It takes a village to raise a child, as they say. But the same might be said about pricing – although I admit that the phrase “it takes a village to establish a price” is a bit less lyrical than the child-raising version. Nevertheless, pricing is a community event, which flies in the face of how many companies approach their pricing strategy.
In general, there are two broad approaches to pricing: cost based or value based. Cost based is the process of counting up your costs, adding some margin, and, voilà!, there’s your price. Value based, on the other hand, looks at the value the buyer gets from your service and from there designates some percentage of the value the buyer is gaining.
It’s common in pricing discussions to champion the value-based approach. It seems fair and usually yields a better return to sellers.
But pricing doesn’t exist in a vacuum. It exists in markets that have these annoying entities called “competitors”. I think this is an area where all of the academic treatises on price theory have their tables and graphs punctured. A common joke is that business would be a lot simpler if it wasn’t for those darn customers. Similarly, pricing would be a lot easier if it wasn’t for those darn competitors.
An area of distribution friction faced by many companies today is the modern day enterprise buying process, which is (excessively, in my opinion) driven by a procurement-led, price-first mentality. If your service saves the customer $10,000 per month, and you agree that the customer will pay you $3,000 per month, that could seem like a good deal for the both of you. The buyer saves $7,000 per month, and the seller makes $3,000 per month.
All of this works until a company with a service that is only 80% as good as your service offers to perform it for $500 per month. Sure, it’s worse, but buyers in large companies are virtually compelled to either throw you into the ditch to save $2,500 per month over your price OR to use that proposal to beat you down from $3,000 to something very near $500.
One could argue that this is the world we’ve always lived in, but I’ve detected a definite sea change in the past several years. Major scandals and their associated regulation (Enron/SOX) as well as enormous economic downturns (2008/2009 Recession) have strengthened the hand of the process-driven procurement monster.
So where to go with pricing? Here are some imperfect thoughts on navigating the world we live in:
1. Just say no. As Michael Porter famously said, the essence of strategy is choosing what NOT to do, and that may be applicable to pricing as well. Once you establish a new low price due to competitive demands, you’ll certainly never recover at that customer and likely will weaken your own resolve in the next deal. So don’t be afraid to say “no” and walk away. Saying “no” to new business too frequently is, of course, not a great growth strategy (except in the case of limited edition collectibles). But saying “no” every now and again can be a great cultural building block for a team: our work is worth more.
2. Recognize warning signs. This is tied to the “just say no” point above. One sign of danger that smart salespeople recognize as a signal to get out of the deal is the “send me your pricing” request at the beginning of the discussion – well before the buyer has any real understanding of your product and how it works. Whenever this happens it is usually is a good time to run, don’t walk, away from the deal. Remember: there are two winners in every deal – the person who actually won and the person who got out of the deal early and spent her time on more fruitful activities.
3. Control the criteria. This is easier said than done, and is a strategy that has been around as long as people have been selling. Your service has some unique capabilities. Figure out what those are and tie them to customer business value. Hammer away at those capabilities. Don’t stop.
4. Blue Ocean. The Blue Ocean Strategy is about striking into open waters where there are fewer competitors. Peter Thiel recently published a book where he exhorted innovators to try to establish a “monopoly” in a growing market. I confess to rolling my eyes when I read that – and frankly, I’m still rolling my eyes (sure Peter, we’ll all just start the next Google. Thanks for the advice). But…..there is a glimmer of insight here, where we accept that crowded markets yield systems-driven price compression and instead choose to move out to open waters.
If you didn’t find a magic bullet in those ideas, it’s because there isn’t one. But then again, this blog is free so I’d like to think subscribers are getting a pretty good deal (if you’re not a subscriber that was a hint to sign up).
For past post I did on this topic, go here.