https://every.to/p/how-to-price-generative-ai-products
Midjourney prompt: "Lemonade stand, watercolor, --c 100" (remixed and Photoshopped for final results)
This essay is brought to you by The Commons. Want to invest in your team and retain your top talent? Check out The Commons - a private community of 1000+ tech operators across 400+ companies.
Want to sponsor Every? Click Here.
It seems like a new generative AI startup is calling me every other day with the same question: how should they set their prices?
Helping startups set their prices is not exactly new to me—I’ve spent years thinking about pricing in my work helping software and internet companies monetize their products. However, the recent uptick in questions from generative AI startups is worrying. Generative AI introduces a problem into software pricing that startups previously didn’t have to deal with: marginal cost.
Marginal cost (of running large language models, for example) breaks the startup product-launch playbook of “engagement first, monetization later.” Freemium is now a dangerous acquisition model. Subscriptions might be highly unprofitable. I hear plenty of doomsday scenarios. Still, if AI startups follow best practices, then pricing their products may not be that scary after all.
Let's address the cost issue right out of the gate. How much should you consider your costs when setting your prices? Pretty much not at all.
Imagine I run a lemonade stand. I'm trying to set the price for a glass of lemonade. Now, I'm not just a lemonade entrepreneur but also a mind reader. My superpower is that I know exactly what my customers are willing to pay for my lemonade. There are 10 people waiting in line for my lemonade: the first customer's willingness to pay—or the maximum price they’re willing to pay for a product or service—is $9, the second customer's is $8, and so on and so forth, until we get to the last customer's willingness to pay of $0 for my lemonade. I have perfect market knowledge. So what's the optimal price for my lemonade?
Assuming that I can't charge different customers different amounts, the optimal price is $5. You can do the math yourself, but if I charge $5, five customers make a purchase, and I pocket $25.
What if I told you that my lemonade costs me $1 per glass to make? Does that change your answer? It shouldn’t. The optimal price is still $5. What if the lemonade cost $4.50 per glass to make? You might tell me I have a bad business, but the optimal price is still $5. Cost has no bearing on what my price should be.
Unlock your team's full potential with The Commons - a premier learning community that gathers 1000+ insightful tech operators from 400+ trailblazing companies.
Did you know 94% of your team would stick with you longer if you invested in their growth? Say goodbye to ineffective training programs and shift to their empowering Sprints, designed to boost your Product, Strategy & operations, Growth, and Strategic Finance teams.
Companies like ResQ, Float, and Thumbtack are already harnessing the power of collective learning and growth with The Commons. Now, it's your turn. Their cohorts are curated and highly limited, but you can get priority access here.