The Real Objective For Price
Like any ideology, blanket statements about the “right way” or the “wrong way” to price are provocative but rarely useful when practitioners attempt to apply them. I worry that for many, the concept of “value-based pricing” is becoming more of ideology than a productive means for improving business performance. I have been in the pricing game for close to twenty years and a great deal of what I do is help companies envision and implement productive approaches to value-based pricing. I have also seen enough to know that the reality of implementing changes in pricing approaches is far messier than simply saying that companies should go out and understand value to customers and then price accordingly.
The truth is that the overwhelming majority of companies are currently using some form of cost or market-based pricing today. It is also true that by objective financial standards, there are many very successful companies where value-based pricing has had little to no impact. At the end of the day, the only thing that matters is whether an organization can achieve sustainable improvements in profits due to improving pricing capabilities. In short, the objective is to make more money, not implement value-based pricing per se.
Having said that, the majority of firms selling into B2B markets should have a plan to move most of their offerings to a value-based approach. In many situations a value-based approach is the one that will maximize both revenues and profits. In this light, the drawbacks to pure cost-based and reactive, market-based pricing are significant. On the other hand, each day you go to war with the army that you have, not the one that you wish you could have. That means in the short to medium-term most firms need to make improvements to their current pricing approaches and prepare the rest of the organization for the ultimate move to value-based pricing.
This move is a non-trivial journey. At the strategic level, it requires new skills in being able to quantify customer value, using value insights to create an array of high to low-value offerings, and creating new pricing strategies and models. At the tactical level, it requires training the sales organization on how to work with customers to analyze value and to stand their ground by forcing price-value trade-offs during negotiations. It requires creation of tools to enable the new sales process and it requires pricing professionals and processes to set prices a new way and to maintain price integrity in the midst of tough negotiations. First and foremost, it requires an executive leadership team that will support these changes and help the organization hang tough when the new approach is tested by customers.
In the meantime, the firm still has to price offerings and deals and make money. So for many, no matter what theory says, that means getting better at cost-based and market-based pricing approaches. Simply improving the accuracy of the costing data used to make pricing decisions will help. Including an assessment of opportunity costs into your pricing decision-making will help. Understanding, even on a qualitative basis, where your offerings provide more or less value than the competition helps as you can adjust your cost multipliers or target prices accordingly.
Finally, the first test for many organizations is trying to kick the discounting habit. If you can’t do this, all of the work to transform your pricing approach is a waste of time. For most companies this first step may have nothing to do with value-based pricing. It usually begins with a process of putting together some simple scatter plots or doing some waterfall analysis and then addressing the biggest drivers of price and margin leakage. It is purely tactical in nature – and when well-executed, very profitable.
We know from our own experience and research that successfully implementing value-based approaches to pricing can result in massive improvements in profits. We also know that the interim steps are also quite profitable. No matter what your pricing approach is or what you want it to be, its a commitment to the pricing journey that’s important. With that commitment, firms will see continuous improvements in financial performance as they improve their pricing maturity.