Pricing in reverse: use a product’s price to figure out what you need to build.
wrong: build something and then figure out how much you can charge. right: choose your desired price, then figure out how to justify it.
— Amy Hoy (@amyhoy) March 5, 2012
Amy brings up a great point and motivates me to finish a post I’ve had sitting around for awhile. Most folks try and make something and then they slap a price on it. Often folks then discover some nasty things about their product. Either the market can’t bear a product at that price, or they aren’t sitting on a profitable business.
One tool in your arsenal which I rarely ever see used is to use a product’s theoretical price to frame what you need to build. So how do you come up with that theoretical price ahead of time?
If you plan on making a big part of your living from selling something online, I have a very interesting strategy for you.
The too long; didn’t read of it is this:
- Look up the cost per click of a term from Google Adwords that you conceivably will use to advertise your product.
- Take that cost per click amount and divide by 0.015.
- You’re done. Build something to justify charging that amount.
Steps 1 and 2 above will give you a number that is a pretty decent ballpark of what you’d need to make on average from a single customer so that you can at least break even on Google Adwords expenses.
Let me show you how valuable this can be by telling you a story of a product/business I’ve considered starting, and then I’ll show you how this formula is developed.
I love reading. I especially love speed reading. You can’t speed read everything, because it takes some of the fun out of reading things like fiction. But for business books, blog posts, and magazine articles, it’s a huge time saver.
So I’d like to distill my speed reading knowledge into a product and sell it. I think I want to make a short ebook on speed reading and maybe sell it for $20. Sound good?
We’ll let’s just cool our jets before making this book and see what Adwords can tell us.
If you go over to Adwords you can use their Keyword Tool (you’ll need an Adwords account to get price data). Let’s look up the exact phrase “speed reading”
[speed reading] gets:
8,100 searches a month in the US on Google.
$1.53 per click
Knowing this data we can start making some assumptions.
Let’s pretend I took an Adword out to my speed reading landing page or online store.
Let’s pretend my ad gets a 1% click through rate. That means 1 out of 100 people who might see my ad in Google click it. That’s a pretty conservative estimate, but not a bad place to start.
So how many clicks (visitors) will we get per month:
8,100 * 0.01 = 81 clicks
How much will we end up spending on ads then to reach all 81 potential customers?
81 clicks * $1.53 per click = $123.93
Now let’s pretend we can convert 1.5% of those visitors to customers. 1.5% is fairly average conversion rate that we could hope to achieve.
81 clicks * 0.015 = 1.215 customers per month
So to figure out our product revenue, we’ll make:
1.215 * $20 = $24.30 per month!
Woah, hold on. Am I reading this right?
Yep.
It’s going to cost you on average $100 a month to make $24.30 in revenue a month.
Well my intention of selling an ebook on speed reading was to make money not lose $100 a month.
So what can we do?
We can raise the price of our ebook!
How much would our ebook have to cost for us to at least break even in Google?
1.215 customers per month * X = $123.93
Since we want to make at least $123.93 in revenue to cover our Adwords expenses, and we know we can maybe get 1.215 customers per month.
Solve for X.
X = $102
$102 just for my ebook!?
Exactly.
If you want to start making money selling some kind of “speed reading” product on Google, you need to be charging your customers at least $102 a shot.
So a 40 page ebook doesn’t sound like it’s going to cut it. As Amy pointed out at the beginning, we can use this price to justify what kind of product we need to sell. This might dash our dreams of selling an ebook, but now we know we have to think bigger.
I can’t just sell an ebook for $102. I’m going to have to create some kind of online video course perhaps. Maybe I could create a software program to help speed readers practice. Etc.
Knowing the minimum price I’ll need to charge actually helps me craft what it is that I need to create in order to make money. This is the reverse of how many people approach creating a product.
This thinking was inspired by Tim Ferris’ Muse Math.
You can boil this whole post down into the simple formula above to find the price you need to charge people.
(Searches per Month * Click Thru Ratio * Conversion Ratio * Revenue per Customer) = (Searches per Month * Click Thru Ratio * Cost Per Click)
(Conversion Ratio * Revenue per Customer) = (Cost Per Click)
so…
Revenue per Customer = (Cost per Click)/(Conversion Ratio)
And it’s not too far out of whack to assume a conversion ratio of 0.015.
Frequently Asked Questions or Made Arguments
But my product is going to spread virally. I won’t need Adwords.
Ok. Great. But it took more than 2 years for Pinterest to “spread virally”. And then there’s companies like 37signals? They have hundred of thousands of blog readers and fans. And they still use advertising on places like Google to reach out to new customers.
Ok, this is for an ebook; I make web apps.
It’s the same logic. For example, you plan on charging your customers per month? Figure out what what kind of revenue you need to make per customer with the formula above and divide by 12. 12 being the assumed lifetime of one of your customers in months. Then you’ll roughly have a monthly price you’ll need to charge to break even on Adwords.
This isn’t the holy grail of helping you figure out what you need to make. And Adwords isn’t the end-all be-all of how you’ll market your product. Maybe word of mouth will really be your best move.
But for a lot of ideas out there, this isn’t a bad place to start to consider whether you’re thinking big enough to be able to charge customers what you’ll need to charge to make a living for yourself using something like “conventional” pay per click advertising.
P.S. You might dig following me on twitter.