How We Almost Lost Everything

If you're running a startup and trying to decide how much to charge for your product, this video is for you. At the early stage, just building something people actually want is such a priority that deciding how much to charge often gets kicked down the road. It's easy to say we'll figure it out later, but in many cases it can make or break your company. In 2015, a critical pricing decision almost broke my company, Soylent, and today I'm going to share the whole story with you. Hi, I'm John Coogan and this is Startup Pricing Explained. I'll start with a little background on the company. I started Soylent with three other co founders in 2013. We had all been trying to build other startup ideas, but nothing was working. We were running out of money, and every day we failed to get a new idea off the ground was one day closer to having to go back and get a real job. Just as we were running out of money and it looked like nothing was ever going to take off, Rob Reinhart came up with an idea to help us extend our Runway by letting us spend less money on food. Instead of buying ramen like other entrepreneurs, he bought raw ingredients and started mixing them together into a nutritionally complete meal that he could drink throughout the day. Pretty much everyone who encountered his idea at the early stage, myself included, thought it sounded pretty weird, but he decided to blog about it anyway. The blog got some attention, which led to interviews in popular press outlets, and pretty soon it was clear that we had to sell Soylent as a real product. In order to fund our first manufacturing run of Soylent, we set up a crowdfunding campaign where people interested in trying it could pledge their money in exchange for a box of Soylent when we were finally ready to ship it. In thinking about the benefits of Soylent, we settled on three key healthy, convenient, and affordable. Typically, food options only satisfy two of these criteria. Nice restaurants are healthy and convenient, but expensive. Fast food is convenient and affordable but unhealthy and growing your own food is affordable and healthy, but is inconvenient in a tiny apartment. Soylent would uniquely satisfy all three. But making a new product radically affordable can be quite difficult when you're a startup. Big companies have lots of advantages when it comes to cutting costs, generally called economies of scale. Large corporations can own their own supply chains and purchase raw materials in massive quantities which which earns them a discount. Once they've driven their cost of goods down, they have the option to either bank those savings as increased profits, or they can get aggressive and try and lower their prices in hopes of driving out the competition. When we initially priced Soylent, we were hyper focused on delivering value to our customers. Our crowdfunding backers were extremely excited about the project and we really wanted to deliver something great. We had a genuine hope that a low cost, healthy food could really help people who were struggling to eat well on a budget. So low prices were essentially non negotiable. To decide how much to charge, we did a simple bottoms up analysis where we looked at how much we expected to spend making the product and then added the slightest bit of buffer room just in case things became more expensive down the line. You have to remember that when we set up the crowdfunding campaign, we didn't have a contract in place with a manufacturer, so we didn't have a solid quote for how much the product would cost to make. Unfortunately for us, our first cost estimates were way off and there was no way we could make any profit at the price we had originally set. So we had to raise prices. But the community wasn't too upset. They generally understood that we were just a small company and we were doing our best to deliver a great product. But the question of pricing would become much more important a few years later. In 2015, our company was humming along. We had introduced new products and found bigger manufacturers who could mass produce Soylent at reduced cost. So we found ourselves in a situation that big businesses face all the time. Should we use those profits to grow our company or reduce prices in hopes that more people would buy our products? To answer this question, we turned to a basic economic theory called price elasticity. Even if you've never taken an economics class in your life, stick with me because the idea is intuitive but quite powerful. The elasticity of demand is defined as the percentage change in quantity demanded divided by the percentage change in price. So if the price of something goes up by 10% and demand drops by 10%, then 10% divided by 10% is 1, and the elasticity of demand is considered unit elastic. Things get much more interesting though, when one of these variables starts moving more dramatically than the other. One classic example involves illegal drugs. Because drugs tend to be addictive, drug users will pay nearly any price for them, meaning that drug prices are inelastic. If the price of a drug doubles due to enforcement action, demand might only fall by 10%. In these situations, drug dealers wind up earning more money from drug sales and in turn have greater resources to skirt the authorities. Elastic goods are the flip side of this coin, meaning that just a small increasing price can dramatically decrease the demand for a product. Luxury items tend to be elastic because they aren't essential to everyday life, although I'm sure some extremely rich people may disagree with me here. In 2015, we believed that the demand for Soylent was elastic because the food and beverage industry is so competitive. By radically reducing our price, we thought that we could bring in a huge number of new customers and and offset any loss of revenues. But there's another important factor to consider. Margins. Revenue is important at a startup, but profit margins are arguably even more important since that's what you use to pay your employees and grow your business. Even though we could cut our prices and potentially increase our revenues, our gross profit would fall disproportionately. This isn't true for all businesses clients Cloud software companies have the benefit of extremely high gross margins and essentially zero marginal cost, so they can often give their products away for free in order to try and maximize the number of customers they bring in. So how should you price your products if you're running a startup? Well, first you need to understand your cost structure. How much revenue does each customer bring in and what are your gross margins on that business? You should try and understand if demand for your product is elastic or inelastic. If you're selling something that people really need, you might be able to set a high price without losing that many customers. If the opposite is true and your product is elastic, you need to be very careful about price changes. Raising your prices even a few percent could decrease your conversion rate significantly. It's important to do both bottom up and top down pricing analyses before you decide what to charge. Figure out what it costs you to provide your product or service to your customers, and then look at what your competition is charging. Once you understand the competitive dynamics in your industry, you'll be in a much stronger position to set your startup up for success when you launch. Lastly, you can usually change your pricing strategy after you launch, but be sure not to alienate your current customers. It's always beneficial to offer existing customers discounts to keep them on board and be clear about how long the new pricing structure will last and what motivated the change. Community management is important at every startup, and transparency is an extremely valuable tool to keep early adopters happy while you're experiencing growing pains. Good luck and if you enjoyed this video, please consider subscribing to the channel. If you have any questions for me, just leave me a comment below or message me on Twitter. Thanks for watching.