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Cracking the Monetization Code: Unlocking Growth for High-Friction Products
When Pricing, Value Proposition, and Acquisition Channels Collide for Success (or Failure)
Hi there, it’s Adam. 🤗 Welcome to my (almost) weekly newsletter. I started this newsletter to provide a no-bullshit, guided approach to solving some of the hardest problems for people and companies. That includes Growth, Product, company building and parenting while working. Subscribe and never miss an issue. Questions? Ask them here.
I’ve been heads down working two jobs the past few months (Reforge EIR and Interim CPTO at ResortPass) – and it’s almost time to come back up for air. Reforge ends at the end of May for me and I’ll become an EIR-alumni! EIR-emeritus? Something.
This week I was reminded how challenging effective monetization is because of two events that happened:
It’s Monetization week at Reforge and I delivered a case with the amazing Chris Miller at Hubspot. He’s VP of Product, Growth and Fintech, but more importantly he’s a monetization expert.
Advisory conversations are heating up again since I’m planning the 2nd half of this year and I had a conversation with a potential advisory client who asked me this question:
Question: “We built a new version of our product that costs more, so we’ve raised prices. But we’re seeing declining conversion rates and increased acquisition costs. What’s the solution?”
Because these two events intersected with one another I wanted to apply some of my favorite monetization frameworks to this specific situation to see how they stack up. Spoiler alert: they stack up really well.
Let’s get into it!
The overarching challenge that this company has is based on a few factors:
They’re a consumer company and they released a new version of their product. It costs more to manufacture so they’re charging more because they have a certain margin target they want to achieve. This is classic Cost Plus Pricing and I’ll elaborate more on that in a bit. The product used to be ~$1,800-2,000 and now it’s $2,300-2,500. A 1.25x increase.
This is a hardware + software product (like Peloton, but it’s not Peloton). Also, the software is mandatory to get the benefit of the product. So… they essentially raised prices again because they require subscription now. That subscription is another ~$150-200/year.
They need to grow and believe the best way to do that is to acquire new customers. Their acquisition is based on a paid ads loop.
Paid ads aren’t performing as well as they once were (across the board, for most companies). So they’re seeing rising costs and declining conversion rates on acquisition. This is further exacerbated by the increased price of their product.
The product and its value proposition are relatively complex – this is definitely a considered purchase both to understand the benefits and because of the price point.
Teams operate relatively independently from one another. The team that built the core product sets its pricing but a different team is in charge of acquisition and retention.
The company approached me with this challenge and a proposed solution: how can we open up new, lower-cost acquisition channels?
This is a valid question – if acquisition costs are rising then they could be offset by finding and standing up lower-cost channels.
Figuring out whether this is the right move, however, is more complicated.
I’ll start with a disclaimer: I haven’t spent an inordinate amount of time with this company (yet). This could end up being terrible advice and you shouldn’t believe everything you read on the internet; unless it’s delivered to your inbox by Substack. In which case, give it the benefit of the doubt, share it widely and smash that subscribe button.
When you think about your Monetization Model there are a few components to consider and price is only one.
The additional components to consider are how you charge (transaction, subscription, ads, etc.), when you charge (up front, after a trial, only for bonus features, i.e. freemium), and what you charge for (this could be usage-based, select features, etc.).
Each of these variables (how/when/what/how much) can add or remove friction to your monetization model.
Let’s diagnose that friction for this product:
As far as consumer products go this is a relatively high-friction monetization model. It’s not a house or a car, but it's certainly more than Netflix, Spotify, or TikTok (I’m told that you don’t have to pay for TikTok but I have no first-hand experience because I am considered an “old person” now).
And this is where things start to get interesting! Because we have a relatively high friction consumer product that can have a cascading impact on the time allotted to realize the product’s value proposition, the acquisition channels available to us, and even which segments of the market will be interested in this product.
Let’s start with the Value Proposition. The time it takes to recognize the value proposition of our product influences how hard it is to form an initial habit with the product (activation) and sustain it for the long term (retention).
This product and the problems it purports to solve are complex and not well understood. It is hard, or high-friction, to understand and calculate the perceived value of this product. As such, the company has developed a lot of educational materials to help market and sell the product. Some people may be willing to self-educate using these materials, but many (most) will not.
The final blow here is that the purchase/checkout experience is entirely self-serve via an online storefront. So I can get to the purchase process without consuming any of the educational content and then I’m served a $2300 price point and a recurring, annual subscription.
So far we have a high-friction monetization model and a high-friction, hard to reach, value proposition.
This is not (yet) bad per se, but let’s add another wrinkle – acquisition channels.
Remember that as far as consumer products go we’re a relatively high friction monetization model and product value proposition. Not a car, house or a boat but pretty far away from Netflix/Spotify/TikTok.
One of the characteristics of a high friction model and value prop are that they require more high cost acquisition channels. I suppose it’s possible to sell a yacht via product virality (might want to turn your speakers down), but I certainly haven’t seen it. Instead, it’s much more likely to sell a high (model) friction product with a high cost channel. When you’re in the market for a yacht you talk to a broker.
And here we arrive at the crux of our challenge – with a high friction monetization model and a high friction value proposition we shouldn’t expect great performance from a lower-cost or free acquisition channel. Lower-cost channels, like virality, referral, and even paid work best for products that are lower friction to adopt and understand. Higher-cost channels like inside/outside sales, retail touchpoints, or even a “sales assisted” model where you add on a sales touch to an existing channel tend to work better in higher-friction scenarios.
Okay, problem solved, right?!? Let’s just throw some salespeople into the mix and all will be right with the world.
Remember that we have this margin preservation goal. That was the reason that we raised the price in the first place and also why the team who oversees acquisition is looking to drive their conversion rate up and costs down. After all, it’s 2023 and we know that efficiency is the name of the game now!
Would adding a sales-assisted motion (for example) increase acquisition costs to an unsustainable level? Very likely, yes. Those pesky salespeople (and their corporate credit cards) are expensive!
This is where that Cost-Plus Pricing consideration comes into play.
First, let’s define Cost Plus Pricing - ChatGPT, do your thing:
Cost-plus pricing, also known as markup pricing, is a straightforward pricing strategy in which a business calculates the total cost of producing a product or providing a service and then adds a percentage markup to determine the final selling price. This percentage is often referred to as the profit margin or markup and is intended to cover the company's overhead costs, such as salaries, rent, and utilities, as well as provide a profit.
Here's a simple formula you can follow for cost-plus pricing:
Selling Price = Total Cost (Production Cost + Overhead Costs) + (Total Cost × Markup Percentage)
For example, if it costs a business $50 to produce a product, and they want to apply a 30% markup, the selling price would be:
Selling Price = $50 + ($50 × 0.30) = $50 + $15 = $65
In this case, the product would be priced at $65.
Cost-plus pricing is easy to implement and ensures that the business covers its production costs and generates a profit. However, this strategy does not take into account the value perceived by customers, competitors' pricing, or market dynamics, which can lead to either overpricing or underpricing the product or service.
A textbook, AI-generated definition. In other words: figure out how much it costs to make your product and then add a markup to it to cover that plus generate profit.
Our pricing methodology matters a lot here because as we’ve seen above the monetization model of your product is inextricably tied to your channel strategy, your product value proposition, and even your market segments.
So if you add a new, more expensive channel because you have a high friction value proposition then the cost-plus model fails you because it doesn’t consider this friction or the channel costs. In fact, it doesn't consider anything other than the input and operating costs for your product.
A better model might be Value-Based Pricing – because this model takes into consideration willingness to pay and could lead to a higher price point with a sale assisted by a high-touch channel. It is harder to pull off though because it requires more market and customer knowledge.
The basic steps required to figure out value-based pricing are:
Identify the target customer segment and understand their needs, preferences, and pain points.
Assess the unique features, benefits, and differentiators of the product or service that create value for the customers.
Analyze the competitive landscape and understand the value proposition of competitors' offerings.
Determine the customer's willingness to pay for the value provided by your product or service.
Set the price based on the perceived value and customers' willingness to pay, while ensuring profitability.
What impact could raising the price further have on the analysis we’ve done so far?
Monetization model: We are already in a “high friction” model and so raising the price further may not have any negative impact on monetization friction.
Value proposition: The product has a complex, high-friction value proposition and is not well understood. Raising the price won’t change this, but it will enable us to introduce higher cost channels.
Acquisition channels: A higher price point supports a set of higher-cost channels; like sales-assisted, inside sales, retail partnerships, etc.
So that settles it! Let’s go raise prices.
Wait a minute.
Remember I told you not to believe everything you read on the internet?
In case you forgot, what I mentioned earlier:
This could end up being terrible advice and you shouldn’t believe everything you read on the internet; unless it’s delivered to your inbox by Substack. In which case, give it the benefit of the doubt, share it widely and smash that subscribe button.
For something complex and not easily reversed, like changing prices, you can’t just do it based on what a random guy said on the internet. Even if that guy is me and writes a newsletter that (a few) people sometimes (rarely) pay attention to.
Before making big changes to pricing I suggest some research!
There are a few common ways to assess willingness to pay:
Surveys and interviews: Ask people! You can directly ask customers about their willingness to pay for a specific product or service, either by using open-ended questions or by providing a range of prices for them to choose from.
Conjoint analysis: This is a statistical technique that involves presenting customers with various product combinations, including different features and prices. Based on their preferences, you can estimate the relative value of each feature and the optimal price points.
Van Westendorp Price Sensitivity Meter: One of my favorites and not just because it has a fun name. This is a survey-based methodology and asks people four pricing questions: at what price would you consider 1) the product is so cheap that you’d question its quality, 2) the product to be a great bargain for the money, 3) the product starting to get expensive, but you’d still consider buying it and 4) the product is too expensive and you wouldn’t consider buying it. There are limitations here of course - it relies on self-reported data, for example, which could be inaccurate.
Experiments: One of the harder methods to pull off. For raising prices you can run a modified painted door test. This is where you change the price on the front-end and observe conversion rate but still charge people the original, cheaper price. You have to be willing to “burn” through some prospective customers because those who see a higher price and abandon your purchasing process may never come back. I don’t recommend this unless you have a steady stream of walk-up customers.
Through all this pricing discovery what you’re looking to figure out is whether you can raise prices to a place that supports higher-cost acquisition channels without impacting conversion to such a level that your growth halts. This seems counterintuitive in the kind of economy that we’re operating in but remember that at $2k+ you’re not targeting bargain shoppers. Your low-cost ad channels may be doing just that though!
The goal of this post was to show you just how interconnected the different components of your growth model are. And this demonstrates the broader connectivity between your acquisition, retention, and monetization strategies. They can’t be viewed independently of one another or owned in silos without collaboration from other teams. In this case, the team that sets the pricing for the product isn’t necessarily considering what it takes to acquire a new customer. As an advisor, I’d recommend that these teams come together with shared growth targets and dual accountability. I talk more about this in the Growth Leadership program at Reforge where we dissect metrics ownership using the Own, Share, Shed framework.
While I’m not certain that raising the price is the absolute best solution in this case I can guarantee that lower-cost acquisition channels are not.
Best of luck with your monetization journey!
There is a great corpus of information on the topic of monetization. For those with more time on their hands who want to dive deeper I recommend: