Guide for seed stage founders
Say you came up with a great idea, in a blue ocean space with little to no competition, where do you price your product or service?
- What price points are your competitors and substitutes? — The answer “we have no competition” often reflects narrow scope: even the Mars migration mission has two well-funded competitors (Musk and Bezos). With deep pockets and sometimes unilateral decision making, many sovereign wealth funds can build factories, foundries, cities in months. With merely tax incentives alone, sovereigns can shift the playing field in just a few years. Think broadly about who your competition CAN be: this will not only help you recruit the best investors and early employees, but also increase the longevity of the success of your company. In the realm of transforming industries and building empires, only the paranoid survive. In addition to pure competitors, substitutes need to be included in the panorama, because substitutes are the solutions your customers are currently using. Think comprehensively about the total cost of substitutes. e.g. For Kindle, the substitute are buying physical books plus storage cost, or public libraries plus transit cost and time cost. ClassPass priced at near the cost of a SoulCycle class or yoga studio class. Peloton’s monthly subscription is priced at slightly below one SoulCycle class. Netflix monthly subscription is around the cost of an average movie ticket. Pricing at near your competitors and substitutes will boost the number of customers that are willing to try you out.
- Fantasy self versus real self — It’s totally fine to aspire to be the next 23andme, and in fact, it’s encouraged! However, will your customers view you more like a uBiome or Viome? 23andme was able to more definitively identify genetic predispositions for disease, warranting the $199 price tag, whereas gut microbiome startups hasn’t quite cracked the disease modification nut, and thus staying at around $99. Seemingly small price difference, but if you are going mass market, these price points matter.
- How sticky are your customers — Even if you have a consumer product or service (versus enterprise), most businesses are focusing more on recurring revenue and subscription models. Instead of selling your product at $199, can you sell it at $99 with a monthly subscription of $9? If you charge a monthly subscription, you must consistently deliver something of value to your customer. The razor and razor blade model, although a frequently used example of recurring revenues and customer lock-in, gets the value equation wrong, and has faced consumer backlash and opened itself up to competition. The real question to ask may be “what value can I deliver to my customers every week/month?” Amazon Prime earns its subscriptions by continuing to expand product offerings and offsetting shipping costs. Costco earns its subscriptions by continuing to offer quality products at the lowest price possible. Netflix earns its subscriptions by continuing to expand its original content. Subscriptions aren’t free money: you have to continue to deliver value to your customers.
- The Uber Limousine model vs the AI/ML spin— Many new tech start at the high-end while gaining enough volume to bring the cost down. This is a well-worn path by Uber with the Black Car Limousine model, by Tesla with the first Roadster at $109k. However, if your business model has the words “big data” or “AI/ML” in it, limousines and $109k Roadsters will not get you enough units sold to gather enough data to train the models necessary for a real AI/ML company, by your next financing round. Thus, your AI asset may instead be viewed as a liability of high salaries and data storage costs. To be valued as an AI/ML company, you must quickly gain enough data to train your models to make accurate predictions that nobody else can. For startups, this time to gather data is likely measured in months, not years.
- P times Q — The Uber limousine model was the beachhead TK needed to demonstrate a proof of concept. The Tesla Roadster was the “show me you can do what Detroit can’t” that Elon needed to convince investors to part with the billions needed to build the Gigafactory. But you can’t stay niche if you want to transform entire industries. The value of your company is ultimately determined by the area under the curve of Price times Quantity, not “does there exist one buyer at this Price?” Founders are often frustrated by investors asking for the initial beachhead, then complaining that the market size isn’t big enough. Investors are really looking for TWO answers: the big vision AND a somewhat concrete path of how you will build to get there.
- Niche cult-favorite — This advice is well-preached because it’s the commonality between startups that succeeded. You’ll know you’ve found product-market-fit and your beachhead, when you find your first 20 loyal fans. Even if it’s a freemium product, are your customers raving about you, can’t stop telling their friends about you? Talk to each of these 20 evangelists, figure out WHY they love your product, ask about their adjacent pain points. These interviews will tell you where you are winning against your competitors (step on the gas in these areas, highlight them in your marketing), what features to add and which adjacencies to expand to next. And this MUST be done by the founding team, you can’t outsource this part even if you are all engineers or scientists, because the nuances aren’t captured in text or numbers. Then find your next 200 evangelists, but keep talking to the first 20 because markets and competition change and they might be the first to notice the change. And as any sales person will tell you, it’s cheaper to retain an existing customer than to prospect for a new customer.
- Margins vs runway — I left the margin consideration last because if you thought about cost and margins first, you’ll subconsciously anchor your price point and influence all of the answers above. Ultimately, you can’t sell a negative EBIT margin product forever, only as long as you have the cash runway to fund it. Thus, the questions become (a) “can you gather enough data during that time to create a data asset (e.g. to validate the AI/ML claims)?” or (b) “can you gain enough Uber limousine customers and Tesla Roadster evangelists during that time to convince investors of your traction and vision?”
The first two years are the hardest, but you’ll learn more about yourself than you ever will working for someone else. It’s a journey unlike any other. Hang in there.