The following is an excerpt from my book:
Running Lean
How to Iterate From Plan A to a Plan That Works

Can you imagine Steve Jobs asking you what you would have been willing to pay for an iPad before it launched? Sounds ludicrous right? Yet, you’ve probably asked a customer for a “ballpark price” at some point.

Well, that’s just backwards.
Think about it for a moment.

There is no reasonable economic justification for a customer to offer anything but a low-ball figure.

They will either know the real value of your product and downplay it in order to get a good deal.
They may honestly not know and this question only makes them uncomfortable.

It is not your customer’s job to set pricing.

An optimal price is one that is accepted but not without some initial resistance. It is your job to both set that price and convince the customer. Apple is a master at this. They manage to charge a premium for their products and get people lining-up for their products.

Pricing is considered more art than science but in the next series of posts I’d like to explore tactics for demystifying how to set and test pricing.

Principle 1: Pricing is Part of the Product
Suppose I place two bottles of water in front of you and tell you that one is $0.50 and the other $2.00. Despite the fact, that you wouldn’t be able to tell them apart in a blind taste test (same enough product), you might be inclined to believe (or at least wonder) whether the more expensive water is of higher quality.

Here, the price can change your perception of the product.

Principle 2: Pricing Determines Your Customers
Pricing doesn’t just define the product but also your customers. Building on the bottled water example, we know there are viable markets at both price points. The bottle you end up picking defines the customer segment you fall in.

Principle 3: Pricing is Relative
In their seminal book on Positioning — The Battle for the Mind, Al Ries and Jack Trout describe the concept of a product ladder which is how customers organize products into a mental hierarchy. Your job is understanding what alternative products occupy the top 3 spots in their mind. These alternatives provide reference price anchors against which your offering will be measured.

Alternatives can be real or extrapolated. In both cases, they help when applying the relativity principle.

Watch how Steve Jobs introduced pricing for the iPad in a brand new product category:

Steve Jobs skillfully anchors iPads against pundit predictions (who used netbooks for price anchors) and makes the iPad look like a steal.

I’ll talk more on how to “pitch” your price in the next post. For today, lets cover how you come up with an initial price to test.

Determining a Starting Price Through Problem Interviews

These principles come heavily into play during problem interviews. Because pricing and product are inseparable, you should not directly bring up the price of your product until you have a clear understanding of what you are building, for who, and know what alternatives already exist.

That is precisely what you set out to learn during problem interviews with potential customers.

Lets see how this plays out in practice. One of my previous products, BoxCloud, was a file-sharing product that simplified the process of transferring large files. Now lots of people could have benefited from the underlying value proposition, but here is a sampling of what I learned from different customer segments:

Existing Alternatives: Email, torrents, personal websites
Pain level: Nice-to-have
Price anchor: Free

Graphic Designers
Existing Alternatives: FTP servers
Pain level: Low for them, high for their clients
Price anchor: Value placed on easy setup and simple web-based interface for customers.

Existing Alternatives: Couriers
Pain level: High
Price anchor: $50 per transfer

I got even more varying responses from accountants, medical professionals, architects, photographers, video game designers, etc.

The same product problem and solution combination could be positioned against a dizzying array of customer segments using different channels and price points. I ultimately used two other criteria — customer pain level and ease of reach, to prioritize starting with the graphic designer segment with a $19/month starter plan. I eventually positioned BoxCloud for small-medium sized businesses and launched a separate sister-product a couple of years later to address another segment — amateur/professional photographers.

Pitching and Testing Your Price Through Solution Interviews

Next time, we’ll cover techniques for pitching and testing your price with customers or better yet “How to get your customers to want to pay even before building your product”.

If you don’t yet have a copy of my book, grab a copy of Running Lean here.

It’s chock full of lots more actionable tactics like these.