Y Combinator Startup Podcast - #148 - Startup School Week 7 Recap - Kevin Hale on Conversion Rates and Pricing

Episode Date: October 16, 2019

We've cut down the seventh week of lectures to be even shorter and combined them into one podcast.Kevin Hale gave both lectures this week. Kevin’s a partner at YC and cofounded Wufoo. His first lecture is on how to improve conversion rates and his second lecture is on pricing for startups.Y Combinator invests a small amount of money ($150k) in a large number of startups (recently 200), twice a year.Learn more about YC and apply for funding here: https://www.ycombinator.com/apply/***Topics00:00 - Intro 00:27 - Kevin Hale - How to Improve Conversion Rates1:02 - Why we care about conversion rates2:02 - 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 spectrum5:52 - The one button interface6:37 - 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 10113:15 - Monetization gives you the biggest bang for your buck14:35 - Price thermometer16:35 - Mistake 1 - Prices are too low16:55 - Mistake 2 - Underestimate costs 17:08 - Mistake 3 - Don't understand your value17:27 - Mistake 4 - Focus on wrong customers18:05 - Sales and profit over a product's life19:20 - Why is pricing innovation hard?21:27 - How to optimize prices 22:32 - $1B formula24:05 - Price and complexity26:55 - 10 - 5 - 20 rule28:20 - Summary

Hey, how's it going? This is Craig Cannon, and you're listening to Y Combinators podcast. Today's episode is a recap of the seventh week of startup school. I've cut down the seventh 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 Wufu. His first lecture is on how to improve conversion rates, and his second lecture is on pricing for startups. All right, here we go. So 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, 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 sort of 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? So the only time you should be working on and improving your conversion rate is because you have a leaky bucket. So I'd like to just talk about a couple of benchmarks into industry so that we all kind of sit on the same page and understand whether like 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 0.5%. So basically, this is old school, like before the Internet. If people just release software out for free and they just hope that somebody will pay for it or their own goodwill.

This is the conversion rate you can expect. Casual download games, it's about 2%. So stuff that you sort of play on and off while waiting in line. Most companies kind of care about this one. Freemium Software as a Service companies, they range between 1.5 and 5%. On average, it's about 3%. So 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%. Adult friend finder.

So depending on what you're selling, people wanted a whole lot more. So 10 to 22% for you. sex and end of loneliness. Even better? So these are, if you don't recognize them, children's social networks. And so 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'd like to use to explain how to solve any user interface problem is using something called the Knowledge Spectrum. 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 another 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 is it's 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? So, 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. So let's imagine that we 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? 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. And 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? Is the button? Is the thing I most want my user to do?

Is it super obvious? Where do I find it? And 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 tingling 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. So 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. So D should be as close to zero as possible from your call to action. 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. Just watch them in action. The next question is, what is this? What is this magic moment? Right? And my test for this, my lips test is like, can I just copy, paste a sentence on this piece? page, the 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 with MBA marketing jargon and talk that there's no sentence that exist on that page that it lets me very clearly understand what it is that this company does. Is it right for me? So people who are super in a rush, impatient, trying to solve their problems, they're quickly trying to identify themselves.

They're like, am I in the wrong place? Is this the right product? And the way they're trying to determine that is to see, like, is there any reflection of themselves in this or any reflection of their problems located anywhere on the page? Is it legit? So the threshold is very low here. It 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? So 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. 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 like, 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? So let's say you're giving away something for free, and really your business models, you make money some other way. You should explain that to people because otherwise people feel paranoid or worried or feels kind of weird. And then lastly, is where can I get help? There's always percentage of users who will go to your website and no matter, no, 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 to just directly ask, then 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. All right. Now for Kevin's lecture on pricing. 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 you help you help yourselves. Same thing with the landing page.

So we're going to go over first principles for pricing. We're going to go over, why is pricing particularly hard for startups for people making innovative products and new markets? Why is it extra difficult? How do you do price optimization? 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. 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 isn't correct. And 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 tricks, sprinkles. Okay. There are three levers you can pull to improve growth. So in the last talk, 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 sort of like 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 kind of understands simply. It's like I get more customers.

I get more logos. It gives me more growth. Retention, of course, is about keeping customers, and modernization is about getting more money per customer. Now, if you increase just your efforts or resources by 1%, your work on acquisition, usually get a return of about 3.32%. In retention, it's about 6.7. And when you're optimizing pricing, that gives you your biggest bang for your buck in terms of impact on your business. yet it's the one that is most neglected, and I think it's the one that everyone is 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 to use a concept called the pricing thermometer. And so you have to understand that when you price something, there's actually like two other factors at play. And so there's a cost, there's the price, and then there's the value. 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 salespeople, 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 it. You either start with the 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 customer is 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 that play that drives it. And it results in four different types of mistakes. The first one is startups will price their products to low. Basically, you consistently undercharge. It is the number one piece of device we give to most

startups to fix their pricing. And I'll talk a little bit of 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 sort of 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, man, if I built a better product and I charge half the competition, I win. The thing is, that almost never happens. And 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. So this is the sales and profit over a product, 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 getting seed funding, you are in the first two stages. Product development stage, introduction. You are not in the growth phase. 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 two to five percent of potential buyers of your market. These people in that two to five percent, they're called early adopters. And the thing that drives them is very different from mainstream people. So there's a couple of things to keep in mind about pricing innovative products.

What you are trying to do fundamentally is require users the change to 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 really difficult, right? Especially if they're 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 risk. So 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.

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. It's like, why is it too good to be true? What is the catch? And what will end up happening is it takes it much longer to get them to understand. This is basically all price optimization. There's no 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? And then 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 try 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

and so 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've figured out something like this on a simple product,

is that these areas at lower prices, if you can afford them in terms of your margin, are actually lost opportunities. And what you want to understand about these are these are what you're going to see if you offer discount pricing or offer tiered pricing at different price points.

Another exercise I like to go with companies when dealing with pricing is help them understand is like, are you in a danger zone? And so what I usually do with my companies is that I help have them sort of calculate what would their business look like or what does it going to look like

to be a billion dollar company. And usually the rule of thumb there is to be doing $100 million a year in sales and revenue. And so that basically is like at your price that you give, how many customers do you need to have to make $100 million in that year? So, 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 of a million users, right? This is consumers. That's what that consumer space looks like. And you know what this down here looks like. $100,000 here.

We call this enterprise. This area here is the 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, right? 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, tend to fit in the wrong place on my next diagram.

So let's imagine that this vertical axis represents price. You can charge either a 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 affects 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 inbound. You can't spend a lot of money outbound or 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-served model.

Transactional. So between $2,000 and $10,000 when you're able to charge this, you're 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 like SLAs or you could start paying for training to help people get onboarded. And for sales, you can't hire a dedicated salesperson, but maybe you can have an inside sales rep to sell within companies or within your customers.

You could maybe have an SDR and you can 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 things on branding, on building up trust with customers. Your support is very, very high touch that you can afford. You can do phone support. You can 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 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. So if you are starting with some kind of price, but you don't know how to be.

how to sort of 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 10x the price of whatever it is I'm charging. And I want to have it so that the value is easily understood to be a 10x. So, 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 10x value of the price, it's going to be hard to get them to move. Their incentive to buy might be too low. 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. And 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 played 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, it's like, I know exactly what this is going to be worth it to you. So when I tell you what the 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. 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 overcomplicate 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 10.520 rule.

Set a price that is 10x that is a tenth of the value. Increase prices by 5% until you are losing 20% of the deals. Thank you very much, guys. All right, thanks for listening. So as always, you can find the transcript and the video at blog. dot ycombinator.com. And if you have a second, it would be awesome to give us a rating and review wherever you find your podcast. See you next time.