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Ask YC: Competitor flying under us...

20 points by theyoungceo ↗ HN
DISCLAIMER: This is kinda long, but if you take the time to read it I will buy you a karma lollipop.

I remember distinctly reading one of PG's maxims: Never let anybody fly underneath you. And we never have.

We are a low cost provider of a hotly demanded product that appeals to public/overnment clients. These particular entities usually pay anywhere between $100K and $20M to have this type of system installed, and can pay ongoing fees anywhere from $500 a month to $500K a year, depending on the size of the organization being outfitted. Suffice it to say that there is a huge market for this product...many many of these organizations all dying to have the product. We have done well with well over $500K in revenue in <2 years, no funding, and a win in a big name startup contest that netted us $100K in cash and prizes out of 250 entrants we competed against.

There are about 6 competitors in the space now. 2 of them are the rolls royce variety -- they don't do any contracts under $1M, have several contracts over $30M, and are public companies or owned by public companies.....they do big government only where the big federal money is, no smaller fish. We aren't really big enough to compete with these fish right now which is fine...we're hot on their tail right now and are very close to taking business away from them.

Two of them are in the middle....been around for 4-5 years, dabble in both big government and small government, both products fairly lackluster and way overpriced. Nonetheless, they are much cheaper than the rolls royces, so they have a smattering of clients that went with them for lack of better option over the years. We have consistently kicked the crap out of them multiple times; neither has ever beat us since we entered the market. We are way beyond them in features and way under them in price, and their customers hate them and call us all the time to switch. Lets call them the Mercedes of the world. They are the least threatening of the bunch.

The last two are "startups" and I use the term loosely. One of these startups scored several "prestigious" contracts before we were around, with a reallllly limited product. They were a little less than the Mercedes variety in price, but IMHO distinctly inferior in features to the Mercedes offering, which was distinctly inferior compared to us. We have had no problem beating them, but occasionally they good a get looking over because they're cheap(er) than Mercedes, but still way more than us.

Now to the issue at hand: the last startup. In this case we have a cornered animal. One man show, has one really small client and is barely a larvae. We knew about him, but never expected to have to take him seriously, because other clients never did and the government rarely goes with early stage startups for anything. The product is really obviously homemade, has zero features other than what we consider the one, basic, bare minimum feature of the product space.

We are at least a third of the way to closing up a large string of smaller government agencies that are associated with each other....we have 3 of them and there are only a few more left. One of the entities in this group is different from all the others in that they draw their funding from an atypical source and are a really ramshackle operation. They are extremely price sensitive. Their folks really love our system, and are totally sold. One thing though: they draw their funding from another department that doesn't give a crap about features, track record, quality or anything, only price. This department also doesn't have to deal with consequences of an inferior system -- they are really just Mom and Dad writing a check for junior to go play with, and are limiting him severely in his allowance. We gave them our standard pricing (which has little margin) and they welched and said semi-finally they are going with the little guy. There are HUGE risks with this because he is remote to them and we are local, and this is an on-site support type of product. We are also universes away in features and they ...

35 comments

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MaysonL
Can you easily downsize your product to where it's substantially less than what X, Y, and Z will want, but more than what one-man Joe is offering? This would also give you the possible future opportunity of selling more features as add-ons.
theyoungceo
We are looking into a different product line that has reduced features for a different type of application in the same vein, but when that option was posed to our decision maker he said he wanted all our functionality and wasn't too interested in a stripped down product....
SwellJoe
I bet he'd also like a pony, and Christmas twice a year.
mailanay
Let this deal go. The company, I was working earlier, had a habit of signing on every customer that knocked their door. In the long run, it created a lot of problems to support those customers (at a very low margin or at a loss), just to maintain the reputation of "not leaving the customers cold" in the marketplace.

Letting this deal go, might also send a strong message to X, Y, Z potential customers, that you are offering much more than the cheapest solution and are willing to walk away.

astrec
Sage advice.

If you do decide to pursue this deal try and take the hit on the upfront and not the ongoings.

johnyzee
Agreed, customers who agonize over price are generally trouble down the road.
wehriam
Perhaps you could lower the initial price, raise the support contact cost, and add a sunset clause. This may appeal to those in charge of funding (who you mention are absent anyway) by shifting dollars around. More diligent clients would see this is not necessarily an attractive alternative and opt for your more traditional pricing model.
trevelyan
If the product and price are reasonable, he should stick to his original pricing. People who need the service will come around as long as it is not terribly expensive, and you avoid perception problems if you change your price wildly.

The reason to be concerned about the competitor offering a cheaper product is if: (1) it will turn into a better product, or (2) it works differently enough to make your business model or product obsolete. Unless either of those conditions are met, this guy should focus on growing his own business rather than trying to crush someone else.

wehriam
This seems like a low-end disruptive innovation. Neither 1 or 2 have to be true for the upstart to become a problem. I don't advocate over-allocating resources towards a competitor who may or may not be a threat. But submitter is already losing business. It may be time to be aggressive.
SwellJoe
You're reading way too much into one piece of advice. The whole "eating from the bottom" thing is a time honored tradition in the computer industry. IBM mainframes were eaten from the bottom by Digital systems, which were eaten from the bottom by Data General mini-computers, which were eaten from the bottom by PCs, which will be eaten from the bottom by mobile devices.

But, your problem is not a paradigm shift that alters the competitive landscape. Your problem is a competitor with unsustainable pricing. Don't play that game. It's foolish and you'll lose more customers than you win by playing it. You'll also dig yourself an early grave (figuratively, and possibly literally, if you take your business too seriously).

Ignore your foolish competitor. Build better products, charge the right price for them (you may still be too cheap), and keep working. The low-priced competitor will continue to lowball his bids, and will eventually get a reputation for under-serving and over-promising. In a year or two, you'll have a chance to re-bid the same customers you lose this year. And the customer won't be so interested in getting the product cheaply.

josefresco
OR, the smaller competitor will deliver a much smaller and simpler product for less money and build a solid reputation as a high value low cost provider who's not over pricing their software just because they're working for the "government" which is known to have deep pockets and understand little about what they're buying.
SwellJoe
"OR, the smaller competitor will deliver a much smaller and simpler product for less money and build a solid reputation as a high value low cost provider who's not over pricing their software"

That's only possible if there has been a paradigm shift that the original poster has not identified. He's stated a few times that his company is operating on thin margins. I'm gonna give him the benefit of the doubt and assume he's running an efficient shop.

I don't believe that leaves room for a "low cost" competitor at the bottom. And, unless it's a commodity, it wouldn't matter anyway. People who do these kinds of acquisitions make a check list...the product that checks off the most items on the list, and brings in a reasonable bid vs. all of the other bidders, gets the contract. It's not like consumer markets.

I still suspect the OP is charging too little, if his product is good, because being the low cost provider in just about any market is not a good place to be. Margins are thin, customer satisfaction is low (think eMachines and Packard Bell vs. Apple and ThinkPad) and you can't make enough to push forward on the projects that'll help you grow and provide better services.

skmurphy
I don't believe that leaves room for a "low cost" competitor at the bottom.

This is precisely the thinking that leads to getting disrupted by a different business model.

SwellJoe
"This is precisely the thinking that leads to getting disrupted by a different business model."

Please re-read my whole comment (and the one above it). I've explicitly discussed paradigm shifts that change the shape of the industry. A "different business model" is obviously one such type of shift. But given the description of the situation, I don't believe the OP is in such a moment in the history of his industry.

skmurphy
I did, it's just that I agree with josefresco's comment, or at least see that scenario as more likely. We have different interpretations of the same information. My other point is the firms that get disrupted always see the alternative as less attractive.
SwellJoe
If that's the case, we can't save his company. If he's being blindsided by a significantly different way of doing business, and one that undercuts his already razor thin margins by a large amount, then his company is already dead and just doesn't know it yet.

That could be the case, of course. So, you're right, we are just taking a different view of the provided data.

theyoungceo
Some clarification on what this product does... * It requires a physical component beyond desktop computers, one that requires ongoing support and maintenance and precision installation. This isn't like a sales order system or something like that, it might more be called a public works project. * It is a service-based ASP model * Bear in mind that the usual pricetag for organizations of medium to large size is $2M to $30M and we are doing these deals in the $100-200k range so we very much are operating on razor thin margins
skmurphy
So your smaller competitor is doing to you what you are doing to your more established competitors. Do you think your major competitors initially discounted your ability to prosper? Also from the perspective of your prospects, given that the next nearest major competitor is 20X your price there may not be enough of a difference between you and your lower priced competitor. Why not be just be 1/2 price of your nearest major competitor instead of 5%? Do you have to discount so strongly? Will you significantly enlarge the number of buyers with your price point or just shrink the total spend in the market? You may be being excluded from many more deals because your price is not credible (e.g. are you trying to sell a $10 car, people wonder what's missing or wrong with it).
theyoungceo
There are two types of government entities: let's call them "private" and "pseudo private"....then there is a third type that is very public, very well funded, and very demanding. The first two markets were grossly underserved because they couldn't dream of affording the product for the third. A few startups have sprung up in this area, and that's where we got our start. Only the two rolls royces have any substantial market share in the big public market, and we're going to be the first company of the little guys poised to make the jump into the big one. We're trying to figure out how we're going to multiply our price by 20x, and it is probably going to mean we fork the product development into two separate lines for the smaller ones and the bigger ones even though the cost structure is more or less the same. The big big guys have been enjoying OBSCENE margins (think 5000%) in the big market for a long time due to the barrier to entry of "establishment" there.
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theyoungceo
OK guys. I have to admit that I was planning on meeting the price and driving down to the customer site this morning to hand deliver it, but upon reconsideration with several advisors including the great ones here, I'm not going to do it. We do have the best product in the market at a very fair price by all measures, and our success shows that. The client in question has already admitted that he knows the funding people are making a mistake and they are probably going to eat it, so I'm going to emphasize the differences and let them stew in their own decision. We are all but guaranteed to win in three other sister entities to this one, and if we have to let one go to hold our line then that's life.

I owe you all some karma lollipops, they will arrive overnight tomorrow.

m0nty
Just make sure you walk away graciously and make it clear you'll still be there when you're needed. Keep sending them your newsletter or other promo material with details of your latest features, case studies of other satisfied customers, testimonials, etc. If these people are digging a hole for themselves, make sure you're the guy who has the rope ready when it starts filling with water ;) These guys could end up being one of your most loyal customers ever, if you save their asses later. Good luck.
dkokelley
Another thing you can do in both this situation and for your company in general is plan on raising your prices.

You've said that you are operating on razor thin margins. Raise your price and possibly get the attention of the clients of the higher-level competitors.

It's also a kick in the rear to your current potential client that "you are worth it," showing them that this is a good deal for them and that what you're offering is clearly a steal at the present time.

Whatever you do though, don't "threaten" to raise prices on them if they don't call in the next 10 minutes. Just let them know, "We're planning on raising our prices about 15% (made up) next year (quarter, month, whatever), but if you decide the other guy isn't what you need we'd be happy to work something out for you. Just let us know soon."

Goodluck!

skmurphy
So what happened? It's been a month and I am curious how things settled out.
petercooper
Be honest with this potential client. Don't act or sound bitter or jealous at all. Totally accept their decision but just point out that if they need you at all in the future, you're just at the end of the phone.

If your competitor is as inferior as you say, those agencies might come back to you for advice on how to "fix" the problem caused by the competitor. Then you can charge more and still look helpful.

This happens a lot in other industries and I have personally benefited from it myself. You get to look good, charge more, and providing service to a customer that was previously shafted is easier than one demanding perfection from day one.

iamelgringo
You'll never win with a price buyer. You can cotton to his needs, but they won't stop until the price is free.

It sounds like you are selling to enterprise and/or government. The normal rules about being the low cost provider don't apply like they would in the consumer market. Joe Spolsky has some interesting tidbits on that one. Every time they increased Fogbuz's, their sales went up as well. There's an aura of price==quality in enterprise software. Instead of offering a product with less features for a cut-rate price, introduce a deluxe version with a couple extra features and double the price. You might be surprised.

dcminter
I have no advice, but this worries me:

"The product [...], has zero features other than what we consider the one, basic, bare minimum feature of the product space."

That sounds like a well targeted product to me, however you feel about it. Could you produce an economy version of your existing application that only had that feature? Then you would be in a good position to upsell later on. Even if the time scales make it impractical for this bid, it might be useful if you come up against this guy again later.

TrevorJ
depends on how you define features. For instance if you say that a firewall has a single feature of keeping your network safe then maybe not, but in reality, there are lots of sub-features involved in that that may not be irreducibly complex.
josefresco
"I can meet their price with little margin, and it's not a big deal, we'll still make money on the up-front but we'll make a lot less than usual on ongoing (not a problem)"

Industries with a high enough profit margin that they can still make good money even with discounting heavily are doomed for extinction, and replacement by someone smaller, younger and hungrier. Good luck and enjoy your success while it lasts.

fdschoeneman
A couple of short pieces of advice. This is a tactical sales problem, not one of strategy or positioning. It sounds like your strategy is just fine. Do your best to at least slow down his decision cycle (keep him from making a bad decision for his organization) which prevents your low-flying competitor from early success. You can do this by offering a very limited version of your product for him to review that matches your competitors features, or ask to delay the decision until you've had a chance to show your product to other stakeholders. There's some chance the buyer is simply using the other company as a negotiation tool to get your price down.

In which case, ignore it. Find the customers who see their problem clearly, and why your specific solution takes care of their needs better than anything else, an concentrate your efforts on them.

Also, if you haven't read SPIN Selling by Neil Rackham, consider doing so when you get some time.

Good luck!

skmurphy
Not enough data to determine if it's a tactical problem or a strategic problem. It would be interesting to hear the "tiny startup competitor's" perspective. They sound a lot like the early cisco. If the poster can't find a feature/benefit that segments the market away from this low cost provider so that his feature set no longer qualifies, it's not clear what stops them from taking this win and continuing to prosper at his expense.
skmurphy
No one ever went broke selling at a profit. If you let this smaller competitor win he now has a bona fide win against you he can cite the next time you run up against him. If X, Y, and Z are close they will also be influenced by the win. The government buys on price, something to bear in mind if you want to continue to play in that market.
maxklein
Drop the price sensitive people. Those guys suck up your time and make the entire business no longer fun. The guys with money are always there for follow ups, upgrades and so on.
kashif
Here is what I would do. I would take the contract at a lower price and ensure that the other guy is history. This is good because

1. It breaks the competition's back. And leaves no room for him to claim territory in the future.

2. With the one man competitor dead you can start increasing prices, clearly in your market there is room for higher pricing. And spend your energy on tackling the rolls-royce and whatever other car you got going there..

heyadayo
Sell this customer a crippled version of your software. Just make it slightly better than your competitor. This 1) Provides a clear future sale when this customer wants to upgrade, and 2) Allows you to sell at your standard rate to X, Y, and Z.