One of the fundamental pillars of neoclassical economics is rational choice theory. Rational choice theory relies on the assumption that people make rational decisions to maximize personal advantage. So that means wanting more, rather than less, of a good that provides value. Since there are constraints on resources (you don’t have unlimited time or money) people make choices on how to optimize that personal advantage.
If you ever took micro-economics, you probably remember the classic supply and demand curves. You move the price up and the quantity of goods sold decreases – makes sense!
However, if you have spent any time in the real world you will quickly realize that people are not rational at all. Even if people were rational, there are many different ways to measure personal advantage over different time horizons. For example, taking crystal meth may be rational in the short term (it makes you feel great, now!); but over the long term, it will likely destroy you.
Behavioral economics attempts to address this hole in rational choice theory and it’s crucial for startups to understand these concepts given the competitive landscape. By understanding them, you can employ these concepts to hack the behavior of your potential customers. There are a ton of new companies fighting for each person’s limited resources and you need every advantage you can get.
As a startup, you can’t simply launch a product and expect people to flock to your site to use it. You need to help people understand why they need your solution and what type of plan or service to purchase. There is a great book, Predictably Irrational: The Hidden Forces That Shape Our Decisions, that describes the many different ways that humans act irrationally when making purchasing decisions. You will see smart startups taking advantage of these irregularities in behavior to acquire customers and their money. Here are some examples that we used at Mailgun.
Anchor To What Your Customers Find Valuable
Diamonds are nothing more than a chunk of coal, but people love diamonds (see diamond-water paradox). This has been accomplished by some questionable methods to limit supply and a copious amount of advertising that diamonds are associated with wealth and other desirable things. We see starlets flaunt diamonds on the red carpet and NBA stars show them off in postgame press conferences. This concept of diamonds equating to wealth is anchored in the collective knowledge of the consumer.
Your consumers have someone, or some company, that they look up to. As a startup, you want to anchor your brand to the things your buyers admire. We had many companies and organizations using Mailgun, such as GitHub, Stripe and Parse, that are esteemed in the developer community. We also have other companies using Mailgun that are bigger and have more brand name recognition to the general public.
However, our target customers are developers, so we need to associate Mailgun with other companies that developers admire. We made sure to place these companies’ logos at the top of our website, right below the header, in effect telling our prospects that, “The developers you respect use Mailgun, so maybe you should too.” It’s important to remember that these logos do not have to be the most important or profitable to your business – they just need to be the most persuasive brands for getting your potential customers to sign up.
Design Is Important
If you are going to offer packaged pricing (and you probably should when starting out), offering three or four plans is usually optimal. Offering multiple plans helps funnel the buyer and the plans provide anchors for each other.
By offering multiple plans you also allow your customers to maximize their utility. Some customers may value your enterprise plan with its SLA and custom contracts and are willing to pay up for that. Others may just want the basics. You should give each the opportunity to pay you!
There are some optical illusions that can be helpful to incorporate in your options. You have probably all seen this one:
If a ball is surround by smaller balls, it will appear larger. However, if larger balls surround that same sized ball, it will appear smaller. Surroundings can have a large impact on what we perceive visually. This is one of the reasons that it is so popular to wrap a thicker border around one of plans. The border draws the eye in.
This has played itself out with scammers that signup for Mailgun. They sign up with stolen credit cards in the hope of sending out phishing emails. Since they are stolen credit cards, they are indifferent to the cost of the different plans. They almost always chose the Priority Plan (our featured plan).
Creating The Context For A Sale
There is a lot of perceived value in “free.” The book examines this trend with an experiment where high-end Lindt chocolates were offered for 15 cents, while a Hershey Kiss was offered for a penny. The result was five times as many people opted to purchase the Lindt chocolate. Later, they lowered the cost of each chocolate by a penny, making the Hershey Kiss free. This action caused the ratio to effectively flip, with five times as many people opting for the Hershey Kiss, even though the price difference between the two chocolates was the same as before.
The freemium model can be an effective marketing tool, but you have to consider the down side. First, you must support customers who are now using your software for free. While this may make sense for some business models, it is an important topic to consider. Second, you have to examine the “cost of free,” namely cheapness. Free is associated with scams and crappy products.
Creating the right context is important for a startup: you have to know what type of service you are going to offer. We all know that it would be socially unacceptable to thank our aunt for a great Thanksgiving meal by paying her $100. The appropriate response would be to bring a side dish or a bottle of wine. Conversely, a simple “thank you” won’t work at a restaurant – you better have some cash on hand. At Mailgun, we made our freemium option limited and subtle. While we didn’t put the option in the buyer’s face, we did want a way for people to get their feet wet with our service. We found it important to establish the context that Mailgun is indeed a paid service and in return it provides value.
So those are a few of the tricks that we have employed to grow Mailgun. In the end, none of these tricks matters if you don’t have a good product; that always needs to be the No. 1 priority. I definitely recommend reading Predictably Irrational: The Hidden Forces That Shape Our Decisions and other books about behavioral economics to learn more about how irrational humans can be. Patrick McKenzie (aka, Patio11 for the Hackernews crowd) recently gave a great talk on these topics, as well.