What To Do When Your Pricing Model Doesn't Match Your Avatar | Ep 865
In this episode of The Game w/ Alex Hormozi, the challenges faced by service providers targeting very small businesses (VSMBs) are examined. Hormozi highlights the mismatch between the volatility of VSMBs, which often cut services during lean periods, and the need for consistent, scalable solutions from their service providers. This instability leads to unprofitable, custom services for providers.
Hormozi advises businesses to choose their market segment carefully. Catering to higher-end customers requires pricing for "worst months" and potentially lower margins. Conversely, serving VSMBs necessitates high-volume, tech-driven services to offset lower customer lifetime value. Whichever path is chosen, he recommends fully committing to an aligned strategy and developing systems to profitably and sustainably serve the target market.
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1-Page Summary
The Mismatch Between Service Model and Target Customer
Alex Hormozi highlights that businesses serving very small businesses (VSMBs) often struggle with an inherent mismatch: the unpredictability of VSMBs cutting services in lean months versus the need for service providers to offer consistent, scalable solutions. This volatility leads to instability and unscalable, unprofitable custom services for these providers.
As VSMBs face fluctuations, Hormozi notes, they tend to cut services in bad months, creating unstable revenue for their service providers.
Businesses must choose to move up-market with higher prices and custom solutions, or down-market with scalable, tech-driven services.
Going up-market requires pricing for the "worst month" of customers, leading to potentially lower margins for providers, according to Hormozi.
Targeting lower-end markets needs high-volume, high-margin services to offset the lower customer lifetime value, he advises.
The Challenges of Serving VSMBs
The high churn common with VSMB customers forces a constant cycle of new acquisitions.
To address this churn, businesses boost advertising, raising acquisition costs and cutting margins, Hormozi explains.
This churn also leads to frustrated teams constantly onboarding replacements for customers who quickly leave.
While churn demands acquiring more customers, major acquisition spikes cause operational challenges.
Slowdowns in acquisition leave employees underutilized, Hormozi points out.
Big acquisition swings also disrupt operations if companies scaled for more business.
Strategies For Addressing the Mismatch
Hormozi advises businesses to carefully choose their target market segment:
Going up-market demands preparing for customers' "worst months" through worst-case pricing, accepting potential margin hits.
Down-market expansions require scalable, high-margin tech services to profitably serve high VSMB volumes.
Hormozi recommends fully committing to the chosen strategy:
Stick with either higher-end custom services or lower-priced templatized offerings, aligning capabilities accordingly.
Develop processes and systems to sustainably and profitably serve the target customer segment, whether up- or down-market.
1-Page Summary
Additional Materials
Clarifications
- VSMBs, or Very Small Businesses, typically have fewer employees, lower revenue, and simpler operations compared to larger enterprises. They often face challenges such as limited resources, fluctuating cash flow, and high sensitivity to market changes. Serving VSMBs requires tailored strategies due to their unique needs and constraints in terms of budget, scalability, and service requirements. Understanding the specific characteristics and dynamics of VSMBs is crucial for businesses aiming to effectively cater to this market segment.
- Churn in the context of customer turnover refers to the rate at which customers stop doing business with a company over a specific period. It is a crucial metric for businesses as it directly impacts revenue and growth. High churn rates indicate that a company is losing customers at a faster pace, which can lead to increased costs associated with acquiring new customers to replace the lost ones.
- Operational challenges related to major acquisition spikes occur when businesses experience sudden and significant increases in acquiring new customers. This can lead to issues such as underutilized employees during slowdowns in acquisition and disruptions in operations if the company is not prepared for the influx of new business. Managing these spikes effectively is crucial to maintaining operational efficiency and ensuring a smooth transition as the business scales.
- Worst-case pricing for customers' worst months means setting prices based on the lowest revenue a customer might generate in a given period, typically during their slowest business months. This approach helps service providers ensure they can cover their costs and maintain profitability even when customers are not utilizing services at their peak levels. By pricing for the worst-case scenario, businesses aim to protect themselves from potential revenue fluctuations and maintain financial stability throughout the customer's lifecycle.
- Customer lifetime value (CLV) is a prediction of the net profit a business expects to earn from its entire future relationship with a customer. It helps companies understand the long-term financial worth of individual customers and guides decisions on marketing strategies and customer acquisition costs. CLV focuses on the future value a customer brings rather than just immediate profits, encouraging businesses to prioritize building strong, lasting customer relationships. By calculating CLV, companies can determine how much they can invest in acquiring new customers while ensuring profitability and sustainable growth.
Counterarguments
- While targeting lower-end markets may require high-volume, high-margin services, it's also possible to achieve profitability through cost leadership and operational efficiency without necessarily having high margins.
- Moving up-market with custom solutions might not always lead to lower margins if the business can provide significant value and differentiate itself, allowing for premium pricing.
- The assumption that high churn is inevitable with VSMB customers may not hold if a service provider can deeply understand and meet the specific needs of VSMBs, leading to increased loyalty and reduced churn.
- Increased advertising costs due to churn could be mitigated by investing in more effective customer retention strategies or referral programs, which might be more cost-efficient than constant customer acquisition.
- The dichotomy between up-market and down-market strategies might be overly simplistic, as there could be a middle path that offers moderately customized solutions at a scalable level.
- The recommendation to fully commit to either higher-end custom services or lower-priced templatized offerings might not consider the potential for a hybrid model that can adapt to customer needs while maintaining scalability.
- The idea that businesses must prepare for the "worst month" in up-market strategies might not take into account the potential for building flexible pricing models that can accommodate fluctuations in customer demand without sacrificing profitability.
- The focus on operational challenges during acquisition spikes doesn't address the possibility of using flexible staffing models or automation to handle fluctuations in workload.
- The advice to develop processes and systems for sustainability and profitability is sound, but it may not acknowledge the need for continuous innovation and adaptation in a rapidly changing market.
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The Mismatch Between Service Model and Target Customer
Businesses serving very small businesses (VSMBs) often find themselves struggling to scale due to a fundamental mismatch between their service offerings and their customer base. This situation can create unsustainable or unprofitable service models.
Scaling Struggles From Mismatched Services and Customers
Consistency is key for business scalability, yet businesses that offer services to VSMBs face a unique challenge. The inherent volatility of VSMBs means that during their bad months, it can lead them to cut back on services as an expense-saving measure. This unpredictability results in service providers to VSMBs experiencing significant financial instability.
Vsmbs Face Volatility and Cut Services In Bad Months
With VSMBs experiencing fluctuating financial months, companies servicing them may suffer during the VSMBs' lean times, leading to an unstable revenue stream for the service provider.
Serving Vsmbs Often Leads To Unscalable, Unprofitable Custom Services
When agencies or service providers target small businesses with high-touch, custom services, they can find themselves in difficult positions of providing unprofitable and unsustainable services. The reality of offering custom solutions without the benefit of scalability creates a painful no man's land where businesses struggle under the weight of unrealistic customer expectations and difficult operations.
Businesses Can Choose to Move Up-market or Down-Market to Address This Mismatch
Businesses looking to correct this mismatch face strategic choices about their target market and service delivery model. They can opt to go up-market with higher prices and more customized services or go down-market with scalable, technology-driven services.
Up-market Moves Require Worst-Case Pricing and Lower Margins
A move up-market requires businesses to consider the worst-case scenarios of their customers' financial stability, often leading to worst-case pricing strateg ...
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The Mismatch Between Service Model and Target Customer
Additional Materials
Clarifications
- VSMBs, or Very Small Businesses, typically have a limited number of employees, a small customer base, and lower revenue compared to larger enterprises. These businesses often operate on a smaller scale, with simpler organizational structures and fewer resources. VSMBs play a significant role in the economy, contributing to job creation and local communities.
- High-touch, custom services typically involve personalized and hands-on interactions tailored to meet the specific needs and preferences of individual clients. These services often require a high level of human involvement, attention to detail, and customization to deliver a unique and specialized experience for each customer. Businesses offering high-touch, custom services focus on building strong relationships with clients, providing dedicated support, and delivering solutions that are uniquely crafted to address the client's specific requirements. This approach contrasts with more standardized or mass-produced services that may not offer the same level of personalization or individualized attention.
- Customer lifetime value (CLV) is a prediction of the net profit a business expects to earn from its entire future relationship with a customer. It helps companies understand the long-term financial value of individual customers and guides decisions on marketing strategies and customer acquisition costs. CLV focuses on the future potential of a customer rather than just past profitability, encouraging businesses to prioritize buil ...
Counterarguments
- VSMBs may not always lead to financial instability if service providers diversify their client base or offer essential services that VSMBs cannot easily cut.
- Custom services can be profitable if they provide significant value to VSMBs, leading to higher customer retention and willingness to pay.
- Businesses could find a niche market serving VSMBs that allows for both customization and scalability, challenging the dichotomy of moving strictly up-market or down-market.
- Worst-case pricing strategies might not always result in thinner margins if they lead to more consistent revenue streams and customer loyalty.
- Down-market strategies ...
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The Challenges This Mismatch Creates For the Business
Alex Hormozi discusses the challenges businesses face when they have high churn rates, a common issue when targeting very small businesses (VSMB).
High Churn Causes Constant Customer Acquisition
The cycle of high churn rates forces businesses into a loop of constant customer acquisition. Hormozi uses the analogy of a "hamster wheel," where new customers are continuously being onboarded, only to fall off soon after, leading to a relentless need for more customer acquisition.
Businesses Address This By Boosting Advertising, Which Raises Acquisition Costs and Cuts Margins
Businesses try to mitigate this high turnover rate by boosting advertising, but this strategy increases the cost of acquisition and decreases gross margins. The influx of cash needed for advertising diminishes profitability as businesses are pushed to compensate for the constant churn by reaching even more potential customers.
Churn Leads To Frustrated Teams Onboarding New Customers
Constant churn leads to so-called churn factories, where teams become frustrated and burnt out due to endlessly onboarding new customers that often leave within three to four months. This frustrating cycle can take a toll on employee morale and productivity.
Rapid Growth in Customers Can Create Operational Challenges
While high churn necessitates constant customer acquisition, rapid increases in new customers can present a different set of operational difficulties.
Dips in Customer Acquisition Leave Employees U ...
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The Challenges This Mismatch Creates For the Business
Additional Materials
Clarifications
- Gross margins represent the difference between revenue and the cost of goods sold, expressed as a percentage. It helps businesses understand how much money they make from their core business activities. By calculating gross margins, companies can assess the profitability of their products or services before factoring in other expenses. Understanding gross margins is crucial for pricing decisions and evaluating the financial health of a business.
- Operational difficulties in a business context typically refer to challenges related to the day-to-day functioning of the company. This can include issues with managing resources efficiently, adapting to changes in customer demand, or maintaining smooth workflows within the organization. Operational challenges often arise when there are disruptions in processes, fluctuations in workload, or inadequacies in the systems and structures that support the business operations. These difficulties can impact various aspects of the business, such as employee productivity, customer satisfaction, and overall profitability.
- Underutilization of staff occurs when employees have less work than they are capable of handling, leading to inefficiency and potential demoralization within the workforce. This situation often arises during periods of decreased customer acquisition or when operational demands do not align with the available workforce capacity. It can result in employees feeling unproductive or undervalued, impacting both individual morale and overall company performance. To address u ...
Counterarguments
- High churn rates may not always lead to a cycle of constant customer acquisition if a business has a strong base of loyal customers or if it operates in a niche market with limited customer potential.
- Boosting advertising is not the only strategy to address high turnover; businesses can also focus on improving customer retention through better service, product enhancements, or customer loyalty programs, which may be more cost-effective in the long run.
- While constant churn can lead to frustrated teams, it can also provide valuable feedback for the business to improve its offerings and customer service, potentially leading to reduced churn over time.
- Rapid growth in customers can be managed effectively with proper planning and scalable processes, turning it into an opportunity for the business rather than a challenge.
- Dips in customer acquisi ...
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Strategies For Addressing the Mismatch
Businesses today face the dilemma of targeting their services for a specific market segment and need to adopt strategic approaches to address this service and customer mismatch.
Evaluate Whether to Offer Upscale Custom Solutions or Budget Templated Services
Hormozi speaks to the crucial decision businesses must make: whether to target up-market customers with customized solutions or down-market customers with scalable, templatized services. This strategic choice implies considering worst-case pricing and potential for lower margins when going up-market, or focusing on scalable, high-margin services for down-market expansions to manage high volumes of very small businesses (VSMBs) sustainably.
Going Up-market Demands Worst-Case Pricing and Lower Margins
Hormozi underlines the need for businesses to prepare for the worst-case scenarios, particularly when going up-market, as this would demand pricing based on clients' worst months, which can lead to lower profit margins for service providers.
Scalable, High-Margin Services Needed For Down-Market Expansion
For businesses considering down-market expansion, Hormozi implies the necessity of creating scalable and tech-driven services that can manage a considerable number of accounts per representative, while maintaining high gross margins with lower-priced, templatized offerings.
Consistently Implement the Chosen Strategy
Hormozi recommends a few vital strategic decisions based on the market orientation of the business.
Commit To Service Model and Target Customer Profile
Businesses must commi ...
Here’s what you’ll find in our full summary
Strategies For Addressing the Mismatch
Additional Materials
Clarifications
- VSMBs (Very Small Businesses) typically have a limited number of employees, a small customer base, and lower revenue compared to larger enterprises. These businesses often operate on a local scale and may have minimal resources for growth and expansion. VSMBs play a crucial role in the economy, contributing to job creation and innovation despite their size constraints.
- Worst-case pricing involves setting prices based on the lowest revenue a customer might generate, preparing for scenarios where clients may not utilize services to their fullest potential, impacting profit margins. This approach helps businesses anticipate and mitigate potential financial risks associated with serving high-end markets by considering the least favorable outcomes. It aims to ensure that pricing strategies are resilient enough to sustain profitability even during challenging periods when customers may not fully utilize premium services.
- When a business commits to a service model and target customer profile, it means they choose a specific approach to cater to either high-end customers with customized solutions or budget-conscious customers with standardized services. This commitment guides all aspects of the business, from product development to market ...
Counterarguments
- The dichotomy between upscale custom solutions and budget templated services may be oversimplified; there is potential for a hybrid approach that offers a degree of customization within a templated framework.
- Worst-case pricing for up-market services might not always result in lower profit margins if the value provided justifies the cost and clients are willing to pay a premium for tailored solutions.
- Scalable, high-margin services for down-market expansion could lead to a race to the bottom in terms of pricing and quality, potentially damaging the brand and customer satisfaction in the long term.
- Committing to a single service model may limit a business's flexibility t ...
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