6 Practical Ways to Find Out if Your Customers are Willing to Pay
My notes from Lenny's Podcast with Madhavan Ramanujam
Stories from the Trenches 🫡
My co-founder and I are in the midst of adjusting our pricing and sales strategy for 2023 and, as a product person, these areas are pushing me out of my comfort zone. You want to know the real reason why it feels uncomfortable to me? I have no playbook.
Thankfully, there are folks who have decades of experience and wisdom in these areas who are willing to share what they've learned from the trenches and I'm going to pass along what I've learned to you here. Last week, I wrote a short article outlining three pricing frameworks from the CRO of a $500M company. This week, I want to share my notes on another aspect of pricing strategy: willingness to pay.
Lenny Rachitsky had a fantastic interview with Madhavan Ramanujam who is widely considered to be "the man" when it comes to pricing and below is a summary of his 6 types of conversations for measuring willingness to pay.
Let's jump in.
Hey, I’m Jacob ✌️ Welcome to all of the product people who subscribed since last time! If you’re not a subscriber yet, I hope you’ll consider joining this band of like-minded folks who are all learning how to build better products.
Pricing → Willingness to Pay ← Product
My background is in product design, not marketing or sales so pricing doesn't come as naturally to me. But that's all changing as I begin to understand pricing's impact on the product roadmap.
"You cannot prioritize a product roadmap without having a willingness to pay conversation. If you're just prioritizing based on what you think or what you feel or technical resources, you're getting it wrong."
—Madhavan Ramanujam
There are really two angles you can come at this to align your roadmap and your customer's willingness to pay.
1. Price-first: Either you set the price and then build the product that customers would be willing to pay that price for.
2. Product-first: Or you build the product and then set the price that customers are willing to pay for that product.
Ideally, you're doing a little bit of both along the way.
You might have an idea about what sort of product you'd like to build. Maybe there's a certain technology you know you want to use (like Figma with WebGL). Or you might have an idea of the market you're pursuing and there's a certain price-point you know you have to hit to stay profitable. In either case, you're trying to move both toward center where you'll find your customers' willingness to pay.
20% of the Product Drives 80% of the Willingness to Pay
The funny thing is that, in our freemium culture, we often will give away the core of the product for free - the very part that drives the willingness to pay. And then we try to monetize the features around the core of the product, but if we've already given away the meat and potatoes for free, there's only so much we can charge for the salad. The overall price point drops.
"20% of what you build drives 80% of the willingness to pay. Often what happens then is this 20% is the easiest thing to build.
And what companies do is they will build it, they will throw it out and they'll say, there's an MVP, give it for free. And then they're trying to chase their tails, building 80% of stuff that is driving 20% of value. So you all already lost the battle."
—Madhavan Ramanujam
We only have to look to F2P games like Fortnite to prove the strategy does work for some. But for many startups who rely on the early cash flow to reach profitability (or at least break-even), giving away the very thing that drives willingness to pay is a non-starter. And yet, that's what many founders are encouraged to do isn't it?
"It's much better to find out what is this 20% so that you can focus on it, nail it, and focus on all of the usability around it and make an awesome product as opposed to not knowing what drives the willingness to pay and just trying to put everything out there."
—Madhavan Ramanujam
6 Practical Conversations to Measure Your Customers’ Willingness to Pay
Okay so let's recap.
We know that willingness to pay exists on a continuum with overpriced products no one will pay for on one end and underpriced products that hamstrings growth on the other. Our job is to find the center where the value exchange is balanced.
And we also know that building the right 20% of the product can often get you 80% toward the center so it's incredibly important to identify the right 20%.
Which begs the questions:
1. How do we know where we are along that continuum?
2. How do we determine what that core 20% is?
If your instinct is to just ask your customers, "how much should I charge?" welcome to the club 🥲
"If you go and ask someone, how much should I charge for this product? You're actually going to get garbage back. That's your job. No one is supposed to tell you how much to charge, and that's the worst way to have the conversation."
—Madhavan Ramanujam
Madhavan walks us through 6 types of conversations to help us answer these two questions. I've tried to order them based on stage of the company from early stage to late stage as best I could but, obviously, some will apply across the board.
1. Start simple (and ask “why?”)
If we come up with an idea, we're naturally going to thing it's the bee's knees. So we have to pressure test it early with the simplest question of all: would you pay for this?
"If you're very early stage, let's say just an idea, just have the conversation. Just even asking, would you pay for it, is a good question because if someone says no, then ask why."
Then you'll hear a lot of good information. If someone says yes, ask them, why would you pay for it, they would articulate back the value that they understood, and that should be in your value messaging."
—Madhavan Ramanujam
It's not a very accurate measure of willingness to pay, but it's the simplest and the quickest to get the ball rolling. If you dig in, you just might stumble across some really interesting insights that could help shape the 20% of the product that will drive the 80% of the willingness to pay.
2. Prioritize the features on your roadmap
Assuming you've gotten a decent amount of interest from folks who say they're willing to pay, you can try to dial in what that core 20% might be in order to help you have more productive "willingness to pay" conversations in the future.
Trying to find that core 20% is a difficult task that's made exponentially difficult with a long backlog of cool features. So we have to install more bumper rails to give customers a simple and easy task.
"There's a lot of psychological theory that people are very adept at identifying the extremes. When it gets in the between, that's when things become tougher.
So what we do is, if we have a list of 10 features, we would take a subset of six or so features out of those 10. And then they say, "In this set of features, identify the most important for you, and the least important."
The most important is defined as, "Must have, I will pay for it." Least important is, "I don't need it. I won't pay for it". And then we will change the set of six, another combination from the 10, and ask that same question."
—Madhavan Ramanujam
3. Measure purchase probability
Once you've nailed down some features on the roadmap that feel like a solid 20%, you can begin to dial in purchase probability. This is a twist on the first conversation that just asked, "would you pay?"
When it comes to asking people if they'll buy something, most people will trend favorably out of kindness to you. Most people don't like hurting other people's feelings. So they'll appease them.
"Yeah, that's a dope idea, I'd totally buy that!"
This conversation helps you bring it back down to reality and measure purchase probability.
"Ask someone, "on a scale of one to five, would you buy it?"
One is "I'm not at all interested," five is "I would buy it for certain," four is, "most likely," and three is, "I'm neutral."
What we are actually seeing is, even if people say, "five", they are probably only 30 to 50% sure about whether they would buy, so if they say, "four", it's 10 to 20%. If they say, "three and below", they're never going to buy it.
If you do this at scale, you can start coming up with a demand curve. And then say, "Where is the price optimal?" If someone says "three," for a certain price point, then you can lower the price and say, okay, would they actually move their ratings to a four or five."
—Madhavan Ramanujam
4. Index against a known company
It's really difficult for customers to pull numbers out of thin air. That's why you should never ask customers, "how much should I charge?" They're wrestling with a bunch of intrinsic biases such as wanting to get a good deal. One way you can combat this is to pull them out of their own head and install some bumper rails by giving them something to benchmark against.
You: "Do you use products like Salesforce in your company?"
Customer: "Yeah, we do."
You: "Let's say Salesforce was indexed at 100 in value. Where do you think we are in terms of the value that we bring to your day-to-day business operations?"
You: "If Salesforce was indexed at a 100 in pricing, where do you think we should be?"
These sorts of conversations will help you gauge where your product's value stacks up against real-world products they're paying for today. That should help you know generally whether to price up or down from that fixed point.
5. Uncover psychological thresholds
If you want to find where certain "danger zones" are in pricing, you can have the following conversations. From what I understand, it isn't as helpful with nailing an exact price, but rather it helps you understand where crossing a certain threshold changes the perception in your customer's mind.
"Take your product that you're going to launch, pitch the value to your customers, have that exact sales and marketing conversation that you'd have after you launch the product, but before. And then ask them, "What do you think is an acceptable price for this innovation?" Everyone would like to low ball, they'll negotiate with themselves."
Let them give an answer, clock it, then ask them, "What do you think is an expensive price?" And then follow that with, "What do you think is a prohibitively expensive price?" Acceptable price is the price where people not only love the product, but they also love the price.
The expensive price tends to be the price that is value priced, as in, they don't love you, they don't hate you, they would pay you, but that's a neutral reaction. Prohibitively expensive tends to be the price that they'll laugh you out the room.
And if you do this at scale, what you'll start seeing is that there are some cliffs in these demand curves, where suddenly, when you cross from let's say 99 to 101, 20 or 30% might say, "It is expensive," or, "Hey, it's prohibitively expensive.""
—Madhavan Ramanujam
6. Discover your customer’s unspoken rules
People are complex creatures. There are little subliminal rules that we all operate by and can make or break a purchase decision. These rules might be different for each person but at scale you can begin to pull out patterns that will help you price for different segments of your audience.
"Put people through actual buying patterns, or actual buying scenarios and say, "Okay, if you had this packaging and pricing, for instance, for your software product, what would you do?"
Then we would change that and say, "If you change the features and the price, how would you react? Would you buy any of these products? Or would you say, I won't choose any of these?"
These are more like shopping scenarios for your products, but it's realistic, and it's akin to real life. Based on how they choose these products, what we are trying to reveal is the mental models and rules that people use to make decisions."
—Madhavan Ramanujam
Takeaways for Founders & Product Leaders
If you haven’t already, hit subscribe to get frameworks like these every Tuesday.
Find the balance between product and price where customers are willing to pay.
The RIGHT 20% of the product can drive 80% of the willingness to pay. Identify that 20% and try to not to give it away for free.
Use these 6 types of conversations to understand how you should segment your audience, adjust your prices, and develop your product.
That’s a wrap! See you in the next one.
—Jacob ✌️
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Further Listening
If you want to listen to the entire episode (which I highly recommend), you can check it out here.
