Start-up lessons learnt on Pricing from Traditional business
A year ago I left my software job to do something which I always wanted to do, open a restaurant and experience doing business. This article covers my learnings, on the topic of Pricing. To my surprise many of the core pricing strategy concepts remain the same, be it a tech start-up or a traditional business.
Pricing is tricky but is crucial for return on investment and success of any business. Here I break down the approaches taken, strategies used and the learnings on getting the price right.
Before that a quick mention about Data. Anything and everything you do is based on data as you’ll see further. If you are already in business you would have internal data as well as external data you collected or if you are just starting you would use your projections which again is based on a lot of data collected.
Pricing approaches
When I started thinking on pricing my product, initially I thought of only two commonly known approaches to decide 1. Cost based and 2. Competition based. While these are important but soon enough I found myself thinking of one more approach, which is 3. Value based. All these approaches inherently depend on the kind of business you are in, your product and the environment you operate in. Let’s dive deeper into them, shall we?
1. Cost based
This seems a simple way of thinking to price your product but not so simple to calculate and arrive at correct numbers. Can be approached by asking a few questions:
- What is the cost of all raw materials used per item? From my restaurant example, unprocessed food items, oil and spices
- What is the cost of shared resources used in production, broken down to arrive at cost per dish? For example gas. This was tricky to calculate and can be done when you look at overall production of all items for a period of time say for a month
- What are the overhead costs of running the business? For example labour, rent, electricity, water, garbage disposal etc which again is taken for a period of time broken down at item level
- What is the marketing cost or your budget for a period of time under consideration?
- What are the ancillary costs of running the business? Like licences, stationary, gadgets, software, maintenance etc
- What is the fixed cost spent on setup?
Important thing here is to have current business data and future projections so as to arrive at cost per item. For example even the direct raw material costs would vary with volume due to economies of scale in future. Similarly, unit economies of other costs mentioned, like overhead costs, ancillary cost, fixed cost etc keeps on getting better and better. So a realistic projection would help in pricing.
Once you have an idea of your cost you add the mark-up of profit you expect to gain to arrive at the final price. This however does not work alone and you need to consider it in conjunction with the next approach i.e competition based.
2. Competition based
You cannot set your pricing without considering this factor. This acts like a cap to your prices. Again better approach is to start with few questions:
- Are you operating for the mass market or niche market or premium market?
- Is your product like a commodity? As then it gets difficult to price higher than the competition
- How big is the market? Can the current players suffice the demand?
- Is it a new/old product in a new/old market?
I took an approach where I had a mixed menu in my restaurant, some of it was mass market like meals and some niche items like unique chaats.
Turns out restaurant business does not fare well on these aspects and have competition which makes it difficult to price. The cost based approach coincides here where if your competition price is still higher than your costs, you are good. But often, as I found, that is not the case, for most of the products competition operates on low margins, expecting high volumes to make up.
This conundrum leads to the thought on the third approach which is Value based pricing.
3. Value based
By value based I mean the value which the customer perceives of your product. This seems abstract at first but can be broken down into specifics. Start with questions like:
- What is the differentiation or USP of your product? In my restaurant example, I introduced few dishes which are not available anywhere in Bangalore
- How difficult or easy is it for customers to find a similar product?
- How big is customer experience part of your offering? Again in restaurant example it is not just the food, ambience experience is a big factor, especially in fine dining restaurants
- Are there any complementary products of your main product? For example ice cream cones complement ice-cream. Alone it is not of much value.
- Is there anything extra you provide with your product or are there any ‘frills’? For example I started adding salad, pickle and chutney in every meal
Qualitative way
Another way of ascertaining the value of your product is via customer feedback, across channels, be it on-line reviews, social media conversations, directly by talking to store customers.
Quantitative way
This means an experimental approach where you introduce some change or addition to your product assuming to increase the value and look at sales and other metrics. For example, I increased the number of pooris (fried bread) in one of the thali in the restaurant to make it more ‘value for money’ and observed the change in numbers. Still a better way would be to do A/B testing with a select group.
Strategies
As I made progress with the above approaches in arriving at pricing, I found this was also not enough.
I wanted right pricing to achieve further objectives than just better ROI. Objectives like:
- Increase sales
- Attract new customers
- Promote products
- Better utilisation of resources
- Achieve economies of scale faster
- Clear up slow moving inventory
That is where you realise, pricing is a continuous activity and you need to keep on trying certain strategies. Listing down strategies as I have experienced and tried in my business.
1. Talk to your customers
Perhaps the best approach to fine tune your prices. Talk to your customers (as many as you can) to get a feel of what they feel about your product prices. Ask them questions on the value they perceive of the product and what they think of the price.
I got a lot of suggestions on getting the right product price fit from doing this. For example, one of the fast moving meals which we named Poori Meal had become quite popular but still in multiple customer feedbacks they felt it was missing something. After some discussions and thought I started giving an accompaniment ‘boondi raita’ to a few customers for free and got their responses on it. People liked the extra item as it complemented well with the pooris in the meal and more importantly it was not just another curry for the sake of addition. Even with slightly increased price when it was added in the regular menu, it became a best selling item.
Maintain all other feedback channels like online reviews, google and social media comments open and do following things:
- Collate and analyse feedback
- Look for opportunities
- Experiment experiment experiment
- Take decisions and make changes in pricing based on the result
- Experiment further
2. Bundles
Another strategy which I found interesting and worked for my restaurant, especially in online sales was bundling or Combos as we call it in the restaurant industry.
Selling two different items individually takes more effort and is restricted by customer preferences. Making a bundle out of it creates a win win like situation for both the business and customers.
For example, Customer A prefers ‘samosa’ (Rs 20) more than ‘gulab jamun’ (Rs 20) and normally buys ‘samosa’ only. Customer B prefers ‘gulab jamun’ more than ‘samosa’ and normally buys ‘gulab jamun’ only. Now when both are offered as a bundle for a discounted price of Rs 30, both Customer A and B see value in it and do not mind buying the bundle. So they bought an item which normally they do not buy. The overall revenue increases from Rs 40 to Rs 60; there is an increase in sales and so in the profit. The discount offered is compensated by economies of scale.
Things to keep in mind:
- Bundles should really fulfil a customer’s needs for example, bundling a meal with a drink, both of which are required by the customer when he comes to eat
- Bundles should provide convenience. It could be as simple as the customer not having the hassle of making too many decisions, for example a full meal combo
- Bundles should be cheaper than individual products bought separately, otherwise what’s the point
Bundling offer few other benefits like:
- You can sometimes introduce new products as part of bundle
- Carefully crafted bundles help in marketing and attracting new customers
- Bundle offers you a competitive edge especially when you have a range of different kind of products in your offering for example if you also have an ice-cream counter in your restaurant you can include meal and ice-cream as bundle
3. Discounts
The previous point also introduced the concept of discounts. Customers love discounts; this may be because of the way customer shops these days, especially online.
I found discount to be a tricky strategy. Before introducing discounts you should ask yourself some critical questions:
- What is the objective of introducing a discount?
- How long do you intend to run a discount?
- Are you burning cash to run discounts?
- How are you positioning your brand?
If you choose to run discounts based on your objective and answers to above questions you should still be careful on few points:
- Always keep track of your bottom line. Even if your objective is to burn cash for say market share but it cannot run for long
- If you price your product too high as you want to run a continuous discount, you can get trapped in the discount expectation and may not be able to remove it later
- Your brand may take a hit especially if you want to build a premium brand
- Discount should not always be the driver for customer to use your product
For my restaurant I had to adopt different strategies for dine in, takeaway and online discounts. In online, due to the customer behaviour, I had to run discounts frequently. The commissions in online business are much higher so I had to inflate the prices, keeping a fine balance, but it was capped and the discount was also limited. In dine-in I mostly introduced inaugural discounts only, when a new dish was being launched for a short time.
4. Psychology hacks
I became more aware of this strategy as I got myself involved more into continuous pricing. It has to do with the customer’s perception on price.
Some of the suggestions, again based on my experience:
- Price short of a milestone
Milestone is like a whole number price related to the product, for example 100, 200. This strategy is not about keeping the price 1 or 0.1 less than the whole number. I never found that to be a great way of pricing. However for some price point for example 100 it is a point of inflection from two digit to three digit price. So I kept the price of certain dish at 95 to experiment this hack
- Strike-out higher price
While reducing price, especially when advertising it, showing a striked out higher price next to actual selling price conveys the message of reduction in price pretty well
- Showing lowest denominator of Price
Using the example of EMI to explain this. It is like showing the EMI price instead of the overall price. It works well in many situations especially when the overall price is a high number. For example I started a monthly subscription for home delivery of meals, I highlighted and showed the per meal price also which makes it look much cheaper
- Price designed to nudge
In this strategy you create different versions of your product and nudge customers to buy a particular version through pricing. For example, for an item called ‘Aloo Tikki’, I created three versions. One basic, one with curd and one with extra ingredients like chick peas. The curd based versions price was kept slightly higher than basic but much lower than the third version.
5. Pricing analytics
This is not a single strategy but making use of analytics to understand what works well for your pricing and see the implications of applying various pricing strategies.
There are many kinds of data which can be used for analysis, like
- Transactional data
- Behavioural (besides pure transaction what other things customer did)
- Environmental (what is happening in internal and external environments during the transaction)
- Network data (customer’s social connections and their actions)
For the sake of simplicity and based on experience I’ll cover transactional data only. Other kinds of data can be kept out of scope for now.
This analysis was done by a few enthusiastic students studying data science with whom I collaborated and they used my restaurant’s data. I omitted customer’s details from the data and mobile numbers were replaced by unique ids to identify customers.
The exercise focussed on three areas:
- Overall Revenue analysis
- Customer analysis and
- Product related analysis
My objective of this exercise was:
- To find trends and correlations in above mentioned areas from existing data
- To get insights to setup new pricing experiments
- To study the result post conducting an experiment
1. Overall Revenue analysis
Few straightforward metrics to measure are:
- Daily, Weekly, Monthly revenue change
- Daily, Weekly, Monthly order change
- Average order value
- Revenue split between sources for example online, take-away and dine-in
Based on metrics several analysis can be done to understand the rise or fall in data. It helps you in planning further strategies like to increase average order value or focus on a particular revenue source more than other. For example, due to high commissions in online source, the margins are much better in dine-in or takeaway and so the pricing can be adjusted to achieve expected numbers.
2. Customer analysis
Looking at the customer data many inferences can be arrived at. First customer segments can be deduced on the basis of RFM analysis. R-Recency, F-Frequency, M-Monetisation or Revenue
Then when we know our customers and their spending better, we can apply strategies to achieve objectives like providing premium services and complementary items to best customers or getting back lost customers by notifying them on promotions running, new product launches etc.
Few other metrics like rate on increase of customer base to new vs repeat customers are helpful for strategising.
3. Product related analysis
Next we come to product related analysis. Here also we can conduct multiple analysis like:
- Share of revenue contribution by each product
- Frequency of sale of each product
Even if you increase the price of high revenue generating, high frequency product by say 5%, it could amount to a significant increase in your profits.
- Associated products, products which go together. This can help in creating bundles or up-selling certain products
- Sales calculations to achieve desired number of sales when you change the price or give discount on a product
- Sales calculations to achieve desired number of sales when you change the price or give discount on a bundle or combo
Conclusion
These were some of the things I did to get right product price fit and achieve my business objectives. Now I am thinking of exploring few more things like loyalty points and customer wallet which customers can use for further purchases.
As I mentioned earlier it is a continuous activity and you should keep on conducting pricing experiments.
I would like to know your thoughts on this and what strategies have you applied in your business. Thanks for reading.
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