How to avoid start-up failure: Price and Cost Issues

CB Insights survey of 110 tech companies that failed found the price cost issues ranked number 7 on a list of twelve causes of failure with 15% of CEOs including this as one of the reasons their company failed.

Businesses run on a simple formula, revenues or price minus costs equals profit. Get either your pricing or costs wrong and you lose money; no start-up can lose money for long. Uber seems to be defying gravity, although they are now cash-positive and making positive profits at the EBITDA level, they are still making losses at the operating level. EBITDA which stands for Earnings Before Interest` Tax Depreciation and Amortization is an indicator of future cash flows and is often used for business valuations.

Let’s start by looking at some of the more common pricing mistakes made by fledgling companies.

1. They set prices in a vacuum. The pricing strategy is set without any discussions with potential customers. They set a price, launch, and wait to see how the customers will react. As part of your demand validation, you will have identified your ideal customer. Maybe you have already discussed your product or service with them. Find the time to talk with them about price.

• “Set it and forget it” pricing. Having decided on a price, founders often fail to go back to review their decision. The introductory price becomes the price. Pricing should be dynamic,  you should be continually reviewing pricing to reflect the marketplace, additional features provided, and what the competition is doing. I believe one reason for this inertia, which I have learned over 30 years of experience, is that salespeople hate going to ask for price increases. They will push back, telling you that the competition has better products at lower prices. Do not worry, your competitors’ salesforce is telling their management the same thing about you; that you have better products at lower prices.

• The price set is too low. Rather than pricing high and letting the market tell you that the price to value equation does not work, even the most confident teams set their prices too low. And, as it is more difficult to raise prices than it is to lower them, the business struggles to get a fair price for the value they are providing. Add to this that volume projections are often over-optimistic you end up with a  price that is insufficient to cover your overheads.

• The pricing structure is over-engineered. Volume rebates, annual rebates, minimum order quantities, combined with product discounting. It’s remarkable how complicated folks can make pricing. I worked for an MNC where the pricing structure was so complicated that even SAP, a powerful ERP system, could not handle automatic pricing. I would include in this section being over-inventive in pricing. In any marketplace, people have become used to buying a product in a certain way. If your product is software, then buyers are accustomed to paying per user. If you decide to charge per site, such as one software supplier did, people become confused.

Your initial customers: In episode 9, on how to avoid mistiming your product launch, I talked about a checklist of five items to ensure your product was ready to launch. One of those items is that you are able to demonstrate that your product works in the real world.  For your first three to five reference customers your first priority should be to ensure that these customers see value in your product; revenue maximization should be well down the priority list.

Test your pricing hypothesis and discuss your pricing proposal with potential customers early. Commonly salespeople avoid the pricing discussion at the early stages. “We will discuss pricing later” Why waste your time? Tell the prospect your proposed pricing early and gauge their reaction. I have learned this in my consulting business. I do not think my fees are excessive and this has been proved correct by my client retention rate. But for some potential clients, my fees are above their budget. Much better to discuss my rates upfront rather than spending time in exploratory talks only to be rejected on price later.

How to Know When You’ve Made a Pricing Mistake

Identifying and remedying a pricing mistake is much easier said than done. It might seem straightforward to look at less-than-stellar sales and immediately know that your price is to blame. But a lot of elements are in play when pricing a product and there are even more to consider when you include your selling and marketing strategies.

Revenue goals, brand positioning, broader demand, marketing objectives, and several other factors play a role in how you price your product. That means a pricing mistake can stem from several possible sources.

That said, some signs you can look for will help you see if you’ve made a pricing mistake. Perhaps the most obvious one is lackluster sales — especially if you have a competitor outperforming you at a particular price point. If that’s the case, you should revaluate your market position and the pricing strategy that comes with it.

Another is seeing sales dive at a certain price over time.

In that case, it probably means the market for your product or service is changing and your pricing strategy will need to change with it.

Ultimately, products and services are worth what people are willing to pay for them. If people aren’t willing to pay a certain price for yours, it probably isn’t worth what you’re charging; at least not at that moment.

You need to price based on your offering’s value, which comes from your positioning and your customer’s perception. Identifying pricing mistakes rests on understanding the value you provide and adjusting your strategy to convey it effectively.

What is burn rate?

Burn rate describes how fast a company is spending its cash reserves to fund overheads. It is also a measure of negative cash flow, and it’s usually quoted as cash spent per month. For example, if your company has cash reserves amounting to $250,000 with a burn rate of $50,000 per month, your company will run out of cash in five months.

You can’t afford to ignore your burn rate

The fact that 82% of startups fail because of cash flow problems tells the story of just how often cash flow is taken for granted by young businesses. Understanding your company’s burn rate is critical to both identifying areas for improvement within your company and planning for the future. Especially if you’re a funded startup, ignoring your burn rate is not an option.

Burn rate identifies the need for budget cuts

A company’s burn rate can hint at overspending. And if you’re running a startup, you’re almost certainly overspending somewhere. The following three areas are likely contenders.

Branding: With so many possible approaches and a varied ROI, branding is often an area of overspending for new companies.

Vendor Relationships: Many young companies let inertia set in early with vendor relationships, even when rates need to be renegotiated or new partnerships sought out.

Office Space: Your lust for brand-new office space may prevent you from enjoying it for long. Lengthy leases and slower-than-expected staff growth can turn a luxurious workspace into a burn-rate albatross.

Presuming you spot it fast enough, a high burn rate due to factors like these can be a blessing in disguise, pointing you toward more effective replacements for needless expenses. If your burn rate is up because of overspending on branding, consider organic means of building your brand profile instead of paid advertisements. If it’s because you’re getting a bad rate from a vendor, use it as an opportunity to shake things up.

And if the burn is due to your corner office, it might be time to move back to the basement for a while.

Burn rate informs how much revenue is needed.

Put simply, you can’t go bankrupt if you make more money than you spend. Beyond that, responsible growth and planning (and so the success of your business) is not possible without knowing how much money is available to reinvest in your company after all the expenses are paid.

For funded startups, the relationship between burn rate and revenue is especially important. You’ll have used your funding cash to build the company in the early stages, with the aim to reach positive cash flow before the money runs out. Sometimes called “cash runway,” this metric tells you how long the money will last at your current burn rate.

It would be best if you ideally targeted having 12 months or more of runway at any given time, particularly in early seed rounds. That way you can take the hit of an unexpected expense, a market downturn, or a complication with your product without feeling the heat of a sudden burn rate increase.