Pricing is one of the core strategic challenges facing all businesses in today’s post-crisis, “global-digital” marketplace. Too high and the market rejects your number as uninformed, too low and the market rejects it because of low perceived value. A common problem is that most companies base pricing on the total cost of goods sold rather than its true value in the marketplace. Patrick Lefler, CEO of the Spruance Group, a world leader in pricing strategies, tells us that one of the common mistakes we make is to calculate prices based on our input costs. He quoted the following during a recent presentation about how not to think about pricing:
“Most of us think in terms of what we do (costs, inputs), not in terms of how the client will prosper. It’s absurd to base price on things that are important to us instead of what’s important to the client.” Alan Weis, PhD, Pres., Summit Consulting
According to Lefler we should determine the value to the customer first, and then go back and strike that number against costs and see if it makes sense. Not the other way around. This makes terrific sense on a number of levels. First, in terms of the coherence with the principles of Guess Free Selling:
“Never discuss your price except in the context of the financial benefit that the client will obtain from your product or service.” GFS, Investment Management, Rule #1
I know – some of you are thinking, “But my stuff really is a commodity – it’s all about price.” Notice that the rule doesn’t say never to negotiate price or that price doesn’t matter. It says to go through the GFS process before you get to your price. If you fail to make a habit of taking every sales conversation sequentially to the “Investment” stage then both you and the prospect are doomed to remain at a commoditized pricing state. Remember, money is an abstraction, but your product has true component value in the buyer’s business. But if no effort has been made to understand what that value is (different to every customer) – no other reality has been created between you with respect to what your product means to them – it’s only the number.
Lefler states Six Rules for getting the most for your products and services:
- Customer Value Pricing NOT Cost Based Pricing. If CVP is lower than CBP there’s a structural problem.
- Value in Anchor Pricing. There are plenty of examples of businesses that cleverly use multiple price points to give the customer the perception of value based on a choice of numbers – when there is really little choice at all. William-Sonoma’s $249 bread machine had plateaued in sales until they added a second bread machine for $449. The more expensive oven did sell moderately – but the $249 sales doubled when compared to its volume as a stand-alone category.
- Never Underestimate the Power of “FREE”: Companies should not discount their core product, but “Free” is an effective and proven strategy for driving business when used in marketing scenario to add value to a proposal; or as a device to consummate a price negotiation by providing something of perceived value for free without reducing the value of the core product.
- Innovate with Price: Lefler notes that “Pricing and innovation are not normally associated together in the same sentence. … sometimes even simple changes in a pricing model can lead to dramatic improvements in bottom line growth.” He goes on to relate how GE transformed its position in the highly competitive aircraft engine business by innovating its MRO (maintenance, repair and overhaul) business by instituting a “power-by-the-hour” services agreement whereby MRO pricing was billed based on the number of hours that the engine was in operation rather than by the “parts and labor” method. This price innovation was a direct result of GE conversations with their customers.
- Price Drives Perception of Value: The Humane Society of Silicon Valley had a problem – people were returning the pets they adopted at a rate that was overwhelming the organization. After a study of the situation management determined that there was an inverse relationship between the cost of the pet and the likelihood of a return – the lower the price the greater the chance of return. The solution they chose was to increase the adoption pricing by 300% and the result was a 10% increase in adoptions and a 50% decrease in returns. This illustrates clear proof of the danger in of assuming that lower prices drives volume.
- Priced to Death: Lefler uses a story from R. Mohammed’s, “The Art of Pricing” about the turn of the century price war between the Erie and the Central Railways (which drove both companies to the brink of failure) to illustrate this essential lesson. “Don’t kid yourself – price wars are a fool’s game.” The temptation to follow a competitor tit-for-tat down the discounting rabbit hole is a compelling one, especially with the encouragement of an astute buyer and a vulnerable (read gullible) salesperson. Procurement professionals are highly trained in techniques to manipulate salespeople to cut their prices, and most salespeople are unprepared to deal with the pressure, (thus highlighting why salespeople require at least an equal measure of training in countermeasures).
The salesperson is the front line in getting the most revenue for the firm’s product, and as an important source of information about pricing conditions “on the street”. For the sales force to make relevant and well-tempered observations about pricing requires them to be trained in the various dimensions of what their price communicates to a buying organization beyond a mere starting point of negotiations that invariably lead to shrinking margins. They need to know how to ask the sort of reality testing questions about the true value to the buyer’s organization; how to create attractive pricing scenarios, and how to seek innovative pricing strategies that can lead to more deals at higher margins.