by Y Combinator10/16/2019
We’ve cut down the seventh week of lectures to be even shorter and combined them into one podcast.
00:00 – Intro
00:27 – Kevin Hale – How to Improve Conversion Rates
1:02 – Why we care about conversion rates
2:02 – Shareware conversion rate is .5%
2:22 – Casual download games is 2%
2:32 – Freemium SaaS range from 1.5 to 5%
3:57 – Knowledge spectrum
5:52 – The one button interface
6:37 – What is the call to action? And the magic moment.
8:02 – What is it?
8:38 – Is it right for me?
9:02 – Is it legit?
9:22 – Who else is using it?
9:52 – How much? What’s the catch?
10:39 – Where can I get help?
11:30 – Kevin Hale – Startup Pricing 101
13:15 – Monetization gives you the biggest bang for your buck
14:35 – Price thermometer
16:35 – Mistake 1 – Prices are too low
16:55 – Mistake 2 – Underestimate costs
17:08 – Mistake 3 – Don’t understand your value
17:27 – Mistake 4 – Focus on wrong customers
18:05 – Sales and profit over a product’s life
19:20 – Why is pricing innovation hard?
21:27 – How to optimize prices
22:32 – $1B formula
24:05 – Price and complexity
26:55 – 10 – 5 – 20 rule
28:20 – Summary
Craig Cannon [00:00] – Hey, how’s it going? This is Craig Cannon, and you’re listening to Y Combinator’s podcast. Today’s episode is a recap of the 7th week of Startup School. I’ve cut down the 7th week of lectures to be even shorter, and combine them into one podcast. Kevin Hale gave both lectures this week. Kevin’s a partner at YC, and co-founded Wufoo. His first lecture is on how to improve conversion rates, and his second lecture is on pricing for startups. All right, here we go.
Kevin Hale [00:27] – This presentation on improving conversion rates is designed to mostly focus on landing pages, but all of the principles and ideas that I’ll talk about in this talk, actually can help you improve the conversion rates of almost anything, any user interface, so keep that in mind. This is a typical example conversion rate funnel, and when you’re trying to improve in conversion rate, you’re basically trying to improve the efficiency of going from one step to the next, and the thing is, why we care about conversion rate, is because it’s part of two different aspects of growth. The two main drivers, and so growth is kind of like the balance between conversion and churn, and basically, growth happens as a gap between the two. Something to keep in mind is that working on churn is actually much easier than working on conversion, so in this talk, we’re working on the harder thing, it’s the thing that usually are going to get started. When I talk to a company, and I’m trying to help them with their conversion rates, the first thing I usually try to figure out is do we even need to be working on this at all? The only time you should be working on and improving your conversion rate is because you have a leaky bucket. I’d like to just talk about a couple of benchmarks in the industry so that we all sit on the same page and understand whether we should be working on this, or working on something else, like putting more things into the top of the funnel. Shareware, conversion rates here is about .5%.
Kevin Hale [02:06] – Basically, this is old school, before the internet, if people just release software out for free, and they just hope that somebody will pay for it, out of their own good will. This is the conversion rate you can expect. Casual download games, it’s about 2%, so stuff that you play on and off while waiting in line. Most companies care about this one, freemium software as a service companies, they range between 1.5 and 5%. On average, it’s about 3%. Once I talk to a company, and they have pages that are converting at about 3%, and that is from like out of 100 visitors that visit your page, 2 to 3% sign up, I usually say, you probably don’t need to spend that much more time on this, there’s probably other things you should work on instead. That being said, you can do much better than that, Flickr, back in the heyday, had a conversion rate between 5 and 10%. AdultFriendFinder. Depending on what you’re selling, people want it a whole lot more, so 10 to 22% for sex and end of loneliness. Even better, so these are, if you don’t recognize them, children’s social networks. Basically, this is the conversion rate to get your kid to shut the fuck up. Right, to leave you alone. TurboTax Online, the monster, 70% conversion rate, basically, you’re going to TurboTax, you’re downloading that software, you are paying for it, it is very, very high intent. Every conversion rate problem looks like every other user interface problem, and the concept, or framework that I like to use to explain how to solve any user interface problem is using something called the Knowledge Spectrum.
Kevin Hale [04:15] – This was created by an amazing interface designer named Jared Spool, and basically, the Knowledge Spectrum says that this represents all knowledge, on a spectrum, and on this side represents zero knowledge, no knowledge, you don’t know anything, and the other side is godlike, all knowledge. Your product, and your user, sits on two points on that line. Just two dimensions. Your user sits here, at what we call the current knowledge point, and your interface, your landing page, the thing you want them to do sits here at the target knowledge point, and every interface problem that’s trying to be solved, is trying to close what we call the knowledge gap. That’s it. You don’t need to go to a complicated design school to know how to solve these problems, you either are going to increase the amount of knowledge that is needed by your user, or you need to decrease the amount of knowledge needed to use your product or interface. That’s it, and I, whenever I’m looking at anyone’s design problem, I’m trying to figure out, do I need to increase knowledge, or do I need to decrease it? The most helpful exercise that I will use from this, once I understand this concept, when I’m trying to design a landing page or to improve it is to simplify things very, very simply, and what I imagine is something called the one button interface. Let’s imagine that we’ve reduced our landing page, our product, to just one button on a page. The question becomes, what do I have to put on this page to get someone to push the button? What’s the minimum amount?
Kevin Hale [06:04] – That’s what you ideally want to have on there, and is there any information that I put on this page that keeps me from pushing the button, or is there any lack of information that keeps me from pushing the button? Now, for every time that I deal with any page that I’m looking at, that I’m trying to help improve, I basically go through a series of seven questions. For every single one. Then, through the series of seven questions, I look very smart. You now can be smart on your own. The first question I ask is, what’s the call-to-action action? Is the button, is the thing I most want my user to do, is it super obvious, where do I find it? The thing to keep in mind about the call-to-action is, it should be really, really close to a concept I like to call The Magic Moment. The Magic Moment is basically the experience, the knowledge, the information, the interaction that someone has with your startup, and all of a sudden they get tingly inside, the light bulb goes off, and they go, “Holy fuck. I’ve been waiting for this my whole life, I now get it, this is super exciting, I can’t wait to use this.” And your call-to-action should be as close to that Magic Moment as possible, that when I click that button, I’m going to be taken to that point. Often, I go through a design critique with someone, and I’m like, what’s your Magic Moment? And then, somehow, the call-to-action is like 27 steps away, from whatever it is that makes someone feel special, or gets really excited about your product or app. D should be as close to zero as possible from your call-to-action.
Kevin Hale [07:51] – The six other questions we’re going to go through relatively quickly, and then, we’re going to go through two examples from people participating in Startup School, so just watch them in action. The next question is, what is this? What is this Magic Moment? And my test for this, my litmus test, is can I just copy-paste a sentence on this page, this landing page, that I can put into an email and send it to my mom, and my mom goes, “I understand what this is”. 99% of time, I look at people’s websites, and they’re so filled MBA marketing jargon and talk that there is no sentence that exists on that page that lets me very clearly understand what it is that this company does. Is it right for me? People who are super in a rush, impatient, trying to solve their problems, they’re quickly trying to identify themselves. Just like, am I in the wrong place? Is this the right product? And the way they’re trying to determine that, as I see, is there any reflection of themselves in this, or any reflection of their problems located anywhere on the page? Is it legit? The threshold is very low here, just can’t look like a Russian spamming website, right? Outside of that, you don’t need to overthink this, thanks to tons of templates and themes out there, you should be able to get over this bar very, very quickly. Who else is using it? A lot of people are uncomfortable using a product unless they know that there’s something else out there, and you might think it’s a variation of legit, but again, this bar is completely different,
Kevin Hale [09:36] – it’s letting me kind of know, oh, a shortcut for is it right for me, and is it legit, and basically, a shortcut for trust, and people, often, are trying to say, oh, if so-and-so is already using this then I should actually give this a chance. How much is it, what’s the catch? This is the one that so many B2B enterprise companies are afraid to put on their website. Which is why we’ve paired this talk up with pricing. And, basically, you should have some empathy. How many times do you go to a website, and go like, “Well, I’ll use this, without knowing how much it costs. Sounds good to me, let’s just do it.” No one does that, and so you shouldn’t be surprised that your conversion rates are affected because you don’t tell people how much it costs, or what’s the catch. Let’s say you’re giving away something for free, and really, your business model is you make money some other way. You should explain that to people, because otherwise people feel paranoid, or worried, or it feels kind of weird. And then, lastly, is where can I get help? There’s always a percentage of users who will go to your website, and it doesn’t matter that you have all the FAQs, you’ve written everything down, you’ve created these beautiful video documentation, they will just go like, “I just want to ask someone, I just need to talk to somebody, I need someone to tell me directly.” And part of it is, some people are just like, “I just want to see if there’s a real person behind this.” That’s number one, or some people are just, can’t be bothered, and sometimes it’s easier for them
Kevin Hale [11:14] – to just directly ask than navigate through the website, and if you don’t make it really easy to find and contact you, or make it look like that you were going to help them if they start using the product, they probably won’t use it.
Craig Cannon [11:27] – All right, now for Kevin’s lecture on pricing.
Kevin Hale [11:30] – This was a highly requested talk from last year. Lots of people had questions about pricing, or really confused, it actually was well requested both at YC itself, it’s a very, very popular workshop that we run, and so we’re going to go over a lot of basic fundamentals for pricing that, hopefully, will just help you understand how to approach your pricing and monetization from first principles, and then help you help yourselves, same thing with the landing page. We’re going to go over our first principles for pricing. We’re going to go over, why is pricing particular hard for startups, for people making innovative products in new markets. Why is it extra difficult? How do you do price optimization, like how do you actually do it, what does that actually look like? And just kind of demystify that whole process. When we look at the challenges of pricing, you start recognizing why certain types of customer segments that you’re going after are difficult, like SMB, and we’ll talk a little bit about that. We’re going to talk about how pricing affects your acquisition strategy, it changes what you can do and what you cannot do, and it’s extremely important because a lot of companies get caught up doing the wrong acquisition strategy, or wasting too much money because their price is incorrect. Then, I’m going to give you some rules of thumbs, some pricing tricks, just to help make it a lot easier when you’re encountering different pricing problems, I call them pricing trick sprinkles, okay. There are three levers you can pull to improve growth, so in the last talk,
Kevin Hale [13:11] – I talked about conversion rate and churn, but monetization is actually the big dog, it’s the one that I really like. Now, there was a survey done with over 500 SaaS companies, and they talked about amount of effort that they put into each one of these strategies, and the returns that they got as a result of it. Now, acquisition is really fun and exciting, it’s the one that everyone understands simply, I get more customers, I get more logos, gives me more growth. Retention, of course, is about keeping customers. Monetization is about getting more money per customer. Now, if you increase just your efforts, or resources by one percent, your work on acquisition, you usually get a return of about 3.32%. In retention, it’s about 6.7. When you’re optimizing pricing, that give you your biggest bang for your buck, in terms of impact on your business, yet it is the one that is most neglected, and I think it’s the one that everyone’s so afraid to touch because they’re so scared that if they get the pricing wrong that they will lose all their customers. Now, the first principles, the basic idea about pricing, the thing, the concept that really opened up in my head, how to think about pricing, how to understand the problems that people are facing, and why startups get it wrong, is the user concept called the Pricing Thermometer. You have to understand that, when you price something, there’s actually like two other factors at play, and so, there’s the cost, there’s the price, and then there’s the value.
Kevin Hale [14:55] – And the interplay and relationship between these items affects how growth happens inside of your company. Now, the gap between price and cost, that is your margin, that is your incentive to sell, and so the bigger that gap is, the more you are driven to want to push your product to your customers, to have your sales people, et cetera. This gap here, between price and value, is incentive to buy, and the larger that gap is, the easier it is to have your customers to want to sign up or use your product. Now, to figure out price, there’s really two ways to go about it. You either start with the cost, if you know what it is, and you figure out where your price is based off of that, that is called cost-plus. The other way to do it is figure out, what is the value of your company, or product, or service, and then you figure out your price from that, and that is called value-based pricing. In startups, and almost pretty consistently across all businesses, everyone will tell you, you should strive for value-based pricing. It allows you to charge a whole lot more, it allows you to manipulate this incentive to buy. The problem is, because people do not understand their relationships, or even understand what are their costs, and what are the value that their customers are going to think about their product, they put their price in a kind of arbitrary place, and they don’t know what are the forces at play that drives it. It results in four different types of mistakes, the first one is startups will price their products too low. Basically, you consistently undercharge,
Kevin Hale [16:44] – the number one piece of advice we give to most startups to fix their pricing, and I’ll talk a little bit about why most companies fall into that trap. You underestimate your costs, and the result is, you have a problem where your margins aren’t enough to cover acquisition. You don’t understand your value, you don’t understand how your company thinks about the problem that you’re solving for them or how they value it. And either they don’t understand your value, or you don’t know how to convince them of the value that you think you offer, and as a result, you can’t get the price that you want. And lastly, you focus on the wrong customers. That you think, man, if I’d built a better product, and I charged half the competition, I win. The thing is, that almost never happens. The reason is because you, as a startup, you as working on something to create a new market, are working on innovative products, you are focused on the wrong customers. They are not the mainstream people who are going to look at the price and make most of the determination based off of that. This is the sales and profit over a product’s life from inception to demise, that’s what it’s called. All you need to know is that these are five different stages of a company, and this is what sales might look like over different stages, and what profits might look like over those different stages. You, who are in Startup School, you, who are are getting seed funding, you are in the first two stages. Product development stage, introduction. You are not in the growth phase,
Kevin Hale [18:39] – and the thing to keep in mind is that the customers in the first two stages, the ones that you’re going after, they don’t look like mainstream customers that you find in growth and maturity stages. They’re not mature customers, they’re early adopters, and the thing to know about early adopters is, you kind of don’t really get a lot of momentum and growth until you get past the first 2 to 5% of potential buyers of your market. These people in that 2 to 5%, they’re called early adopters, and the thing that drives them is very different from mainstream people. There’s a couple of things to keep in mind about pricing innovative products, what you are trying to do fundamentally is require users to change their pattern. To stop doing it the old, shitty spreadsheet way, and do it in the new better your way, and getting someone to change their pattern is actually difficult, right? Especially if they are a mature person. Partly because the average user lacks information needed, and the trust in you, or whatever it is that you’re making, to make that change, to take that risk. You are entrepreneurs, you’re comfortable taking risks, your customers are not entrepreneurs, for the most part, they’re probably less comfortable taking risks. In the beginning, you’re going after people who are willing to take a risk, and those are early adopters. Those are people who care about benefits above all else, that the highest value to them is beating their competition, doing something much better, and taking a chance that something new will give them that edge over anybody else.
Kevin Hale [20:30] – Those early adopters, therefore, are not price-sensitive. If anything, if you’ve built a better product, and you charge less, it looks like you have reputation risk. Why is it too good to be true? What is the catch? What will end up happening, is it takes it much longer to get them to understand. This is, basically, all price optimization. This is the most complicated way that you can try to show price optimization. This is a demand-yield curve, and what you have on this side is different prices, and on this side you have sales, unit sales, and basically, what you are trying to figure out when you’re optimizing the price that you’re charging your customers is like, basically, what is the perfect balance between how much I charge, and how much sales volume I get? Your price optimization is basically that. Try different prices, and then see what the effect is. When I have my companies optimize their prices, they just use a very simple table, you don’t need to figure that weird-ass graph. Basically, you want to have a column that says, these are the prices I’m going to try, and then what is the result in conversion rate, what is the result in sales volume, and then, how much revenue did I generate? That’s all it is. Let’s say I have prices at these different price points, and I get these different conversion rates, and I get this sales volume, I should immediately be able to see who the winner is. Here we go. Now, the one thing to keep in mind, once we have figured out something like this, on a simple product,
Kevin Hale [22:09] – is that these areas at lower prices, if you can afford them, in terms of your margin, are actually lost opportunities. What you want to understand about these, are these are what you’re going to see if you offered discount pricing, or offered tiered pricing at different price points. Another exercise I like to do with companies when dealing with pricing, is help them understand, are you in a danger zone? What I usually do with my companies, is that I help have them calculate what would their business look like, or what is it going to look like to be a billion dollar company and usually the rule of thumb there is to be doing a $100 million dollars a year, in sales, in revenue. And so, that basically, your price that you give, how many customers do you need to have to make $100 million dollars in that year. Let’s have a bunch of different price points, then we know, okay, great, I need these number of customers in order to make this formula work. You understand what that looks like, at $100 price point with a potential about million users, this is consumers, that’s what that consumer space looks like. You know what this down here looks like, $100 thousand a year, we call this enterprise, this area here is a part that a lot of companies are in and really, really struggle, they’re on the struggle bus, and it tends to be SMB. These are people who kind of treat their money like consumers, but they kind of look like they might be an enterprise, and the reason why this is such a danger zone is because it will tend to fit
Kevin Hale [24:01] – in the wrong place on my next diagram. Let’s imagine that this vertical axis represents price, you can charge either high price or a low price for your product, and this represents complexity of your sales process, low complexity, to high complexity. If you are having a product that is $2,000 or less, and is basically self-serve, then you have something in this quadrant here, and this effects, completely, what you can do in terms of what drives your business. What you can spend on to get that sort of growth. That price point here at $2,000, it needs to have almost all marketing be in-bound, you can’t spend a lot of money outbound, or on ads, et cetera. Your support has to be completely self-serve, or very, very minimal. You have no sales team at this price point, you can’t afford it, right? But, conversions can happen on the same day, must be in a self-serve model. Transactional, so between $2 and $10,000, when you’re able to charge this, you are able to have a few new toys at your sleeves, and so, marketing now can be focused on generating qualified leads, your customer support can now offer SLAs, or you could start paying for training to help people get on-boarded, and for sales, you can’t hire a dedicated sales person, but maybe you could have an inside sales rep to sell within companies, or within your customers. You could maybe have an SDR, and you could maybe have someone dedicated to giving product demos. Sales cycle here should not be longer than one to three months. Enterprise, so over $25,000, now, for marketing, you can start spending
Kevin Hale [25:53] – things on branding, on building up trust with customers, your support is very, very high touched that you can afford, you can do phone support, you could have a customer success person dedicated to the client, and for sales, you’re going to start thinking about sales managers, dividing stuff into territories, and having sales engineers that participate in terms of the conversion and the sales calls. These will have a sales cycle of about six to 12 months. This is the garbage zone, right? And you know, if you’re potentially in this, and this is the big wake-up call for you, if it’s taking you months, and months, and months to close someone, but you’re not making a lot of money to cover it, you have a process where your acquisition costs are just too high for you to be sustainable, and you have to get yourself out of that problem. All of your work should be towards increasing the perceived value of your product or service. I’m going to end on a good rule of thumb. If you are starting with some kind of price, but you don’t know how to optimize it, or figure it out, then here’s a good place to get going. The first thing is, I like to have things where the value is x10 the price of whatever it is I’m charging, and I want to have it so that the value is easily understood to be at x10. For example, if I charge for a product that is $10, then it should be, in terms of perceived value by my customer, that it’s worth $100 to them. If they do not immediately understand the x10 value of the price, it’s going to be hard to get them to move, their incentive to buy might be too low.
Kevin Hale [27:46] – Once you have any kind of price, and this is particularly important for people who are doing B2B or enterprise sale, you should start practicing raising prices. I like to just start by raising prices by 5%, if you feel really confident, jump it up by bigger numbers, if you want, but this is a pretty safe way to do it so that you can feel comfortable with it, and you want to keep raising prices until you’re losing 20% of your customers, that’s about a good balance to have in terms of understanding that like, I have a good price here, I’m losing 20% of my deals, it’s not too high, it’s not too low. In summary for pricing, pricing gives the most bang for your buck, you should work on pricing, if you’ve never touched the pricing of your product, then you’re losing out on lots of potential growth. Understand the variables, do you really understand your cost, do you understand why you’ve put the price where it is, and do you understand the value? When you go into a sales meeting, or a call, do you talk to people and you basically say, “I know exactly what this is going to be worth to you, so when I tell you what this price is going to be, you’re going to be like, damn, that’s totally worth it.” Go after early adopters, remember, as a startup, that is who you’re going after. So when you are talking to customers, and they are taking a really long time to make a decision or they’re wanting to have a lot more proof that other people are using it, you are not talking to an early adopter, you’re wasting a lot of time on non-believers.
Kevin Hale [29:20] – Go after them first, don’t take it personally when these people who are much more mature aren’t ready for your product. They were never going to be. Your job is to get through that first 2 to 5% of the market. Those early adopters care more about benefits than price, so don’t undercharge your products when you have something that is of value and easily understood to have value. Get organized, when you’re doing price optimization, it’s really, really easy, don’t over-complicate things, figure out a bunch of different price points you want to check, understand sales volume, conversion rate, and the revenue that’s involved, and that will help you make the best pricing decision. Your price will determine your acquisition strategy, if you realize that your sales cycle, or all the things that you’re spending on, is way too much for the amount of money that you’re charging, you either need to increase the price or completely reduce your acquisition strategy costs. Use the 10-5-20 rule. Set a price that is 10X, that is a 10th of the value, increase prices by 5%, until you are losing 20% of the deals. Thank you very much guys.
Craig Cannon [30:42] – All right, thanks for listening. As always, you can find the transcript and video at blog.ycombinator.com. If you have a second, it would be awesome to give us a rating and review wherever you find your podcasts. See you next time.
Y Combinator created a new model for funding early stage startups. Twice a year we invest a small amount of money ($150k) in a large number of startups (recently 200). The startups move to Silicon