited to the point that the customer can clearly link the product value to the price, leading to a sale. It is important to remember that the whole point of the trial is to convert a non-paying user into a paying customer.
When this does not happen, this creates a value deficit. At the early stages, this is not about maximizing revenue or gain. This is simply assessing and getting what you’re worth.
As startups grow, the biggest danger comes as value debt compounds.
Managing value debt requires more resources, and if not careful, the inefficient deployment of those resources. This is manageable for the most proactive (and lucky) companies. Unfortunately, for most companies, this is rarely actively managed. The cost of maintaining growth coupled with correcting lost value is an expensive combination that can prove simply not sustainable.
Minimizing or getting to value surplus — customers are willing to pay you even more than your product is “worth” — helps startups to stack gains over time. Scale comes when the system is flexible enough to absorb the influx of customers, and their value and willingness to pay.
Here are four signs that a startup is at risk of value debt.
One of the clearest signs that a startup is in value debt or runs the risk of value debt is that they are under-charging for their product or service.
This does not mean the price cannot be low. It means the price is unintentionally lower than the willingness-to-pay of the startup’s target customers.
The key input here is the startup understands their customer’s willingness-to-pay, and made a strategic decision to position its pricing at a certain level.
More often what I see are prices tracked to competition or worse, a guess. If you don’t have a clear idea of how much your customers are willing to pay, then you may accidentally end up in value debt.
I have yet to meet a startup that did not create value for their customers. The problem arises if a startup does not know what drives that value. In these circumstances, it is very difficult to ask for and defend a fair value exchange.
Startups measure product usage and demand, but which of these components drive value for the user? More importantly, what drives so much value that they would pay you?
This can be the convenience of the service, enhanced productivity, quality of customer service, free shipping, the list goes on. What is critical is aligning your pricing and packaging offer against these value drivers.
When you don’t, your pricing may be distorting the actual demand you are creating for your customers and how you’re capturing that demand.
Founders think big. Big vision. Big markets. Big goals. Big impact.
So when founders are creating their pricing it is usually for big customer segments. It’s hard to have outsized impact when you’re addressing a small segment, right?
The problem is that when you try to price for broad customer segments, too early, you run the risk of diluting your value by compromising your pricing to fit more potential customers.
Studies show that startups don’t hit that accelerated growth stage until they convert 2% to 5% of their prospective customer segment. That’s specific, targeted, and relatively small.
I like to think of customer segments like the rings of a tree trunk. At the innermost ring is the foundation of the trunk or your early adopters. As you move further and further away you move towards the most vulnerable part of the trunk, the bark. The goal is to move across each ring by building pricing and propositions for those customers.
It is not uncommon for successful growth startups to reach unicorn status with single-digit market shares. Their foundation for growth is driven by core customers who are aligned with the product value and are willing to pay.
It is also a solid way to stay focused and prioritize your customer acquisition effort.
Building a high-growth startup costs money. It is not about profitability at day one (or day 1,825), but it is about being efficient with the resources you have.
So when I see a startup where the cost of acquiring customers is far outpacing the revenue they bring in, it is a signal of potential value debt.
Pricing plays a critical role for a startup’s acquisition strategy. Pricing tells you the customers to target, the sales and marketing tools and resources to use, and the vital acquisition margins.
When the startup does not have a clear picture of their value, the acquisition strategy will often reflect that disconnect.
There is something to be said about acquisitions tactics for testing and learning. Some startups do this, and do this extremely well. What is still often lost, even if the acquisition process is improved, is the value created through pricing — both in revenue traction and ultimately valuation. Pricing remains the unknown or is not updated to reflect enhancements to the startup, product and value.
We have all heard stories of startups that became a decade-old-overnight-success.
While the zoomed out view shows a clean upward and to the right trajectory, zooming-in often shows a far clumpier journey. There were certainly some high risk bets that paid off.
Another thing all these startups did well was discover how to manage value debt. They discovered pricing was intricately linked to their brand and value proposition. These startups figured out they could design and influence their pricing to do more for their growth.
If you don’t know your value, your customers are going to define your value for you. Too often incorrectly. Make the big bets, but don’t gamble away the value your startup is working so hard to build.
Ed Lee is a pricing leader and CEO of HelloAdvisr, a growth consultancy helping startups accelerate growth with high-impact pricing strategies. Previously held leadership roles in corporate and management consulting where he advised global companies and brands on pricing strategy. Ed has expertise in pricing strategy, monetization and pricing design, business models, and investment due diligence. His industry experience includes eCommerce, software, digital health, fintech, and consumer brands.