Free Small Business Health Care Seminar

For those of you who are in Silicon Valley, you may be interested in this free seminar being sponsored by the West Valley Enterpreneurship Foundation and West Valley College this week.  The topic is health insurance for small business and the impact of health care reform (as it currently stands).

Health Care for Small Business - Navigating Federal Reform

Thursday, October 27, 2011 @ 6:00pm

West Valley College, Fox Center, Room 120

1400 Fruitvale Ave., Saratoga CA (map)

Presenters:  Dan Ellis & Gina Jarin, IPB Insurance

Link to the Meetup site with information is here.

Picking People

One of the most challenging aspects of running any business is hiring the right people.  In my 20+ year career, I've probably made every mistake in the book.  In the process, I've managed to develop some hiring guidelines that have, at least for me, eliminated the worst of the errors and improved the likelihood of finding the right person for the job.  But even so, there remains a strong element of subjectivity.

Now the first step of any hiring process is to have a good job description so that you know whom you're looking for and what you want them to do for you.  But assuming that you have this, here's what I look for when I hire, what I call the 3A's.

• Attitude - First and foremost, I look for the right attitude.  Right attitude means someone who actually wants the job that I have, is willing to learn the way it's done in your company, is willing to do the dirty work as well as the glamorous stuff that every job entails, and thinks TEAM not just about themselves.  I also look for people who enjoy what they do and aren't in it just for the money.  I still remember one interview for a manufacturing engineer during the height of the dot-com boom.  This one guy walks in the door, leans back in his chair and the first words out of his mouth after hello are "so what's the stock option plan look like?"  Needless to say, he didn't get the job.
• Accomplishment - Next I look for demonstrated proof of the skills listed on the resume as well as proof that the person has been successful applying them.  This is where reference and background checks are important.  M.S. degree in nuclear physics from M.I.T.?  Easy enough to check.  An innovator in graphic design?  A little harder, but let me see the portfolio.  Strong project management skills?  A lot harder but possible to probe by asking specifics.  For example, how do they track projects?  What are the pros/cons of using a waterfall vs. Agile methodology for project management?  How do you handle team members who are chronically late?
• Aptitude - Thirdly, I try to ascertain fit.  This is the soft, squishy personality stuff.  Not only do you want someone who is going to work well within your culture, you also want someone who's natural bent plays to the requirements of the job.  Some key fit parameters:
• Process vs. "product" orientation - see my blog post on this one
• Communication style:  written vs. graphical vs. verbal
• Communication style:  concrete vs. abstract/conceptual
• Detail orientation vs. big picture
• Extrovert vs. introvert
• Collaborative vs. individual problem solving
• Work style:  multi-tasking vs. serial tasking
• Integrated vs. discrete orientation toward work/life balance

(I've run into some absurd situations caused by poor fit.  I still recall one ridiculous meeting between sales and accounting at one company I was at over expense report reimbursements.  On the one hand you've got a bunch of product oriented, verbal, concrete thinking, extroverts continually ducking out of the meeting to take phone calls trying to convince a group of process oriented, "put it in writing", conceptual detail people who had allotted exactly 30 minutes to this meeting that they should be able to be reimbursed just by turning over a stack of credit card receipts....you get the picture.)

Finally, there is one thing I look at beyond the 3A's:  Character. Is this a person that will tell me truth? How certain am I that they won't lie, cheat, or steal?  Does this person have the courage of their convictions?  Do they have the ability to admit to mistakes?  In short, can I trust this person to do the right thing by me?  For me, this is where intuition comes in.  If the answer is no, I don't care how stellar they are on the 3A's, don't hire.  Keep searching.

Wall Street vs. Main Street Negotiations

I was recently asked by an entrepreneur what my advice would be on how to handle a contract negotiation between his company and a large, Wall Street financial services firm.  He was a bit concerned by the rather one sided terms being proposed by in the initial draft of the contract.  He was also getting annoyed that every time he tried to push back, he inevitably found himself arguing with their lawyers instead of the principals themselves.  And for the past week, they had stopped returning his emails and phone calls altogether.  Needless to say, the entrepreneur was concerned that his push back had soured the deal.

I told him to take a deep breath and relax, while I acquainted him with the realities of a Wall Street Negotiation.

At the risk of grossly stereotyping, it has been my experience that there are two fundamental negotiating styles.  One I call Wall Street Negotiations, the other I call Main Street Negotiations.  Now I'm a Main Street kind of guy so in the descriptions that follow, my biases should be pretty easy to observe.

Wall Street Negotiation
This type of negotiating style is based on the premise that one has a fiduciary duty to get the most out of any deal for one's shareholders.  Leaving money on the table is bad and indeed might even get one sued.  Every term is crucial and advantage can be found by having the best specialists (i.e. lawyers and accountants) on the team.  The assumption is that the other guy is thinking exactly the same way, there is an understanding by both parties that the negotiation is just business (not personal), and no matter how contentious the negotiating process, once the deal is inked, bygones will be bygones and we'll all be able to work together going forward.

Wall Street Negotiators, as a rule like, to put out the first contract draft, heavily biased in their favor to establish the base position.  This puts the other party in the position of having to pull the contract back towards center.  Wall Street Negotiators will make lavish use of teams of high powered attorneys and accountants to (a) insure they have the best experts able to scrape every penny off the table and (b) to "cover their a--" in the event someone unhappy with the final outcome decides to sue.

To many Wall Street Negotiators, the negotiation is a challenging and stimulating game and where the money is made.  One uses feints, posturing, and signaling to drive towards the most favorable position.  Need to make the other party sweat?  Delay returning those calls for a few days.  Or make sure you have people to play "good cop/bad cop".  Need to buy time?  Have the lawyers make a mountain out of a molehill on some minor term.  One can always cave in later if doing so is to one's advantage or one needs to change the tenor of the negotiations.  Brinksmanship can be good and remember to feign indifference because the perverse thing about negotiations is that often the person able to extract the most concessions is often the person who is perceived to care the least about whether the deal goes through or not.

Main Street Negotiation

Almost at the other end of the spectrum, this style is based on the premise that a good deal must be "win/win" and if a deal is fundamentally sound, there will be plenty of money on the table so focus on the dollars and don't sweat the pennies.  Main Street Negotiators are more interested in executing on the deal;  the negotiation is just something to be gotten through so one can get on with the business.

Therefore, to save time and legal fees, the first draft of the contract will tend to be start somewhere in the middle, the rationale being that that's where everyone will end up in the end anyways.  Also, the fewer contestable points, the smoother the negotiation is likely to go and subsequently the better the feelings during the negotiation process.  The tenor of the relationship is important because once the deal is done, one has to work with the opposing party to execute. Also, for many Main Streeters, especially entrepreneurs, business is not "just business", it's their life and there is quite a bit of personal involved.

For Main Street Negotiators, deals are not an everyday event and the money is perceived to made not by the deal but by the operational execution afterwards.  They don't perceive the process as a game;  they just want to get to the end so they can get onto the real work.

Clash of Expectations
Now when a Wall Street firm negotiates with another Wall Street firm or a Main Street firm with another Main Street firm, there generally isn't an issue.  Both parties are working off the same expectations and things usually work quite well.  The issue comes when a Main Street firm finds itself negotiating with a Wall Street firm.  With completely different negotiating styles and expectations, things can turn sour quickly, usually for the Main Street firm which is not used to the more rough and tumble style of Wall Street.

So who tends to practice Wall Street Negotiations?  Investment banks.  Private equity firms.  Venture capitalist firms.

The latter is what makes cynics of entrepreneurs.  Used to a win/win atmosphere, if they haven't been in a Wall Street Negotiation before, they can sometimes feel bullied and at a disadvantage during a term sheet negotiation.

So what can you do if you find yourself in a Wall Street Negotiation?

• First off, realize that you ARE engaged in a Wall Street Negotiation - That means expect the first draft contract to be skewed.  Expect that you will have to fight to bring it to the center.  Don't concede minor points too quickly; you might need them as bargaining chips later. 
• Get your own attorney and CPA - This will tend to mitigate the gamesmanship and give you someone on your team who talks the lingo of the other sides attorney and CPA.
• You deal with the principals;  let the lawyers deal with the lawyers, CPAs with CPAs - You should drive the business terms.  Let your lawyer negotiate the legal terms.  Let the CPAs fight out the financial model assumptions.  Use the professionals to put some emotional distance between you and the negotiation and keep you out of the minutia and focused on the key points.
• Don't let the emotions drive you - Don't vilify the other party.  They are not the spawn of Satan.  They're just doing their job which is to extract the most favorable terms for their firm.
• Don't be afraid of pauses and silences - Don't read the worst into failure to return email or phone calls.  Don't feel like you have to fill every silence with words.  For some reasons, Americans hate silence;  I've seen several deals with Japanese firms where the Japanese won concessions just because the American negotiator couldn't shut up.
• Try to establish a personal connection with the other party - Go to dinner, meet for drinks, play golf.  The more you can bring relationship into the picture, the more you can shift it towards a win/win direction.
• Know your walk away points ahead of time - Make sure you know up front under what conditions you would walk away from the deal.  This also helps keep the emotions down and also makes you appear less eager, strengthening your position.

Vacation: A Management Tool

I'm finally back after a two month blogger's holiday. Three weeks of that was spent teaching high school students marketing and entrepreneurship. The last three weeks was spent on a family vacation overseas in Korea with no voicemail and limited email. During the last three weeks, I was pleased to find that other than a few minor issues, the office didn't fall apart and our staff did a great job of keeping clients supported in my absence.

Chalk up another win for Vacation as Management Tool.

I'm not talking about the mental health benefits of vacation downtime, which are well documented. Rather I'm referring to a practice I started years ago whereby I deliberately absented myself from my job for two to three weeks in order to test how well I had done the following:

• Trained my staff
• Created processes and systems
• Delegated routine operational issues

Two to three weeks seems to be about the right time for any weaknesses in the above to show up but without letting them blow into full fledged crises.  These become targets for improvement.

As a corporate executive, I would use the vacation test to evaluate how well the managers working for me were doing.  While the first criteria was departmental performance, in my book, one of the key jobs of a manager/supervisor is how well they train their people to work without them.  Weak managers tended to be too involved in the day-to-day which deprived their people of development opportunities and left the organization vulnerable to a single point of failure (themselves).  It also limited their advancement opportunities by making it difficult to move them to new positions.  Also, I've found that if you let it, work will expand to fill all available hours;  weak managers tended to be so busy with tasks that could and should have been delegated that they never had the time needed to think about new opportunities or how things could be improved.

Now lest my startup readers think that delegation does not apply to them (after all delegation assumes that there is someone to whom work can be delegated), I would counter with this question:

"How are you expecting to scale?"

Of course the answer is you hire or you contract out.  Either way, you only scale by bringing in people...

• ...to do specialist tasks for which your team lacks the skills
• ...to do tasks that someone else can do more expertly and/or efficiently
• ...to unburden "bottleneck" specialists of tasks that can be done by others (usually cheaper)

When you hire you usually need to develop processes and procedures to enable them to execute and/or train them.  Then you need to delegate the job to them and figure out how to monitor the results.  This is called management* and it is harder to do than it looks.  In a startup, their never seems to be enough time to train;  it's often easier to just do the task than explain and train.  And setting up processes?  Not only is flowcharting out and documenting all the little steps time consuming, it can be BORING, especially to many entrepreneurs who enjoy the excitement of deal making and creation.  And the darn processes are constantly changing!

Nevertheless if you plan to scale, training, process development, infrastructure development, and delegation are necessary.

I run into this issue with entrepreneurs all the time.  Many startups begin with the entrepreneur and a couple of technical guys to do the development.  Initially, when cash is lacking, the entrepreneur/CEO (Chief Everything Officer) is forced to handle everything else from fundraising to key partner negotiations to bookkeeping.  But as money starts to trickle in, while some entrepreneurs can readily relinquish things they are not good at and are necessary but not generating value (e.g. bookkeeping), others have a tough time letting go.  We often have to remind the latter that the value of their enterprise is not going to depend on how detailed their bookkeeping entries are.  Rather it will depend on how well they've demonstrated product/market fit, landed paying customers, and established strategic partnerships.  Any time spent on the former rather than the latter is not time well spent.

The nice thing about Vacation as Management Tool is that if forces one to figure out how to make sure that things don't fall apart in your absence.  You actually have to do the training, establish the process, and delegate the work.  And as an added bonus, the time spent away will hopefully leave you refreshed, renewing your capacity for creative thought and new insights about your business.


*  I sometimes get the smug question from an entrepreneur "why would we ever need managers?"  My answer: "You don't provided all your people communicate with each other perfectly, they self-coordinate tasks seemlessly, all play together well, and they all know the mission and understand the implications of that mission for their own tasks."  In my 20+ years of managing people, I'm still looking for those people.

Shameless Pitch II: Stanford Marketing Course, BUS213

I'm back (more on this next post) and it's back!

What's "it"?

Starting September 28, 2011 I'll once again be teaching a six week evening course called "Monetizing Business Models" (Course Code: BUS213) as part of Stanford University's Continuing Studies program.  An improved version of the course taught earlier this winter, BUS213 will cover strategic marketing concepts and frameworks that can be used to evaluate the money making potential of a new business idea, whether as a startup, a new venture inside a corporation, or as an investment.  And per student request, we'll be going into more depth with respect to price setting strategies and tactics.

We'll be covering product/market fit and exploring different ways to analyze business models.  The course assumes no previous experience in marketing. We'll be using Customer Development as the backbone methodology, focusing primarily on the Customer Discovery phase.  Our course text is a great little book called The Entrepreneur's Guide to Customer Development, by Brant Cooper and Patrick Vlaskovits.

If you're interested, you can register online starting August 22, 2011 at the Stanford Continuing Studies website.  Here is the direct link to the course.

Hope to see you there!

The "Other Stuff"

This week has been a whirlwind of activities associated with my son Alex's graduation from middle school.  We've had final performances, award ceremonies, and, of course, the graduation itself.  Maybe it's an East Coast/West Coast thing or maybe the times have just changed, but I don't recall any of this hoopla when I finished 8th grade.

What I found most interesting this week was the awards ceremony.  There must have been fifty different awards given out over a wide range of activities - music, art, leadership, drama, science, math, spirit, community service - the list went on and on.  I was quite impressed by the diversity of opportunities offered by the middle school, all chances for a student to find their passion and place where they might excel in their own unique way. And I understand the high school offers even more!

And from the whispered comments amongst the students, I think this took some of them by surprise as well.  I kept hearing some variation of "XXX?!  How did XXX get that award?  They're not that smart!"

I found that type of comment very interesting.

You see, in Silicon Valley, brains and achievement are practically objects of worship.  In fact, brains are almost automatically linked in the minds of many with achievement in a mathematical relationship that looks like this:

SUCCESS = ACHIEVEMENT 

where ACHIEVEMENT = f (BRAINS, knowledge, other stuff )

But in my experience, while being smart and educated are no doubt an asset, they are a helpful yet insufficient condition for achievement.  (And I'm not willing to equate success with mere achievement.)  Instead, what I've seen is that it is often the "other stuff" that accounts for why someone who is less gifted intellectually can achieve as much or more as their high IQ peers.

What is the other stuff?  While obviously not an exhaustive list (and in no particular order):

• Capacity and willingness to work hard - A big part of achieving something is be willing to do the work that needs to be done.
• Determination - In almost every challenging endeavor, there is a roadblock or two or three.  Those with the will to keep at it often find a way over, under, around, or through it.
• Resiliance in the face of setbacks - And in the process of overcoming roadblocks, there are many blind alleys and unforeseen setbacks.  Those willing to press on and not succumb to despair are much more likely to achieve their goals.
• Courage to try - The first step on the road to achievement is just putting yourself out there.  The journey of a 1000 miles isn't happening if you're afraid to step out of the house.
• Being able to relate to other people - While individuals are often the catalyst, it is difficult to achieve things without the help of others.

And that's what I saw at awards night.  While there were definitelymany awards aimed at scholastic excellence, there were just as many celebrating endeavors where the other stuff was just as, if not more important, to success than sheer brainpower.  What a great lesson for the students.

Over the next three weeks, I'll be taking a three week blogging holiday until mid-July. The reason?  I've again been given the privilege of teaching high school students about business as part of the Stanford Educational Program for Gifted Youth (EPGY).  These are some of the meta-lessons I hope to convey.

The Employee to Entrepreneur Transition

I work with a lot of startups and to me, one of the most fascinating journeys of personal growth to watch is the transition from corporate employee to entrepreneur.  While there are many who believe that "entrepreneurs are born not made" and that an entrepreneurial personality is completely antithetical to being a good corporate employee, my experience, supported by a 2009 Kauffman Foundation study⁽¹⁾, has been that this distinction is not so cut and dried.

According to the Kauffman Foundation study, there are two types of entrepreneurs.  The first, whom they label "early entrepreneurs" fits the classic Silicon Valley stereotype:  college educated, twenty-something single male who may or may not have graduated, technically oriented, iconoclast with a strong independent streak (e.g. Bill Gates, Larry Page).

However, the second more typical entrepreneur is a 40-year old married male with children.  About half had over ten years industry experience working for other companies before starting their first company.  Nearly half had either zero or negative entrepreneurial aspirations.  The majority were good students in high school and college with 95% of these holding at least a Bachelor's degree and 47% holding an advanced degree.  In short, these were people who fit the mold and in many cases performed well as corporate employees.  So it is possible to become an entrepreneur after having a corporate background.

Having said that, there is a definite transition that has to occur for a former corporate employee to become a successful entrepreneur, one that I've personally experienced.  And as you might expect, some are able to make the transition quickly and easily, while others not at all.  In my case, it took fifteen years (but I tend to be pig-headed and somewhat resistant to change).

So what does the employee to entrepreneur transition look like?

• Defined Program =>Undefined Program:  As an employee, you job is to execute the program.  Your time, priorities, and, in many cases, even the means are defined.  This is true even if you are CEO.  As an entrepreneur, it is up to you to create the program.  There is no one telling you what your priorities should be or how or when you should spend your time.
• Predictable Income=>Variable (initially zero) Income:  As an employee, you contribute your time, skills, and knowledge in exchange for a regular paycheck.  Base salary typically doesn't vary with how the business is doing (unless it is very, very bad in which case even the pay cut is pretty predictable).  As an entrepreneur, assuming that you get to the point of revenue, your income will often scale up, down, and sideways depending on the cash needs of your business.  Need a raise?  Then you have to find a way to raise profits.
• Safety Net=>No Net:  As an employee, most companies often some form of benefits from health to retirement. Lose your job?  You can apply for unemployment.  As an entrepreneur, you may not be able to afford the luxury of benefits.  If you're lucky, you might be able to get medical.  Forget about a 401(k) plan.  And if your venture goes under particularly if you are classified as self-employed, you can't apply for unemployment.
• Infrastructure=>No Infrastructure:  As an employee, its amazing how much office infrastructure one takes for granted until you become an entrepreneur and don't have it.  Payroll?  Copy machine?  Printer?  IT support?  Travel arrangements?  These are somewhat lacking when your office is the local Starbucks.  This can be particularly jarring for senior level corporate executives turned entrepreneur used to having an executive assistant.
• Specialist=>Generalist:  As an employee, good corporate practice is to have a well defined job description with clear lines of responsibility.  Your value is in your "technical" skills whether that skill is JAVA programming or HR compliance.  And therefore your employer wants you to focus on doing your specialty well.  As an entrepreneur, you need to be able to handle many things outside your area of expertise, because if you don't, it won't get done.  Your value is in crystallizing and communicating a vision, motivating your team, and securing resources via your network.

It's important to understand this transition to avoid two common pitfalls that can sabotage your startup:

• Spending money in areas you can't afford:  When you're doing a startup, your number one job is to get to product/market fit with a viable business model.  Any money spent on things not directly impacting this reduces your chance of success.  Now is not the time to spring for life insurance benefits, remodel the office, and hire an executive assistant to schedule your airline flights.
• Hiring the wrong founding employees:  Silicon Valley is rife with horror stories about founding teams hiring the big company executive with the great connections but who can't seem to operate without support staff, won't extend outside their comfort zone, insists on 9-5 hours, and can't afford to skip an occasional paycheck.  Screen for this.

At the end of the day, the source of the pitfalls is fear.  When you're forty-something with a spouse and kids, not having a paycheck is scary.  Not having health insurance is scary.  Not having enough staff to handle the details so that you know balls are being dropped is scary.  Not having an executable road map is scary.

Which brings me to the defining characteristics of every successful entrepreneur:  courage driven by vision.

Footnotes:
(1)  Wadhwa, Vivek et.al, "The Anatomy of an Entrepreneur,"  The Marion Ewing Kauffman Foundation (2009).

Education for the Small Business Entrepreneur

About six months ago, I wrote several posts (see below) about the differences between small business vs. scalable entprepreneurship and the implications for an educational curriculum.  Silicon Valley, for the most part, is geared towards scalable startups (i.e. the companies that seek to be the next Google).  As a result, programs in entrepreneurship offered by Stanford, UC-Berkeley, etc. tend to be oriented towards entrepreneurs with the big ideas.

But what about entrepreneurs with more modest ambitions?  While organizations like SCORE have long sponsored clinics for small business people, there doesn't seem to be the same effort geared towards educating small business entrepreneurs. Yet, it's a well publicized fact that 45.6% of people employed in the U.S. work for companies with less than 100 people and that these firms make up 99.6% of U.S. companies.  It is also a well known fact that the rate of small business failure is high.  And while I don't have hard facts to support it, based on what I've seen working with small business people, it is my hypothesis that much of this failure could be prevented by educating small business entrepreneurs in the tools and concepts they need to make better decisions.

Since I wrote this post, I've had the good fortune to become connected with educators and business people who feel the same way.  I've been part of an advisory group working with West Valley College in Saratoga, CA.  Under the leadership of Heidi Diamond, Dept. Chair for Business Administration and Real Estate, West Valley has created two new offerings in entrepreneurial education geared towards the needs of the small business entrepreneur.  The first, called the Entrepreneurship Academy starts July 12 and is directed towards budding small business entrepreneurs.  The second, called the Small Business Academy starts July 9 and is geared towards more experienced small business people who have gotten their businesses off the ground but are looking for the knowledge to take their ventures to the next level.

For those of you who may be interested or know someone who may be interested, I encourage you to check it out.  You can link to the West Valley College course website on either of the two links above or by going to http://westvalley.edu/trainingsource/.

Related Posts:
Education, Entrepreneurship, and Employment
The Creative Economy
Small Business vs. Scalable Entrepreneurship

Task "Triage"

Lately its been so busy that I've had to move into "task triage" mode where it's no longer an issue of IF something is going to be left undone.  Rather it's WHAT is going to be left undone.  I first learned this lesson as a product manager, which is one of those jobs where it's absolutely impossible to do everything that needs to be done.  Most product managers learn a couple of lessons quickly:

• How to say "no"
• How to prioritize the critical from the "nice-to-haves"
• That sometimes good enough is the best you can manage

Saying "no" has the obvious benefit of cutting down the "to do" list.  But it took me awhile to get over the guilt of turning down requests, especially where they represented future opportunities.  Ultimately sleep deprivation taught me that the consequences of saying yes all the time were more painful than saying no in most cases.

Good enough comes from recognizing that in many cases, especially in project management and business development, getting something out there, even if it wasn't perfect was better than getting nothing out there because it wasn't perfect.  This is tough on perfectionists (of which I am not).  This trait is probably why I'm a pretty good general manager, business development person, and troubleshooter, and was at best a mediocre engineer, would starve as a designer, and is a good thing for society that I'm not a surgeon.

With respect to prioritizing tasks, the best framework I ever learned was from Stephen Covey's Seven Habits.  Specifically:

1. Important and urgent tasks:  Do them.  But first ask, am I the only person who can do these (by virtue of my position or special skills) or can they be done by someone else (even if I can do them better)?  If the former:  do them.  If the latter:  train and delegate!
2. Important but not urgent tasks:  Schedule time for them or they don't happen.  Interestingly, these are usually the tasks that allow me to get rid of the next set which are...
3. Urgent but unimportant tasks:  See step 2 above.  These are usually candidates for delegation or outsourcing.
4. Unimportant and not urgent tasks:  I.e. time wasters.  Will playing Angry Birds for the 12th time really change my life?

Of course deciding what is important depends on knowing what your goals are.

But even with this framework, there are times when the task load ramps to the point where clearing through category 1 tasks takes all my time.  So be it; such is life.

Hows that for rationalizing why my blogging has been erratic lately?

The "A-Player" Myth

"DirtPud.Ding, a ground-breaking, mobile, digital media, clean-tech, social networking app developer seeks a world-class, ROCK STAR software developer.  Must have a proven track record developing high profile, killer iPhone applications, be a team player, pro-active self-starter, and willing to work for equity only.  Candidates should have worked in a startup that successfully exited to Google and know Mark Andreesen on a first name basis."

Sound familiar?  Just another Silicon Valley job posting by some startup seeking an "A-player" for peanuts.  After all, it's a given that for a startup to succeed, everyone you hire must be an "A-player," right?  Get the team right and everything just flows!

Maybe.

Now don't get me wrong, there is nothing wrong with trying to hire "A-players."  One should try to hire the best talent possible.  But how realistic is it to expect that you will be able to hire WORLD CLASS, ROCK STAR talent for all of your positions when you' haven't even reached Ramen-profitability and your office is the local Starbucks?  What if you can't?

If your expectation is that you MUST have all "A-players" to succeed, your startup will fail.

So what's an "A-player?"  Most people would define an "A-player" to be someone who:

• Is Rhodes Scholar smart with state-of-the-art working expertise in their professional field whether that be software programming, sales, or accounting.
• Has sufficient experience to apply those skills, identify and anticipate issues, troubleshoot ambiguous situations, creatively problem solve, and guide the startup in the proper direction.
• Is a team player, one who can fit their activities into those of others, subordinate their own interests as needed for the common good, and still has great interpersonal skills at 3:00 am in the morning.
• Is self-managing, setting priorities in line with overall company goals, disciplined enough to keep their tasks on track, coordinates them with others, communicates well, and makes minimal demands on management attention.
• Has a can do, positive attitude uplifting to their team mates.
• Is ethical, of outstanding person character, and free of excessive ego.
• Has the dedication and energy to put in the extra hours and effort required, when the startup needs it (which is pretty much 24/7).

In short, an "A-player" is the model human being (let alone employee).

The fact of the matter is that these people are (a) very scarce and (b) in incredibly high demand. Economics 101 tells you that this means that even if you can find them, they are likely to be gainfully employed as someone else's highly compensated employee or making a living (i.e. they charge) as a very well paid independent.

The other fact of the matter is that most of us fall short in one or more of the areas listed above; we're NOT Charlie Sheen (as he perceives himself to be) but Mere Mortals.  So at the risk of offending someone, this means that most likely, most of the people working in your startup are Mere Mortals and not "A-Players."

This does not mean that you can't have an "A-Team."

An "A-Team" is more than just a collection of "A-players."  An "A-Team" is one that blends the strengths of all its members, both "A-players" and Mere Mortals,  in such a way that overall team strength is maximized and weaknesses mitigated resulting in high performance.  Characteristics of an "A-Team" are focused direction, a high level of work quality and quantity, high energy and esprit de corps, an almost intuitive level of communication between team members, creativity, confidence, and an optimistic approach to challenges.

The advantages of the "A-Team" approach are as follows:

• The recruiting pool is deeper - The simple fact is there are more Mere Mortals available.  This does not necessarily make recruiting any easier (see below).  But recruiting now becomes an issue of determining fit vs. being an issue of pure availability.
• The business is more robust and more scalable - A business that depends on the unique skill sets of just it's "A-Players" is more vulnerable and harder to scale than one based on a team.
• "A-players" thrive too - If you create an environment where Mere Mortals can thrive, its likely to be friendly to "A-players" too.

So with these advantages, why do so many entrepreneurs focus on "A-players" instead of an "A-Team?"

• Belief that "A-players" don't need to be managed or led - In my experience, in any team with >2 people (some would say >1) this is false.  There is no such thing as perfect coordination without some management.
• Belief that people come "hard wired" - This is the belief that one either is or is not an "A-player."  In reality, management studies show that performance is often context specific.  It has been my experience that people can change and be trained;  why else do we have teachers and mentors?
• Many entrepreneurs are lousy people managers - Let's face it, some of the most visionary entrepreneurs are terrible at managing people or even outright jerks.  It takes a certain level of empathy and patience to lead people well and create an "A-Team" environment.  (Also note that being a good people person is not a requirement to being an effective visionary leader.)
• Because they should - Part of the job of being CEO is recruiting key talent.  You do need "A-players."  You just don't want to build your business on the basis that everyone has to be one; your business will come to a grinding halt when you can't fill the positions you need.

How to Create an "A-Team"
So let's say that you want to create an "A-Team."  While there is no formula for this and a lot depends on the skill of the management team and group as a whole (after all we are dealing with messy, quirky, people who don't behave logically), one of the best books written on the subject is Hidden Value:  How Great Companies Achieve Extraordinary Results with Ordinary People, by Charles O'Reilly and Jeffrey Pfeffer.

Here are some practices common to all "A-Teams."

• Hire A-players for key, value proposition critical positions; hire Mere-Mortals elsewhere - This means that you must have a good understanding of what your business's key value propositions are and what are the key resources needed to deliver them.  For example,you may not require a Rock Star in accouting...unless you are an accounting firm.
• Hire for fit - Fit to what?  Values and culture.  Which means you have to know what your values are.  Values should tell people what priorities are important to the company, how the company will treat people, how decisions are made, what the company stands for and what lines the company won't cross.   High performance teams take time to build which means you have to hire for commitment.
• Share knowledge - Information is the lifeblood of an "A-Team."  If you want to engage your employees' brains, both "A-players" and Mere Mortals, they must have access to detailed information about what the company is doing and attempting to accomplish.
• Team based systems and rewards - To foster collaboration, knowledge sharing, and build esprit de corps, rewards should be based on whether the entire team wins or not.
• Training - "A-Teams" invest in improving the capabilities of all their members.  Particularly in a rapidly changing environment, it is important to provide the training needed to keep employees current.

By all means, seek to hire "A-players" but build your business on the back of an "A-Team."

How to Set Prices: Customer Value Analysis

5th and final post in a series on How to Set Pricing

I first learned about value pricing as a product manager at Metcal.  At that time the company was a startup making high end hand soldering equipment for PCB assembly houses.  To give you an idea of how high end, at that time a Metcal soldering station sold for 5x that of competitive units, and the consumable tips were 10-15x that of the competition in what most would call a commodity market.  Yet, in eight years, the company went from being the #8 to #2 market share player.

Now while there were many reasons for the company's success  - superior technology, ergonomically friendly design, robust product quality, etc. - the killer app in the company's sales arsenal was a customer value analysis created by one of the sales managers.  This simple spreadsheet model translated the product's feature/benefits into a quantified customer value proposition.

When distilled to the basics, B2B customers buy products and services for three ultimate value objectives:

• Reduce costs
• Increase revenues
• Reduce risks

Faster speed, greater convenience, and growth usually translate into one of these three.  In Metcal's case, the product features translated into the following benefits:

• Superior solder joint quality (reduced defect costs and risk)
• Faster soldering time (reduced labor cost)
• Elimination of calibration (reduced labor cost)
• Faster operator training time (reduced labor cost)

Metcal's value analysis was an Excel spreadsheet that allowed customers to input their time, process, and cost data, compare them against the cost of acquiring new solder stations and more expensive consumables and see the return on investment, payback, and net present value figures associated with the value created.  On top of that, the value analysis often prompted customers to consider factors that they may not have thought of, like training time.  The financial decision makers inside the customer quickly saw that the acquisition cost for Metcal's products was a relatively small percentage of the overall value created (in this case reduced costs), the essence of value pricing.

The main idea behind value pricing is that if your offering creates value, you price such that you and the customer share it.  Normally, this is not 50/50 but weighted in the favor of the customer;  the more value the customer captures, the stronger the value proposition.


Value pricing is widely practiced in B2B markets, especially where relationships are complex and long term.  Examples include logistics outsourcing where the supplier is paid on the basis of procurement costs reduced; SaaS vendors often price their subscription services to capture 10-30% of value created for customers over a three year time horizon vs. using a traditional enterprise software solution.

To create a value analysis requires a deep understanding of how your offering impacts a customer's business economics.  Gaining this insight takes time.  For a startup to gain this insight, it typically must have access to a someone with extensive, specific domain expertise, one who understands the customer's business model well enough to know where the lever points are that have the greatest potential to affect profitability and growth.

Creating a Value Analysis
In order to create a value analysis, you need to know the following well enough to code it into a spreadsheet:

• What is the main value proposition you are offering to your target customer?  Lower costs, higher revenues, lower risk?  For Metcal it was mainly lowering the per unit cost of production.
• How does this tie into the customer's value calculation? For Metcal, this had a direct impact on the direct labor line in cost of goods sold on a P&L.
  
• What are the factors used by the customer to assess value?  For Metcal, production rate, labor cost, defect rate, calibration and setup time were input factors in assessing value.
• What factors are not used by the customer to assess value and should be?  For Metcal, many customers neglected to factor in operator training time.
• What is the feature => benefit => value proposition chain for each of your offering's features?  For example, Metcal's superior technology => x% defect rate reduction => y% less rework => z% lower cost.
• What is the relevant payback factor used by the customer?  Is it payback time?  IRR?
• What is the relevant payback time used by the customer? 

Assuming that you can create a value analysis, two value methods can be used to set  pricing.


Method 8:  Share of Value Pricing
In this method, a "typical" customer use case is created using the value analysis.  Pricing is then set at 10-30% of the value, adjusted as needed for competitive market conditions.  This method is practiced by many SaaS companies relative to traditional enterprise software offerings.

Method 9:  Performance Pricing
Alternatively, for a specific customer, using the value analysis, compensation is based on a defined percentage of the value created (i.e. savings or revenue growth).  This method is often practiced by industrial logistics suppliers, auto parts suppliers, electronic contract manufacturers., and cost-control consultants.  Think of it as the corporate equivalent of a commission plan.  Because payment is dependent on performance, using this method requires you to have a good handle not only on the customer's economics, but your own.

Summary of Pricing Methods
To summarize the nine different pricing methods discussed, they are:

1. Cost Plus Pricing
2. Direct Market Competitive Pricing
3. Competitive Substitute Pricing
4. Target Customer Survey
5. Price Bracketing
6. Price/Feature Stripping
7. Customer Set Pricing
8. Share of Value Pricing
9. Performance Pricing

Happy pricing!

How to Set Prices: Value Pricing Methods

4th in a series on How to Set Pricing

Last post we discussed tangible pricing methods.  We now turn to value pricing methods.  Simply put, value pricing methods seek to establish a price based on some percentage of the value perceived by the customer.  While this seems straight forward in theory, this can be difficult to establish in practice for the following reasons:

• One must understand what the customer perceives as value in your offering
• One must understand the customer's time frame over which value is calculated
• The full value may be in intangible areas that the customer may not be aware of

Customer Perception of Value
In order to determine what percentage of value you can capture in your pricing, you must first understand what your offering's value is to the customer. This means you must first understand who your customers are.  Again, while this seems like a no brainer, I've found that for most startups, while they have strong beliefs about who their customers are and what value they are offering to them, they actually have NO CLUE.  Beliefs unsupported by data means NO CLUE!

Does that sound harsh?  See if you can answer the following question about your customer value:

• What is the demographic profile of your target customer?  What hard evidence do you have to support this?  Can you put this on paper?
• What are their acute pains in ranked order and what is your supporting data?
• How does your offering's features address each acute pain and what customer evidence do you have to prove this? (Not what hypothetical, logical reasoning you have that it should address this?)
• What competitive substitutes are your target customers using today to address their acute pain and how do you know this?
• What does your customer's life look like before they start using your offering?  How is it different afterwards?  What facts do you have to support this?
• Can you construct a mathematical model for value analysis that shows how different levels of acute pain reduction translate into customer value?  (This will be the subject of the last post in this series.)

If you can't answer these questions, I would argue that you don't truly understand the value of what you are offering your customers.  For help on this, see my previous post "Developing a Customer Profile".  A large part of the value of Steve Blank's customer development methodology is to convert these customer beliefs into customer facts.

There are a couple of methods that can be used to collect value data.  But unlike the four tangible pricing methods discussed previously, value pricing methods require (1) talking directly with individual target customers (2) an attempt to close a sale and (3) involve the risk of alienating a target customer to get the data.
The reason for this is that the only form of validated value data is a sale or other binding purchase commitment.  What people tell you they will pay in conversation is very different than when you ask them to sign a purchase order.

Each of the methods described below requires that you:

1. Know and have access to customers who fit your target profile
2. Have a hypothesis about your offering value that you can quickly communicate to customers (see my post on "Focused Selling")
3. Have hypotheses about how different features of your offering address target customer acute pain

Method 5:  Price Bracketing
Start discussion with an initial set of target customers.  Once you think you have a good understanding of the reasons the customer might buy and they have a good understanding of what you have to offer, to get an initial feel for value, ask two questions:

• Below what price would this be a "no-brainer" purchase that you could commit to today?
• Above what price would there be no chance of them ever buying and why?

Once you've determined this, tell the customer your pricing is coming in at a figure that is 75% of the range (i.e. if the "no brainer" price is $100 and the "no way" price is $1100, the 75% figure is $850).  Try to close the sale.  Most likely when (not if) they balk, find out what's stopping them from making a commitment today and pay attention.  Assuming you still can't close the deal, thank them for the valuable information and let them know that you obviously have some work to do on your costs and find out if they would be willing to talk again in the future.  Most likely, if you do this with 3-5 target customers, you'll quickly be able to determine what parts of your value proposition are holding up and which need adjustment.  Adjust accordingly.

Method 6:  Price/Feature Stripping
Armed with a new offering presentation from Method 5, ideally meet with a different set of target customers.  (If you are in a small B2B market with a restricted set of target customers, you may need to go back to the first set).  This time, once you think you have a good understanding of the reason the customer might buy and they have a good understanding of what you have to offer, try to close a sale at the 75% price number from Method 5.  Depending on which reaction you get do the following:

• Customer Accepts:  Congratulations, you've gotten a sale...but you haven't learned much.  Raise the price by 20% before you talk to the next target customer.
• Customer Rejects:  Understand why.  Then get a counter-offer.  Once you have it, talk about which features you can strip to get to the counter-offered price.  As you have the feature stripping discussion, you should get a feel for the relative value of each feature.

Again, 3-5 target customers should give you a good feel for how your value proposition should be adjusted.  It should also give you a feel for your minimum viable product.

At this point, go back to the first set of target customers and let them know that you've found some ways to work the cost issue both internally and by removal of certain features to get closer to the the previously discussed "no brainer" price.  See if you can close the sale again, this time at the average counter-offer price from the second set of target customers.  You will then get one of two reactions;

• Customer Accepts:  Congratulations, you've gotten a sale and validated the feature/value hypotheses.
• Customer Rejects:  Understand why.  In many cases, the new objections won't be price based, but will be sales process based.  Congratulations, you can now move forward to address the non-price related set of impediments to gaining market traction.

Method 7:  Customer Set Pricing
One alternate method for determining value is to let customers set their own price.  Examples of this include self-published e-books where the author request that people pay what they think the item is worth and museums, which request visitor set donations in lieu of an admission fee.  The most obvious risk of letting customers set prices is not being able to set prices adequate to cover costs, but depending on the nature of your offering this method may work for you.  To be viable it helps to have:

• Large potential customer base where the volume of payers is likely to be large enough to offset the inevitable free riders.
• Target customer base has some social or peer pressure element to pay something - This works for many charitable organization and the museum example cited earlier.
• Low or no incremental cost to delivering additional offering vs. probability having more paying users - In the case of the museum whether they have 500 or 5000 visitors a day does not change their operating cost but greatly increases the likelihood of donations.  For the e-book author, once the book is written, delivering additional copies across the web is pretty cheap.

There is one final method for setting value based pricing.  This involves the creation and development of a mathematical customer value analysis.  Pricing is then based on some percentage of this calculated value.  This will be the subject of the final post in this series.

Next post:  Customer Value Analysis

How to Set Prices: Tangible Pricing Methods

3rd in a series on How to Set Pricing

In order to set pricing, certain decisions need to be made with respect to:

1. Pricing Strategy
2. Business Revenue Model
3. Pricing Mechanisms

As discussed in the prior two posts, these three elements can be combined in many different ways; arriving at the proper combination is part planning, part art, and part trial and error.  But assuming you've gotten this far, it still leaves the question of what price to charge? 

First, let me state that I've been pricing goods and services for many years and for those of you who like precision and certainty, the pricing process is messy and imperfect.  Nevertheless, there are several methods that can be used to establish initial pricing.  These tend to fall into two group:  tangible pricing and value pricing.  Tangible price methods stem from obtainable data.  Value price methods require more exploratory efforts.  This post will deal with tangible price methods.

Method 1: Cost Plus Pricing
The most basic and simplest to understand is cost plus pricing.  This is where you add up your costs, tack on your target margin to set a price.  Remember that one of the key objectives in pricing is to charge enough to cover your costs and make a profit.  At least on the surface, this would seem to address the issue.  However, cost plus pricing often results in a price that is not competitive in the market place (i.e. think $500 screwdrivers for the government).  So what to do?

First, you cannot ignore cost but there are two kinds of cost:  direct and indirect.  Direct costs, typically classed as Cost of Goods Sold (COGS), are the immediate costs tied to delivering a unit of product or service.  For example, if you're selling a widget, the cost of the parts in the widget plus the amount of labor time to build the widget plus the cost to ship it are direct costs.

 Your pricing must be greater than the direct cost.  Otherwise you are shipping dollar bills out with each unit.

On the other hand indirect costs are not directly tied to the cost of delivering a specific unit, though they may be needed for producing the product or service.  Often times they are relatively fixed costs like engineering wages, rent, or electricity.  They are real costs needed to support operations but not directly assignable to a specific unit of product or service.

These costs are often allocated across the total units produced. For example, if you have $500/month in rent and build 5000 units/month, you might allocate $0.10 of this cost to each unit built.  But if you only build 500 units/month, you would allocate $1.00 of this cost to each unit.  And this is what complicates cost plus pricing.  To cover this, do you charge $0.10 or $1.00?

Not only must you charge more than the direct cost, in order to make a profit, you must charge enough more to cover the indirect costs at a particular volume level.

To further complicate the picture, the line between a direct cost and indirect cost is often murky.

The bottom line is that you should not use cost as the sole means of establishing price, but you cannot ignore it either.  And if you find that you can't price high enough to cover all of your costs or reduce your costs sufficiently, you may have a more fundamental business model problem.

Method 2: Direct Market Competitive Pricing
If you have direct competition for your product or service, one way to establish a reference price point is by surveying the competition.  Where prices are posted (e.g. for retail goods) this is easy to do.  For services, where prices are often not posted, there are a couple of ways to get prices:

• Ask people who use the services what they are paying
• Attempt to contract for the service to get a quote
• Get a friend with a business to attempt to contract for the service to get a quote

5-10 quotes should enable you to get a feel for the average and range of competitive market pricing.  Keep in mind that this just establishes a reference point.  Depending on your pricing strategy, you may choose to price higher or lower than market.

Method 3:  Competitive Substitute Pricing
In some cases, there may not be a directly competitive product or service to your offering.  In this case, you should look at pricing for competitive substitutes.  Competitive substitutes are products or services that in combination with other things allow the buyer to gain the same functionality or achieve the same goal as your product or service would directly.  As an example, if I need to add up a bunch of numbers, I can use a calculator, my computer, my cell phone, my digital watch, a pen & paper, an abacus, or just do it in my head.  All are competitive substitutes to each other with different costs associated with purchasing the different items.

Depending on the strength of the competitive substitute in achieving the buyer's purchase objective vs. your product or service, the price being charged may limit the premium you can charge.

For example, lets assume that high speed rail service between San Jose, CA and Los Angeles actually becomes a reality in my lifetime.  If I have to price the service, three competitive substitutes are plane, car, or bus.  Transit time by high speed rail is 3 hours, plane is 1.5 hours, car is 6 hours, and bus 7 hours.

Assuming I own a car, this is the cheapest in dollars, involving maybe $50 in gas.  The bus is about $55 and I don't have to drive;  I can spend the time reading or on my laptop courtesy of mobile Wi-Fi.  The plane is ostensibly the fastest but when you add all the security and boarding issues associated with air travel, total time is probably closer to 3-3.5 hours for a ticket price of $120.

So what should the price of a train ticket be?  You can definitely charge more than the car or bus because of the speed advantage.  The plane is the nearest serious competitor so a floor reference price would be $120 per ticket.  Could it be more?  Absolutely.  It depends on how well the train positions its value to its target ridership;  this moves into the realm of value pricing.

Tangible price methods make it relatively easy to determine a current market reference point.  But if your product is meant to be a superior solution to the market, it does not help you determine what premium over market you might be able to charge.  (This is less of an issue if your product is meant to be a cheaper solution to the market.)

Method 4:  Target Customer Survey
While method's 2 & 3 look at competitive pricing, another way to determine pricing is to survey potential buyers.  This first involves understanding who are your target customers.

Customer surveys work best for familiar product categories with fewer options.  Most people find it difficult to establish an anchor price point for innovative or unfamiliar product categories and will therefore skew answers low.  Products with many features can be confusing, although conjoint analysis can help establish  feature/price tradeoffs.  It also helps to have product samples or some kind of demo; people give better feedback with things they can see or touch versus abstract concepts and ideas.

But one potential strength of this method is that it may tell you something about the nature of the price-demand curve.  Why is this important?  Let's look at two price-demand curves.  The one on the left is a stereotypical commodity demand curve where demand falls with increasing unit price.  The one on the right is typical of many branded goods where too low or too high a price can cause demand to fall (e.g. the Mercedes C-Class example mentioned in the first post in the series).

As you can see, depending on what the nature of the curve might be, and where you are on the curve a decrease in price may or may not improve demand.

The other pro of this method might be to identify the existence of an optimum price point different from the current competitive market price.  For example, when LCD TVs first came out, a 42" model was ~$4500.  But the LCD TV makers knew this was not the optimum point; it was a price constrained by their costs.  By conducting customer surveys, they determined that $1000 was the magic inflection point at which demand would skyrocket.  They worked diligently to drive costs down so as to be able to price to this point.  Sure enough, 42" LCD TVs hit the $1000 retail point in 2008 and took off, in spite of the fact that a global recession was underway.

Next post:  Value Pricing Methods

How to Set Prices: Revenue Models and Pricing Mechanisms

2nd in a series on How to Set Pricing

In setting prices, three major elements need to be considered:

1. Pricing Strategy
2. Business Revenue Model
3. Pricing Mechanisms

Last post, we discussed Pricing Strategy.  This post, we give an overview of Revenue Models and Pricing Mechanisms to show how they impact pricing decisions.

FULL DISCLOSURE:  Most of this information has been paraphrased from Business Model Generation by Alexander Oesterwalder and Yves Pigneur.  If you are interested in business models, I highly recommend this book.

Revenue Models
As with pricing strategies, while there are many variations, the most common generic revenue strategies are as follows:

• Title Passes to Buyer
• Asset Sale - The straightforward one.  Buyer pays Seller; Seller gives Buyer the goods which the Buyer then owns.
• Title Stays with Seller
• Usage Fee - Buyer consumes a service.  The more consumed, the more paid.  Example:  telephone minutes.
• Subscription Fee - Buyer pays for time based access to a service.  Example:  gym memberships, Netflix streaming
• Renting - Similar to a usage fee but in this case Buyer pays for temporary exclusive access to an asset.  Example:  office rental, car rental
• Licensing - Buyer pays for right to use intellectual property owned by Seller.  Example:  media rights
• Middleman
• Brokerage Fee - Company takes a fee for providing services to connect two or more parties.  Example:  real estate, credit card issuers
• Advertising Fee - Company takes a fee for providing and promoting Buyer access to a prospective Seller base

The different pricing strategies discussed before - predatory, skimming, bundling, and multi-tier - can be applied to each of the revenue models.  For example, American Express pursues a premium brokerage fee pricing model and strategy vs. Visa which pursues a more mainstream brokerage fee model.  Both charge fee for card usage but American Express's is substantially higher than Visa's.  This fits American Express's strategy of going after higher net worth individuals.  In line with this strategy, American Express also charges a relatively high annual subscription fee for card access vs. Visa, which in many cases does not charge any annual fee.  This goes hand-in-hand with American Express's travel and other services most likely to be of interest to higher net worth consumers.

Pricing Mechanisms
Once you understand the revenue model and pricing strategy you wish to pursue, you need to decide on the actual mechanism of how you will charge.  Once again, while may variations and combinations are possible, the generic options are:

• Fixed Pricing
• List - The basic one.  Fixed price for an individual product or service.
• Feature Priced - Price depends on the number, quality or type of features offered.  The default mechanism used with a bundling pricing strategy.
• Segmented Discriminated  - Price depends on the type of customer being targeted.  The default mechanism used with a multi-tier pricing strategy.
• Volume Based - Price is a function of the quantity purchased with price usually decreasing with increasing volume.
• Dynamic Pricing
• Negotiated - Price is set by active negotiation between Buyer and Seller.
• Yield Management - Price depends on inventory and time of purchase.  Often used where capacity is fixed and perishable.  Example:  airline seats
• Real-time Market - Price is based on supply and demand usually facilitated by an active exchange.  Example:  stocks
• Auctions - Price determined by competitive bidding.  An auctioneer often establishes a floor reference price then facilitates the bidding up process.  In the case of a reverse auction, a Buyer sets a ceiling reference price, then facilitates a bidding down process.  The reverse auction is only possible where the Buyer has unique leverage over a group of Sellers.

Again, it is possible to combine any of the pricing mechanisms with any of the price strategies and revenue models, although in this case, some price strategies fit together better with some price mechanisms (e.g. bundling with feature pricing).

Once a decision has been made with respect to pricing strategy, revenue model, and pricing mechanism, the final decision that needs to be made is what price to charge.  In the case of dynamic pricing, the question is what reference price to open with as the final price will be ultimately be determined by the market.

Next blog post:  Tangible Pricing Methods

How to Set Prices: Pricing Strategy

1st in a series on How to Set Pricing

I recently received the student feedback from BUS213:  Monetizing Marketing Models, the course I taught for Stanford Continuing Studies during the Winter 2011 quarter.  Overall, the course was well received.  But the number one area where students would have liked to go deeper was in how to set pricing.

So for those of my former students who may be reading this blog,  I've decided to do a series of in-depth posts that I hope will be helpful in this area. The first few posts will deal with an overview and frameworks.  The last with tactics and practical tips.

Pricing Overview
As anyone who has studied Marketing 101 knows, Price is one of the classic "4Ps" of the marketing mix (the others being Product, Promotion, and Place).  In setting prices, three major elements need to be considered:

1. Pricing Strategy
2. Business Revenue Model
3. Pricing Mechanisms

Setting prices can be a fairly technical marketing specialty, particularly in well established consumer product categories like packaged goods, the travel industries, and commodities.  For the purposes of this discussion, I will focus on the less scientific and more "seat-of-the-pants" situations encountered by entrepreneurs in less well defined B2B and B2C markets.

Pricing Objectives
There are three main objectives to be considered in setting prices:

1. Cost/profit - Pricing must be set sufficient to cover costs and generate a sufficient profit to support and grow the business.   What complicates this is the nature of the revenue model and time frame over which profits are generated.
2. Market positioning - Prices are a key signal to prospective buyers of a product or businesses market position.  In known product categories, they can establish buyer expectations for the product.  For example, if a car sells for $90,000 and another sells for $15,000 a buyer will have a certain image of what one car is versus the other.  Where a product category is new to the buyer, pricing can establish a reference point for comparative expectation versus competitive substitutes.  The main thing to remember is that pricing should be set consistent with a company's brand and market positioning.
3. Market share - Pricing can affect the rate at which a product penetrates a market.  In general, cheaper pricing creates less buyer resistance during the sale process and promotes faster product adoption and share growth.  But not always.  When Mercedes first released the C-Class with pricing in the low $30,000s, because the price was so counter to the company's luxury brand image, it actually impeded consumer acceptance.  The other factor here is what competitors are charging.  Depending on the nature of competition within an industry, this may limit what prices can be set.  For example, in commodity businesses, it is almost impossible to establish premium pricing due the existence of interchangeable competitive substitutes.  And price decreases are matched almost instantly by competitors.  But in luxury goods, where the value of the products are more intangible, a wide variation in pricing can exist.

Ideally, prices should be set to maximize business profitability over time.  Profit over time is a function of unit price, unit volume (i.e. share), and time.

Pricing Strategies
A company's price strategy is the way in which it decides how to blend the tradeoffs between the various objectives above.  It must be set as part of a company's overall competitive strategy.  For example, if the company is in a new technology sector with low barriers to entry (i.e. social media) where much of its value is based on its network, it may need to pursue a first to market, fast growth approach. In this case, it may want to pursue a loss leader price strategy in order to facilitate this.

While the variations are endless, the most common generic price strategies are:

• Predatory - This is where a company prices its product at very low margin, or even at cost* in order to gain entry into a new market. Over time, as the company establishes a more dominant share position, it increases prices to be more in line with its target brand position.  This often used where a new entrant is seeking entry into an existing market with established competition.  Predatory pricing is not without its pitfalls including:
• Sending the wrong positioning signal to the market
• Difficulty in raising prices due to customer backlash
• Sacrificing negotiating room
• Leaving money on the table
• Difficulty in covering costs
• Skimming - At the opposite end of the spectrum, this is where a company prices at a premium to capture the high end segments first.  Then as it saturates a buyer segment, it drops prices to appeal to new buyer segments.  This strategy requires that some meaningful differentiation exists to support a premium price segment.  Skimming also has its pitfalls including:
• Increases sales resistance, lowers demand, and slows sales adoption
• Creates an umbrella for competitive entry
• Creates customer "ill will"
• Gives customers an incentive to search for alternatives
• Bundling - This is an intermediate strategy where a company groups together different products and features in such a way that it can offer variations at different prices.  This gives the company great flexibility to offer a combination of features that appeals most to different buyer segments while maximizing the profitability of the various offerings.  An example of this is the automobile industry where the variety of packages can be overwhelming.  By bundling together desirable but costly features (e.g. automotive transmission) with less desirable but more profitable features (e.g. "all weather" package), the overall profitability of the car can be optimized.
• Multi-tier  - This is another intermediate strategy where the company offers distinct product categories at different price segments to appeal to different buyers.  Again, an example from the auto industry is Toyota used to offer a mainstream (Toyota) and luxury (Lexus) model under different brands for substantially the same car (Camry vs. ES300).  Another example would be the freemium model practiced by the SaaS industry where it is common to offer both a basic free version and a premium paid version.

Next post:  Revenue Models and Price Mechanisms

*  Note:  Setting prices below direct costs is illegal in many countries. While often difficult to prove given the creativity in cost accounting allocations, the practice of "dumping" or predatory share pricing has been the subject of several WTC actions in the past.  One such high-profile case involved the sale of Korean DRAM memory chips to the U.S. in the 1990s.

Perspective

March 10, 2011 around 11:45pm PST my wife was watching TV in the other room when she rushed out with a grim look on her face.  "Ed, you need to see this."

I slowly hauled myself up from my desk, tired after a 15 hour day in what had been a long week.  Wife and son recovering from the flu.  The usual frenetic round of weekly kid's activities and business meetings, capped by a couple of client rush jobs.  Our Volvo had broken down yet again. And we'd been preparing for a visit by a Japanese exchange student from Tsuchiura* this Saturday.

As I shuffled into the family room, my wife just pointed at the TV.

Perspective hit.

I watched a wall of water rush across farmlands while the screen ticker explained that a tsunami had been unleashed by an earthquake off the Sendai coast.  Disbelief as I realized that the small objects being swept away were houses!  Shock as I realized the water was moving faster than the cars on the highway!  Horror as it sank in that this was not a Hollywood movie.

How trivial my little problems.

Please pray for the people of Japan as they struggle with the aftermath of the disaster. Here is a link to the Red Cross website if you want to help.


*  Understandably and unfortunately, the Tsuchiura exchange visit has been canceled.  Tsuchiura is a city 50 km (~30 miles) north of Tokyo but south of Sendai.  While not directly affected by the tsunami, the city did sustain damage from the numerous aftershocks of the earthquake, has experienced disruption of utility services, and is concerned about the potential threat posed by the partial meltdown at the nuclear reactor complex in Fukushima just 200km (~125 miles) away.

Dealing with the Nitty Gritty: Resources and Wrap Up

Part 6 and final post in a series in Startup Stages

Co-founders.  Suppliers.  Employees.  Customers.  Government.  So what are the compliance and risk management resources available to a startup?

• Do-It-Yourself Resources – There are a host of websites, guides, and other resources supplying legal templates, HR compliance kits, on-line payroll management etc. While inexpensive in terms of dollars, this route can be very time consuming, requiring the entrepreneur to learn about, select, integrate, implement, and manage all of the separate pieces.
• Attorneys, CPAs, and Other Professional Outsource Firms – Legal, accounting, HR, and other compliance professionals can be hired on an outsourced basis, greatly simplifying the management burden on the entrepreneur and increasing the quality of compliance and risk management. But these professionals are very expensive, need to be actively managed, and in the end, you the entrepreneur will need to integrate it all together. In addition, these professionals are advisors, not operating people, and are often more risk averse than the entrepreneur needs them to be, resulting in unnecessary expense.
• CFOs, CAOs, HR In-house Staff – Of course, you can hire your own CFO, CAO, or HR staff who will be able to take care of many of these issues directly, thus minimizing the use of the more expensive professionals.  They can also manage the professionals when more complicated issues arise, reducing the time burden on the entrepreneur. But it may be the case that you don’t need these positions staffed on a full-time basis, in which case hiring internal staff may not be the most cost effective solution.

In Summary…
While the startup must manage a number of compliance and risk issues, the main ones are liability protection, tax compliance, and employment law compliance. In terms of summary practical guidelines, the startup should:

1. Organize formally early to put in place basic liability protection and establish the most favorable tax treatment for the business.
2. Define intellectual property strategy and processes early in order to maximize the value of the startup’s intellectual property and minimize the risk of infringement.
3. Do the appropriate trademark searches, and register your domain names and trademarks early on, to minimize the risk of having to change your name after brand equity has been built up.
4. Be aware that hiring employees is a significant step up in legal compliance requirements and insurance overhead that the startup will need to bear and should have the processes in place to handle beforehand.
5. Delay leasing dedicated space, with its attendant addition of long term liability and insurance overhead, as long as possible. Consider hosted office space as an alternative.
6. Be aware that customer contracts will introduce an additional step up in potential liability and insurance overhead. The startup should have the processes in place to handle this before accepting a contract.
7. Select the appropriate resource/cost for the level and complexity of risk.  Do-it-Yourself resources are fine for simple, more mechanical processes, while ill-defined or complex issues, like intellectual property strategy, should be handled by the appropriate specialists.

Related posts in this series:
The "Nitty Gritty" of Startup Formation
Intellectual Property Creation and Startups
Startup Stage:  Buying Stuff and Independent Contractors
The BIG Risk Trigger:  Hiring
Space (and) The Final Frontier