What’s the Value of the Problem You Solve?
Package delivery startup Doorman just announced that they’re shutting down. The company’s feature service was allowing customers to have packages shipped to Doorman, who would then deliver the package at a time you chose. (No more long delivery windows or stolen packages).
It’s not a bad idea, but the company had a major pricing problem. A year ago they raised the rates of their service so that their most expensive plan jumped from $29 a month to $89 a month.
Would you pay that much just for slightly more convenient package delivery?
Matching Price to Value
I see people offering services like this every day where the value of the problem that’s being solved doesn’t match the price at all.
If someone is offering me a service to track the mileage on a rental car, but I get unlimited miles, what’s the value of the problem being solved? Nil. And that’s about how much I’d be willing to pay for it.
With Doorman, 80% of the problem was that the value of the service for the customer didn’t match the cost required from the company to solve it. As a customer, $29/month might be worth it (consider, say, the cost if 1/10th of my packages are stolen, or of the time and money I’m losing driving to a FedEx warehouse because they refused to drop my package without a signature).
Doorman priced what the market would take, which is fine if that’s also where your costs match up. But the company really screwed up in assessing its unit economics. It comes down to simple math: total cost divided by total number of customers. Clearly, when they did sit down to do the division, they realized the costs were way out of line with the value of the problem on the customer’s side.
At that point, not only did raising the rates effectively turn off new customers, it alienated their existing ones by making the service feel like a bait-and-switch.
Especially as a start-up, it’s tempting to want to focus on one side of the equation or the other. If your costs are low, but you’re solving a very painful problem, you might miss out on the opportunity for a greater profit margin given what the market could bear.
Or, much worse, you price your service based on what you think people will pay in the hopes that your unit costs will drop once you can scale (optimistic but incredibly foolish). Either way you’re losing.
If you want to be able to succeed and stay nimble on your toes, you need to build out your customer economics so you can understand what happens when things shift. Without a buffer and some profit built in you can be upside down quick.
How to Price Things Right
I know this from running a food delivery company. We knew our numbers cold and learned fast how important that was very early on.
We took a sample size of 10,000 orders and found our average cost per order for food delivery was $2.37. For any order under $11, our margins were so low (or negative) that it just didn’t make sense to deliver.
We also saw that we had a large pool of orders in the $5–7 range (I can’t even tell you how many $5.37 pints of ice cream we delivered…) which were naturally becoming a pain point for us. In the end, we decided the best option was to set a $10 minimum for free delivery. For anything less than that, customers would pay $2 for delivery.
This decision worked for a few reasons:
(1) A large proportion of our customers could still get free delivery. As long as they were making $10+ orders, we were offering them a valuable service for no extra cost whatsoever.
(2) The delivery minimum encouraged customers to change their behavior in a way that was mutually beneficial. We saw our average order jump from $8 to $13 because customers would add on another item to get the free delivery. Our revenues went up and customers got more product out of the deal.
(3) Our cost point matched the value point. If our costs had been in the $5 range, I have no doubt we would have had less success implementing a paid delivery. But for most people, $2 is worth solving the problem of having to go out and pick it up yourself. (And let’s be honest, if you’re ordering one thing, it’s because you really want it and that extra $2 to get it immediately is well worth it. I’m looking at you, ice cream…)
What does it cost? What is it worth? If the second number is bigger than the first, you’ve got a viable model. But if cost outweighs value, you need to head back to the drawing board.