Pricing is probably one of the most important decisions taken by management. However, pricing decisions are often made in a surprising way. As a very quantitative factor, you would expect management to rely heavily on numbers and data analysis. This is much less the case as would be expected. I learned recently from this major consumer company selling its products through retail chains where the discussions was mostly based on 'gut feeling' between two disagreeing managers. The discussion going along these lines: "I believe a 20% price cut would increase sales", "no 10% should be enough"... Price elasticity and data analysis didn't really appear in the conversation. And this was a Fortune 500 company!
Starting with today's post, we'll explore some framework and examples on pricing and how to improve decision on this most critical point.
The following table highlights, at a high level, some ways of thinking or analyzing pricing.
B2B |
B2C |
|
Small Company |
|
|
Big Company |
|
|
Underlying this table and the variations of approaches is data quantity factor. Very simply put, if your company does 5 or 10 deals a year, or in fact anything below ~100, data analysis will not help you much. Deals will vary too much from one another; specific aspects will hide a potential pattern. Big companies in B2B overcome this difficulty with scale and size. Global analysis or country benchmarking allows identifying patterns and validating hypothesis on topic such as discount or cost of sales. In B2C, data are usually available, both in ecommerce channel and in traditional retail and allows diving into more 'traditional' analysis : price elasticity, sales analysis,…
Small companies in B2B rely mostly on empirical elements, combined with competitors' analysis. The 'cost based pricing' method is prevalent in many traditional industries. Defense contractors typically work on 'cost plus' basis where they add a negotiated markup to their cost. This historical way of pricing is now being challenged by the budget crisis and the willingness of many governments to reduce defense spending. 'Cost based pricing' methods with its many shades of grey tend to be somewhat inefficient for a simple reason: they focus on the vendor's problem (the costs) and not the customers' side (the value). Over the last 10 years, we have worked with many B2B startups on pricing. Pricing a new and innovative product or service will always be difficult and include some judgment calls. However a 'scientific', fact based approach, allows finding a good equilibrium: this is what we call 'Value Based Pricing'. The objective of the process is to discover the value that the new product or service will create for the enterprise customer. Of course, this fact finding is a significant effort as buyers will not necessarily disclose to the seller its own ROI analysis. Understanding the value chain from the buyer's perspective is a full project that will typically include two or more of the following activities:
- In-depth interviews with prospective buyers, but clearly not with purchasing departments but with the beneficiaries of the solution. In several instances, we have also find finance people to be useful as they are the ones running or validating the numbers that are prepared by the buying team.
- Competitor analysis is critical. Even if you think that your solution is unique, this is not the way the buyer will see it. They will look at your solution as incremental: incremental vs. what they are currently using or incremental vs. competition. It is never a black or white choice.
- Industry and vertical analysis. The web provides a wealth of information and market data. Understanding in details value chain, cost and margin structure will provide valuable insight into the pricing of your solution.
So, no magic formula but a clear and structured approach to get to the solution. The result of this work is often a range of price that seems acceptable. The final choice will depend very much of what type of industry you are in. If prices are public or easily accessible, it is often a good idea to err on the low side of the range to be safe. In enterprise market and especially in technology, such as enterprise software, we tend to go for the high end of the range:
- It is easier to lower than increase price. In technology, prices go down with time. That is just the way it is (mostly driven by Moore's law and network effect)
- If the price is not public, a direct sales force can adjust the price down with discounts. It needs to be managed carefully at the execution level but it will give more flexibility and less risk of leaving too much money on the table.
This illustrated typically the way we work with technology startups to get to a good price positioning in a simple and practical way.
Next time, we'll look at New Product Pricing and how to set up the price of a new product at its introduction.
Frederic Halley
Comments