The most common mistake in startups is underpricing. No, I don’t have data to prove it, I haven’t done the study, and I’m not going to. I’ve seen it for several decades. Somewhere in the back of our entrepreneurial minds we still get stuck in the mistaken idea that startup companies are supposed to win by having the lowest price.
Sorry, but it just isn’t true. We got that mentality somewhere back in the nineteenth century with classic economics, particularly the idea of “elasticity.” When they said a lower price means higher volume they were talking about lumps of coal. They had no idea about price positioning and strategy, or buyer preferences; and very little about working capital.
Thanks to Andrea Learned of Marketing Profs Daily Fix for pointing to Ray Fisman’s article Will Customers Pay More To Do Good in Slate Magazine:
First, the researchers recorded the weekly sales of the towels and candles without labeling any of them as fair-labor certified, measuring purchasing decisions based solely on taste. After a few weeks, Hiscox and Smyth spent the night at ABC sticking fair-labor labels on one brand of towels and one brand of candles. When the store reopened, sales of the now-labeled fair-labor towels jumped by 11 percent relative to sales of the unlabeled brand. For candles, the effect was even greater—an increase of 26 percent.
A few weeks later, Hiscox and Smyth were back in the stockroom, marking up the prices on the labeled towels and candles by 10 percent. Quite remarkably, this increase made people buy even more towels and candles (a 20 percent increase for towels and 30 percent for candles). The authors suggest this may be because the higher prices made the products’ fair-labor claims more credible.
Obviously the intended main point of this research is the impact of fair-labor practices on buying preferences. Still, notice how increasing the prices also increased the volume. A 10 percent increase in price produced a 20 percent increase in sales of towels and 30 percent in sales of candles. In this case pricing was what we call “inelastic.” A higher price meant higher volume.
Inelastic markets are quite common. A couple of generations of marketers have been telling and retelling the story of the introduction of Pillsbury cake mixes, which failed miserably in 1951 at 10 cents a package and then succeeded spectacularly just two years later when they were reintroduced at 25 cents. The point was that the lower price wasn’t credible.
What isn’t so common is research pointing this out, in plain terms, as in this study. The point is that the low price isn’t always that attractive; not for a lot of things. In this case the higher price makes the labor practices claim credible. In many other cases higher prices make other claims credible, like organic food, healthy ingredients, safer medicine, better professional services, more enjoyable vacations, cleaner rooms, safer cars, faster cars.
The low-price high-volume strategy works great for Costco and Wal-Mart, both of them huge companies with huge budgets and enormous capital to make a promise and keep it. Don’t think that this necessarily applies to your startup.
Tim Berry is the founder and chairman of Palo Alto Software and Bplans.com. Follow him on Twitter @Timberry.
