Forward Pricing: A Key Ingredient to Disruption

These days, the term "disruption" is all the rage in business and entrepreneurial circles. Startups want to "disrupt the status quo" with slick designs, clever business solutions and innovative products, but too often find themselves mired in cost and production problems. Limited bargaining power means higher production costs, and startups lack economies of scale to spread the high costs to their fixed goods. As a result, innovative products are priced out of a competitive range, and good ideas quickly turn into missed opportunities.

So if you're a startup or an entrepreneur, how do you work around these cost and production problems? How do you price your products to achieve hyper growth for your company and disruption in your industry?

The answer turns out to be very straightforward: Forward Pricing.

Over the last twenty years of starting and growing businesses, I've been able to level the playing field with large competitors through a combination of two tactics: Absorbing the costs of lowering prices for consumers with the knowledge that it will pay off in the future, and finding ways to obtain future costs in the present.

To help you achieve this sort of rapid growth, here's a step-by-step breakdown on how to use a "forward pricing" strategy to keep your company competitive with its rivals and reshape your industry in the process.

Step 1: Look for Creative Cost-Cutting Solutions

Staying price-competitive on an industry level involves making a lot of small decisions on a company level. The first step is to look for small ways to shave costs, and one way to do this is look at trends of declining costs, whether that be market driven or volume driven.

  • Volume-led forward pricing

At a vendor-specific level, costs will go down as your commitment to suppliers goes up. At one of my companies -- the mobile service provider Ultra Mobile -- one tactic we employ to achieve lower costs is what I call "ramp-up" volume targets. These discounts presented us with a crucial opportunity to scale the business quickly. We set up contracts to pay one of our suppliers a discounted rate based on volume over a three-year period, with volume targets that increased over time. By having our key supplier "forward price" to us, i.e. give us lower prices for bigger anticipated volumes in the future, we were able to benefit from lower prices as we ramped up our customer base.

This was a risky move; if we didn't hit our milestones, we would have to pay back the discounts we'd been given. However, our advantage was that our vendors were excited to work with us in the present, and we demonstrated the growth potential of our business relationship by assuming most of the risk in the transaction.

Our willingness to take a risk meant a lot to our vendors, and Ultra Mobile was ultimately able to lock in the volume targets. If you're looking to make your vendors happy, small cost-saving measures like "ramp-up" targets create additional incentives for your company to push for extra customers.

  • Industry-led forward pricing

An industry's holistic growth can lead to lower costs for everyone. An example of this is wholesale international voice rates, and IndiaLD -- one of my other businesses which sells India-focused international calling -- sees these rates as its primary cost. We've seen rates drop relatively consistently over the past 10 years that we've been in this business.

This audience is so price-sensitive that dropping your rates 1-2 percent below competitors will cause some of their customers to migrate to you. Traditionally, a firm in the industry would wait for a drop in production costs, and then pass those savings straight on to customers. Immediately afterward, that company's competitors would drop their prices to the same level as a retention measure.

We chose to use forward pricing as an acquisition play. We did this by forecasting where rates would be, and then we forwarded that price drop to consumers. We'd take a hit in the short term, but the customers we'd win by dropping our prices before everyone else paid dividends in the long term once the rest of the industry followed suit.

Step 2: Maintain Incentives

Once you've made the decision to use forward pricing and done your pricing calculations, the question still remains: How do you keep everyone (namely sales people and distributors) on board as you grow? The answer is once again pretty straightforward: Incentivize them.

At Ultra Mobile, we were able to keep our sales team on board during our growth by giving them performance-based compensation deals, with stretch targets that paid out proportionately more money if salespeople hit them. It was a no-brainer -- better compensation makes salespeople happy and encourages rapid growth.

On the supply side, we incentivized distributors by asking for discounts if they hit certain sales figures. Though it may seem counterintuitive, we noticed that distributors tended to accept discounts once they saw how much business they were going to do with us. After all, it's a lot better to take a smaller margin on $1 million in sales than a larger percentage of $100,000.

If you incentivize people to grow, you'll be able to maintain your level of growth over a period of time. This is a crucial step in making a splash in the industry overall.

Step 3: Drive with Hyper-Growth

If you've set volume targets for your suppliers and incentivized your distributors and sales teams properly, the final step is to drive hyper growth by passing the price cut on to consumers: Forecast where rates will be in the future, and forward that price drop to consumers in the present.

Forward pricing has been a key ingredient in achieving extraordinary growth at every one of the companies I've founded. Not only does setting a forward price allow your low-margin business to remain competitive with more-established rivals, but by assuming your company will grow quickly over the next three years, you create a self-fulfilling prophecy that pushes your employees to do whatever it takes to scale your firm to its profitability tipping point.

This, however, is not enough.

In order to truly disrupt an industry, your organization needs to be built from the ground up for the express purpose of achieving hyper-growth. This means staffing your team with flexible, entrepreneurial employees, instituting a culture that encourages people to take risks on new opportunities, and being willing to dig deep for creative solutions like the ramp-up contract clause.

That said, if you start with forward pricing to lower costs and scale production, you'll be one step closer to eliminating your rivals' competitive advantage. That sounds pretty disruptive to me.