Finding the Right Price

dollar signsOf all the problems that face entrepreneurs, finding the right price is probably the most difficult. The right price is a balance between maximizing income over time and the range of prices that buyers will pay.

The problem is very complex and the methods employed to solve it are often little more than throwing a dart at a bunch of numbers on the wall. Very few startups know on the day they start charging for their service, application or product, if they have really maximized their possible income. Is there a method for determining prices that Lean Startups might adapt to their agile-based test and evaluate cycles?

We seldom think of the sports vertical as an innovator, but in this case, there are several developments that are worth considering. Sports teams have a pricing problem in common with startups, but they can face pricing pressures several times in a season. Teams depend to a great extent on maximizing the price of tickets while maintaining full stadiums and venues. If they are moving toward a championship, unsold seat inventory may actually be sold at a loss to the secondary market that can then mark up the price to whatever the market will pay. If they are coming out of a winning season, their seats may sell well at first, but if they don’t play well in the first few games, they may suddenly find the stadium nearly empty because people are unwilling to pay elevated prices for games they think might be boring. When that happens, vendors at the park suffer too and as their profits go down, the spiral continues to eat at revenue.

An article in the Harvard Business Review caught my eye recently because it points out that a variant of the Dutch auction, called Purple Pricing, may point the way to an answer. In a Dutch auction, the price starts high and is lowered until sales begin. It works because there is a limited quantity available and if buyers need it, they will at some point have to jump in and buy enough product to keep from being closed out of the market. In that sense, it maximizes the profit available to the seller.

Purple Pricing, as used by sports teams, makes one important change to the Dutch Auction model. It offers a guarantee to buyers that if they buy at a higher price to assure they get a seat, they will be refunded the different between the eventual price, if it turns out to be lower, and the price they paid.  In practice, there is a floor price that assures that season ticket holders won’t be undercut by seat pricing in the season, and that floor price also protects the team to assure that costs are fully covered even if better profits don’t appear.

Since this is a new pricing system, it is still too soon to assess how sports teams that use Purple Pricing will fare in the marketplace, but it is interesting to consider how entrepreneurs might apply the same principles to finding a price in their market. Because it depends to a degree on a limited supply, it will require some adaption depending on the business model involved, but even so, there are ways that Lean Startups might adapt the idea:

  • Create a limited group for early adopters with a cost. Guarantee to buyers that although the price for the service or product may start at a level that appears to them to be high, they will receive the difference between what they paid and the final price if it is eventually lowered to fill out the pool of early adopters.
  • Assure early adopters that if the price they buy at is eventually lowered in full release, they can get the lower price and if it is higher, they will be able to continue at the lower price for a specified period of time.

The ultimate goal is to create a situation where the market will help determine the product value and price, while avoiding the situation where it is given away or sold at a price too low because the founders are concerned they will hurt adoption by starting out with a price that creates too much friction. Starting with a free product or with a very low initial price often leads to an initial group of users who will not stay when prices rise to support the business model and who may lead the business in directions that will never support a scalable business model.

I don’t know of any founders who have adopted a variant of the idea as yet, but I’m willing to bet there will be people who see an opportunity to try new ideas. What about you? Do you see opportunities to adapt the Purple Pricing idea to price testing? How would you do it?