When we work with startups in my Practice, one of the things I put so much efforts is pricing. Besides the cost-based pricing, value-based pricing and the typical marginal cost modeling, I like to look for a costing system that can replicate itself. Of course, there are just few products and services that can deliver such capacities.
Replicating pricing model is a cost model that has a low initial cost-burden feature which makes it easier for customers to adopt the product, but with the requirement that over the life of the product, the product will be generating additional income. And that means that you can easily scale the product through faster penetration due to the low initial cost. However, the product-system additional cost, while largely low, runs for years and will generate more revenue over the lifetime of the product. (Think of a very low fixed cost with a variable cost that is also low, but in continuum.) For this type of product, there is a duality: you have a main product with another supporting product. The customer has to buy the main product, and will then need the supporting one in perpetuity, for the main product to be useful.
Subscription service pricing is not a replicating pricing model because most times the acquisition cost remains the same cost you pay over time. You have a subscription to Tekedia and you pay $20 yearly but that amount does not change year-on-year. Also, there is no other supporting element to Tekedia. It is simply the same product (access to all contents in Tekedia) with no duality.
Good product examples of replicating pricing model are the following:
- Razor and blade: You pay for the razor and over years you keep buying blades. The guy that pioneered this sales model in the U.S. military gave away the razors for free. He made money from the blades.
- Printer and Ink Cartridges: You make the cost of printer very low and then make money via ink cartridges. Dell at a time was giving free printer with any laptop purchase. The company knew that it would make money on the ink cartridges, over years from the customers to cover the printer giveaway.
- Espresso Machines and Coffee Pods: In most Western cities, people make their coffees at home. The machine to make it is a one-off purchase. They keep it low to make it affordable. But the deal is the coffee pods which someone has to be buying to make the coffee. By keeping the machines low, it makes it easier for people to acquire them. Then, through the sales of the pods, a company can cover discounted espresso machine cost.
As I have noted in the past, pricing is a very important element in any startup. Without the ingenuity of the pioneer of software sales, the industry would not have made so much money. In software, you buy a product, but you never really own it unless you keep paying licensing fees. Once you stop paying the licensing fees, you have automatically defaulted and are now using an illegal product. Imagine if Microsoft and Oracle do not have annual licensing fees from their corporate clients, they would not have made a lot of success.
Also consider if Ford and Toyota had required that to remain having the legal rights to your car, you must service it with them yearly with some fees paid. If you do not pay that fee, the car rights automatically return to them. They could have done that when the automobile sector was at infancy, and the world might have accepted it. This will be different from your typical oil change. Even if they do not need to do anything, you would be required to pay the fees to Ford or Toyota to have legal rights to continue using the car. Annual software licensing does not consider whether you are using the software. Simply, provided you plan to use it, once the license is due, you have to pay. So, you see companies paying for licenses for software that is still inside a package, unopened. If they do not, they are “storing” that software illegally.
That brings me to the challenges of Qualcomm which has a novel way its mobile chipsets are priced. Today, you can buy a mobile chipset for $10 and use it to make a product that sells for $500. Qualcomm pioneered a model where instead of paying for the chipset, you pay it on the percentage of the final product. In other words, if say 10% compensation, it means they get $50 if the product sells for $500. That certainly gives them a better pricing positioning. Unfortunately for Qualcomm, other semiconductor companies are not interested in that. So, only Qualcomm was pushing and using that pricing model in the industry.
The implication is that Qualcomm has seen resistance from companies like Apple and many governments in some Asian countries where it has competitors. What Qualcomm wants to do today could have been done at the onset of the component and chip distribution industry. I think it is late now. Apple wants to pay $18 for Qualcomm chipset and not a percentage of its iPhone price.
So, as you work your products and services, think carefully on pricing. Besides innovation and technology, you can go far with the right product pricing models. Facebook has a freemium pricing model, knowing that it can use aggregation to build a huge advertising business. You need to find what works right for you. Pricing is not something you just wake up and do: you must think critically on its implications to growth and scalability of your startup.