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By Patrick Lefler
Value-based pricing is the ultimate objective for most organizations. It’s what enables successful firms to charge above-average industry margins for their products that ultimately drive superior bottom-line results. But to be successful, value-based pricing requires having clearly defined benefits that differentiate you from the competition. Benefits, communicated through your value proposition, must be so strong that buyers will recognize the value you bring to the table and be willing to pay your asking price. [1]
Successful implementation of this strategy requires a combination of hard work, patience, confidence and a little bit of luck. As you move down the road of success for value-based pricing, beware of these three challenges that must be overcome to reach that final destination.
Do the required heavy lifting
Unlike cost-based (or cost-plus) pricing, which only requires a percent markup over costs, value-based pricing requires that you compile a full inventory of the benefits offered to your customers during the price discovery process.
This is the “heavy lifting” that requires you to leave the office and meet with key prospects. Talk not only to the economic buyers, but also survey the end users, the influencers and the key recommenders. They all have a stake in the buying process and they all have their own opinions as to the actual value of your product or offering. And don’t forget to ask about your competitors—talking to your potential buyers is sometimes the best way to glean information about the competition.
See which value propositions resonate best with your audience. Find out what existing products are out there and how much perceived value they add. Gather data on how they are priced. As you collect this data from your audience, you will begin to have a better feel for the perceived value of your product.
In new markets, sometimes the value is determined by the cost of alternative solutions available to the customer. These alternative solutions can be anything from internal development within the buyer’s organization to, in some cases, many different products that are currently being purchased by the buyer that can be replaced by a single product or offering.
Another area to examine is the non-product features that prospects might highly value. Depending on the offering, unique services can add significantly to the value of your product. Additionally, other non-product features, such as offering easy availability and fast delivery through distribution channels, should not be forgotten. You might be surprised at the value that some buyers place in these non-product features. But you will never know unless you go out and ask.
In the end, this will be an iterative process that may seem to be more art than science. And remember, you are not selling the product here; rather, you are going out and having discussions about perceived value among key members of the buyer community.
Don’t taint the decision-making process
Determining the value of your product involves both collecting hard data and mixing it in with a number of different intangibles. It’s an internal discussion that takes place among the various stakeholders immediately after the data has been collected.
One piece of data that should never be part of this early discussion is the cost of building the product. One of the biggest mistakes you can make during the pricing process is to taint your decision-making process by introducing cost information into the discussion.
William Davidow, author of the classic marketing book Marketing High Technology, says this about the conflicts inherent in introducing cost data into a value-based pricing discussion:
“When a marketing department is given cost information about a product, it will tend to rely heavily on that information in determining the value of the product to a customer. I’ve long believed that the first pass at pricing a product should be made without foreknowledge of what the product will cost to manufacture. When a marketing department knows the cost and market acceptable to the company, it will use that data to determine a price acceptable to the company rather than one to the market. If you are interested in finding out if your company is guilty of pricing by computation, try this experiment. Deprive your marketing department of cost information during a pricing exercise and see how much agony it produces in the group. The experiment will quickly bring that problem to the surface.” [2]
Resist the temptation to take shortcuts in your pricing analysis discussions. While including internal production costs into the later stages of the discussion is necessary, introducing the cost information too soon into the pricing analysis will taint the outcome and eventually result in money being left on the table.
The first sell is always to your sales force
Nothing can sink value-based pricing faster than having a sales force that has not bought into the strategy. This means that the sales force has to believe deep down that prices reflect the value that is created for their customers. If they don’t, they will be easy prey to discounting pressures once buyers recognize this lack of confidence. Because of this, the first sale always has to be to your sales force.
So why is this buy-in so challenging? One reason is that the data behind value-based pricing is significantly harder to wrap your hands around. Most of it is based off of conversations with the different members of the buyer community (users, buyers, decision makers, etc.) about value—which results in data that is much more subjective. Contrast this with the experience of most cost and cost-plus strategies where pricing is based off of much more objective data—such as internal production costs—and desired margins. Information that is much easier to understand results in prices that are much easier to defend.
Instilling the necessary confidence in your sales force to successfully execute value-based pricing is hard work. It takes time and, sometimes, specialized training. And it’s not going to happen just in a two-hour pricing strategy meeting that typically occurs at the end of the annual sales launch.
The key is to ensure that the sales force understands the value provided to their customers. This value, again, comes from a detailed analysis of the product, the competitive environment and the particular needs of the customer. Your sales force has to be absolutely confident both in the underlying pricing and that the value proposition they use will resonate with their customers.
One of the worst outcomes for a value-based pricing strategy happens when sales professionals are not ready for it. When this occurs, high-value features and services are given away and discounting soon follows. This typically results in an undesired—and impossible to stop—movement back to lower-margin cost-based pricing. [3]
Conclusion
Firms that utilize value-based pricing need to create a credible value proposition that communicates to the customer the value of the offering. This value proposition must be based on credible and untainted information that comes from various outside sources: buyers, competitors and alternate products in use today. Once a strategy is developed, the first and most important sale is always to the sales force.
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[1] Reed K. Holder and Mark R. Burton, Pricing With Confidence (Hoboken, NJ: John Wiley & Sons, Inc., 2008) p. 170
[2] William H. Davidow, Marketing High Technology (New York, NY: The Free Press, 1986) p. 104.
[3] Holder and Burton, p. 172.
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Patrick Lefler is the founder of The Spruance Group; a management consulting firm that helps growing companies grow dramatically faster. He is a former Marine Corps officer and a graduate of both Annapolis and The Wharton School. The Spruance Group acts as a trusted partner by offering unbiased advice and providing unique solutions to help clients solve their most pressing product strategy needs. For more information, visit www.spruancegroup.com or contact Patrick at: plefler@spruancegroup.com |