A frequent question during our Price class is “How should we compensate our sales force?”
Salespeople have a huge influence on our achieved margin. They are the front line in any negotiations. They are the ones who communicate our value to the customer. They set the customer expectations on what price they should be paying.
Since they have so much influence, how do we influence them to do the right thing when it comes to getting the highest price?
You may have heard the phrase, “Salespeople are coin operated” meaning they do what they are paid to do. (Nothing against sales people because I think we all do this.) However, salespeople usually make commission on the sales they make. The most common type of commission is a percentage of revenue.
Unfortunately, when we use a percentage of revenue as their compensation plan, it motivates them to close more deals quickly, even at lower prices. That’s not what we want. We like the more deals quickly part, just not at lower prices.
Here is a good explanation by the Freakonomics authors, Steven Levitt and Stephen Dubner on why real estate agents don’t try to get the best price for your house. The same is true for most sales situations. It’s hard work to get the last few dollars in a sale, and it’s just not worth the salespersons time to go get them.
How can we structure a compensation plan that will go get those last few dollars? First, please know that compensation is a huge topic which we are not exhaustively covering here. Instead, we only want to focus on the price piece.
One idea would be to compensate sales as a percentage of the margin achieved. That way when the company makes more profit, so does the salesperson. Sales would have a decent percentage of the profits so they have more incentives to get higher prices. The big downside to this is most companies don’t want to share their costs with their salespeople. When sales knows the costs to build a product, it often drives prices down, not up. Sales then knows how low they can go and the company will still accept the deal.
A better solution is to determine a target price for each sales situation. What price should a salesperson be able to achieve? This target price is often a function of the industry, geographic territory, type of customer, size of the deal and more. You can determine this target price by what customers have historically paid.
Once you have a target price, you can then offer incentives based on how much above or below the target price the salesperson closed the deal at. For example, you might have a commission structure that looks something like this:
- 10% for any deal at or above 10% over target price
- 8% for any deal at or above 5% over target price
- 5% for any deal at or above target price
- 3$ for any deal at or above 5% below target price
- 1% for any other deal we accept
With a compensation plan that looks like this, small changes in realized price can make a big difference in the salesperson’s commission. Hence, the incentives are more aligned for sales to try to get the highest price possible.
Sales compensation is a big topic, but the lesson here is important. If we want to get that last 1% of the price, we need to find ways to incentivize our salesforce to try harder. This technique does that.
Last week I attended the Train the Trainer class put on by Ed Tate and Darren LaCroix of the World Champions Edge. Great class. There is always something new to learn, but that’s not the point of this blog.
They had arranged a special rate of only $49 a night for a room at the Palms Resort. What a great price. As a very frequent traveler, I haven’t paid $49 in years. And the Palms is a nice resort. My room was as spacious and clean as any 4 star hotel.
When I checked in the agent told me they had a $25 resort fee. Wow! A 50% up charge as a fee! The below is from the Palms website www.palms.com/faqs
The resort fee is a daily fee of $25.00 (plus applicable tax) that is charged at the end of your stay. This is a standard practice at the majority of the hotels in Las Vegas, we promise.
The resort fee includes:
Complimentary In-Room High speed internet service (faster rates available for additional fee)
Complimentary access to Palms Cardio Center & Palms Place Fitness Center
Shuttle Service to and from the Forum Shops 11AM-8PM Daily [please note hours may adjust some]
Daily Newspaper (available at select locations)
Unlimited local and toll-free calls
Airline Boarding Pass printing
Copies and faxes at the Front Desk and Concierge (does not include color and large print jobs)
Many of us at the event joked that we paid $25 for “Complementary WiFi.”
I’m not complaining. $74 a night is still a great price, but notice how well the Palms understands their customers decisions. The room rate is critical in that decision so the Palms works hard to keep that as low as possible. Then, once they have you on location, they try to make as much as possible, not only from their “resort fee” but also from food, gambling, and more.
I ate in the resort the entire time, because it was convenient and there weren’t any restaurants within easy walking distance. Their restaurants were a little pricey, but not ridiculous. My breakfasts were about $15, one lunch was about the same, and one dinner was well over $100 at their steak place. The food was good so again I’m not complaining. Just pointing out their pricing strategy.
Don’t forget the gambling. Of course they want you to gamble. I played a little video poker. Won $6 the first night and lost $20 the second, so they got another $14 from me.
There are many other ways they can get your money that I didn’t experience. For example, they had a spa, a shopping area and even a fortune teller.
The key lesson here though, the Palms Resort clearly priced the room at a very low price to attract customers. The room rate was the factor that helped people choose the Palms over other locations. Then, once their customers check in, they find other ways to earn profit.
You should be thinking the exact same way. What product or service do your customers use to decide whether or not to engage with you? Consider pricing that product aggressively to attract more customers. Of course, that only makes sense if you have add-on products and services where you can make the profit you give up from your aggressive pricing tactics. If you don’t have additional means to make profit from your customers, then it’s very difficult to be aggressive with the price on the original product.
You may be thinking this is deceptive and you don’t want to do it. What happens to you if your competitors implement this strategy? If they have the ability to charge very low prices for the decision product, how will you compete? Maybe the owner of the Palms Resort doesn’t really like doing business this way, but the Rio and the Orleans resorts, both close by, use this pricing strategy. The Palms doesn’t really have a choice if they want to stay in business.
Think hard about how you can use a complementary pricing strategy.
Photo complements of Wikipedia
Usually when we use the phrase “the competitive landscape” we are looking to enter a market and trying to decide how it looks. Is this a market where we want to play or not?
Pricing offers a unique perspective on this question.
First, remember that costs are essentially irrelevant to pricing. What really matters is how much our customers are willing to pay. However, when deciding whether or not to enter a business, costs become extremely important, both fixed costs and variable costs play a role. Today we will focus only on the variable cost aspect.
A key component in looking at the competitive landscape is the margin your competitors are making. If they are selling an extremely high margin product, there may be room for competition. This is a strong indicator that competition isn’t driving the price down toward costs. Of course, when you enter, your competitors may choose to compete on price to hold their market share, but at least it doesn’t start that way.
If your competitors are selling at relatively low margins for the industry, and especially if they are low relative to what you are willing to accept, then you have to decide if you are adding enough extra value that you can charge higher prices. Alternatively, do you have a strong cost advantage, meaning you can manufacture at a much lower cost than your competitors? Something has to be different if you want to enter the market.
Before you enter the market, ask yourself, “what price will I be able to charge?” Use the value based pricing process to see how much your product will be worth relative to your competition. Then, if you plan to price lower than your competitor have a justifiable belief on how they will respond. Will they ignore you because you’re the new kid in the market? Will they aggressively compete to not lose any share? You need to predict your prices and your competitors responses. If they compete aggressively, will you have enough margin in your product to meet your corporation’s goals?
Although costs rarely matter when setting prices, they are critical in deciding whether or not you want to be in a business. Determine your pricing up front, including your competitor reactions, then decide if you want to enter this market.
Costs matter when deciding to enter a business. Knowing your pricing up front is necessary to predict profitability. Understanding pricing will help you understand your competitive landscape.
A Sharks season ticket holder wrote:
I was surprised to learn that the SJ Sharks are printing variable pricing on the tickets for the games. “This means that the price printed on your ticket will reflect the true market value based on the expected demand for each game.”
So if you are in a low priced (Tier 1) game, do you wear your old uniform?
It turns out that the Sharks are considering the opponent and the day of the week the game is scheduled to estimate demand and therefore price. This makes perfect sense for pricing individual games.
What didn’t instantly make sense though is why do this for season ticket holders, who pay for the season, not individual tickets. Why should the Sharks bother printing different prices on each paper ticket?
After a little digging you find that this behavior provides more value to their season ticket holders.
To make sense of this you need to know that the NHL hosts a site called NHL TicketExchange, which is where you can legally go to sell tickets to any game you might not be able to attend. However, you can only sell them for the face value of the ticket. This variable pricing allows the season ticket holders to sell the best games at higher prices.
Also, when you add up the prices of all of the individual games, you get a number larger than the price of the season ticket. This means if a season ticket holder could sell every ticket at face value, he or she would make a profit.
What is fascinating about this example is simply by changing the printed price on a paper ticket, the Sharks provided more value for their season ticket holder. Are you always on the lookout for ways to add value to your customers? It doesn’t have to be with the price label (and rarely will be). When we add value, we make happier, more loyal customers who will likely be willing to pay more.
I love to see unusual pricing behaviors. They are intriguing and often we can learn something interesting from them, even if it’s what not to do. Please send me any apparently inexplicable pricing you run into.
The following question was asked on the LinkedIn group Pragmatic Marketing Alumni. FYI, Rhoda, who asked the question, works for a large company that sells information products.
Global Pricing – Fact or Friction
No. It isn’t a typo. I really mean friction. Lately I’ve been thinking a great deal about how readily we do business on a global basis. Yet, working for a company that has been around for over 170 years, we’re faced with many traditions. In some cases, it is those traditions which have made our brand recognized around the world as being trustworthy and accurate. We’ve continually adapted and changed with the times.
With physical products there are clearly reasons for pricing differences based on geographies, but with software (or in my case, data), I’m not so sure. With the current trends of transparency, do we create more buying friction by having geographic pricing differences?
I am not a pricing expert, so I ask the group membership to weigh in on this topic. Are differences in pricing based on geography a leftover, unnecessary legacy or are companies justified in charging a different price for the same product or service in different countries?
Hi Rhoda, If we could boil all of pricing down to a single concept (which we can’t) it would be “charge what your customers are willing to pay.” Pricing based on geography is typically based on the fact that customers in some regions are willing to pay more than customers in other regions. For example, many hardware components (e.g. semiconductors) sell for less in Asia and for more in US and Europe. This isn’t about cost to serve, this is about willingness to pay.
Two cautions, which may be causing your angst. First, we have to be careful of arbitrage. Can someone in one region buy at a lower price and resell at higher price in another region. As a digital information product, you have this problem even if you charge the same price to everyone because typically there is no cost to your customers if they replicate your information. I’m sure you have means in place to minimize people pirating your information.
Second, sometimes customers in one region get upset that they have to pay more than another region. This only happens when they are aware of what others are paying. Most companies who charge different prices by the region try to not let anyone else know what prices are actually paid. The easiest way to do this is to publish a single worldwide price and then offer discounts to the geographies who you think have a lower willingness to pay.
Now you face the problem of large multi-national organization that get quoted different prices for the same item across regions. This is extremely hard to deal with. You either get to try to justify the price difference (support costs?) or offer the same price for the large multi-nationals regardless of where the information is consumed. My preference is usually to be a true partner to your multinationals and give them your best price regardless of location.
Of course there could be many nuances, but these three points should get you started in the right direction:
1. Charge what your customers are willing to pay
2. Avoid arbitrage across regions.
3. Hide your best prices from those who pay more when you can.
Most people don’t know pricing, and most people don’t know they don’t know pricing.
More and more companies are building pricing departments in recognition of these two “facts”. I’ve seen several different ways of organizing pricing, but one seems to stand out, especially for large corporations.
These effective pricing departments essentially act as internal pricing consultants. They understand how to apply pricing concepts, they understand the pricing systems used within the company, and they understand the corporation’s objectives and how pricing contributes to achieving those goals. However, pricing departments do not understand the unique value proposition offered by each individual product.
Given that, pricing departments have several critical roles. They provide pricing expertise to product lines who ask for it or need it. This often looks just like a consulting role, coming in to learn as much as possible, helping clean up the situation and then leaving it to the product line to do the continuing execution.
Pricing departments also help define, resource, and implement new pricing tools and processes. Pricing touches on almost every other department within a company. It certainly effects sales, marketing, and finance. Everyone seems to have a strong interest. Pricing is the role that can balance all of these interests in creating company wide processes and systems.
Finally, pricing departments take a lead role in monitoring pricing effectiveness. They usually set up the systems to collect the right data and share that information with the product teams. They frequently build in alerts to notify the product teams when something interesting changes.
Ironically, one thing pricing departments rarely do is set prices. They don’t know enough about the specific products to do so. Instead they work closely with product managers or product specific pricing people to make sure they know how to determine the right price.
Of course, it’s never as simple as this, but as a general guideline this structure for pricing departments within large corporations works well.
Graphic by Pixabay
For hardware products, we typically charge per unit. When you make hamburgers, you charge for the number of hamburgers people want to buy. (Of course it is more complex, but that’s for later.) This is typical because your costs of manufacturing are directly proportional to the number of units purchased and … buyers assume firms use cost plus pricing. So it’s natural.
For software product though this is very different. The marginal cost of the next unit of software is close to zero. What does it cost Microsoft to download the latest version of Office to you? Almost nothing. That’s not to say there isn’t development cost, but the cost to manufacture the next unit is minimal.
In software, buyers can’t use cost plus buying. Instead, they have to decide if the product is actually worth the price you are charging. Therein lies the clue. When pricing software, we want to charge for the items your customers get the most value from. In pricing literature these are often called value drivers.
The goal is that the people and companies who receive the most value pay the highest prices.
Many enterprise level software companies charge by the number of users and the number of modules implemented. For example, Saleforce.com does exactly that. The more salespeople and support people using Salesforce, the more value these companies receive, the higher the price. Similarly, the more options companies enable in Salesforce, the more value they receive, the more they pay.
The hard part is determining your value drivers. For them to be effective they must differentiate customers with different willingness to pay, they must be actionable, and they need to seem fair to your customers.
Let’s keep exploring Salesforce.com as an example. What else might they be able to charge for that differentiates willingness to pay? How about companies that currently have horrible sales processes vs those that have great sales processes. The horrible ones would surely get more value. Yet, that isn’t very actionable. It’s difficult for Saleforce to set a price based on the starting conditioning of their customers. (Although not impossible by any means.)
Maybe Saleforce should charge based on the revenue of the companies they serve. Companies with higher revenues surely get more value from closing deals through salesforce than those with low revenue. However, as a general rule, companies don’t see this as fair. Simply charging a portion of revenue is frowned upon. It’s not a “feature” in their software they can charge for.
Another wonderful example is LinkedIn. Recruiters get the most value by far from using LinkedIn. So, LinkedIn created a set of features that are valuable to recruiters and they charge a lot for them.
If you are selling software, the key questions to answer: What drives value to your customers? How do you charge for that value?
Photo by Pixabay
You’re on the edge of closing a huge deal. Your salespeople have done a great job of selling value. They have convinced the buyers and the users that yours is the right solution for their company. All is on track. Then, of course, purchasing gets involved to get a better deal and mostly a lower price.
Purchasing agents are well trained negotiators who know every trick in the book. They do this multiple times a week. Most importantly, they are very patient. There is no sense of urgency on them to close the deal.
Your CEO, on the other hand, wants to know why this deal hasn’t closed yet. It should be done by now. He says “take me in there and I’ll close this.” And of course he does. The purchasing agent says “all we need is another 3% and we can close this.” The CEO says “Deal!”
The CEO has the authority to close any deal. He is often impatient to have the contract in hand and he certainly doesn’t want to spend a lot of time in front of the purchasing agent. Besides, he looks like a hero when he succeeds and he looks feckless if he fails. All factors point to the CEO closing too early at too bad of a deal.
Negotiation training firms will tell you when they run pre-training exercises, executives typically perform the worst. Not that they are dumb or incompetent, but more that they are over-confident and impatient.
Of course, sending the CEO in to negotiate makes it more likely the deal will close. They will typically do whatever it takes. This means sales people are thrilled to invite the CEO in. The salespersons biggest goal is closing the sale, perfectly aligned with the CEO closing impatiently. And purchasing invites this as well. Purchasing agents often ask to have an executive come negotiate. Why wouldn’t they? Bringing in an impatient executive with the authority to give in is a surefire winner for the purchasing agent.
This means it’s you, product and pricing, against sales, purchasing and the CEO. Not a very comfortable position. The solution, have these conversations when you’re not in the throes of a big negotiation. Share this blog with them. Talk to whichever company provides negotiation training to your sales team to corroborate these claims. (I’ve heard it many times so you will inevitably find the same.)
Don’t forget, small improvements in price can lead to huge improvements in profitability. Focusing on who negotiates and making sure they are well trained is an easy way grow profits.
Photo by Pixabay
Here is a recent question by email.
Thanks Mark for great blog and insightful book. I’m currently working my way through a Kindle edition, learned a lot about pricing that’s for sure and will definitely recommend to clients. One thing I didn’t see you talk about on your blog is the 9 vs 7 pricing gimmick. In the real world, most prices will end with a 9 or 5 occasionally (9.99, 99, etc.). But, online and especially with info products, there has been a trend to end price with a 7. For example, most ebooks and programs are 17, 27, 47, 67, 97, and so on. What’s your expert opinion on this? Have you seen any credible research that clearly shows which one is better? I know why we use 9.99 instead of a 10, but how effective is 7? Thanks a lot!
This question hits me close to home, particularly because my dissertation was on why firms use 99 cents as their price endings. Although I’ve blogged on this before, here is a quick review.
The driving factor behind the effectiveness of 99 cents is that was are bad or lazy subtractors. For example, a product that normally sells for $400 on sale for $299 feels like a much better deal than a product that normally sells for $399 on sale for $299. The same happens when people are choosing between our product and a competitors.
That driving factor has led products that end in 99 to look to people like a good price. The opposite of that is we have learned to associate prices that end in 00 with higher quality.
However, none of that answers the question posed above. And unfortunately I don’t know the answer. First, after searching on Amazon and iTunes, I still found that most prices end in 9 rather than 7. Please feel free to share sites with prices that predominately end in 7.
I searched the academic literature and didn’t find anything either. If you know of something, please share.
I found a couple discussion sites on software on this topic, and the conclusion was you should A/B test it to see which works for you. In other words, there wasn’t a conclusion.
Don’t forget that many retailers use the right hand digit of a price to indicate the state of the product. For example, Costco uses prices that end in 7 to indicate that the price has been marked down from the regular price (which ends in 9). Gap and Old Navy use prices that end in 7 to indicate they are the final markdown, the lowest price they will go. This means to me that they don’t think any psychological effect is very big, so they use the digit for internal communications.
At this point, I’m not satisfied with any answer. If you have an answer, or evidence, or research, please share it. We would all like to know.
Photo by thebayentrepreneur
Last week, the least expensive paperback version of my book on Amazon was $236 even though the cover price is $20. Wow. The Kindle version was reasonably priced at $9.99. But $236? And it wasn’t just one company. There were multiple vendors offering my book in that price range.
You may or may not know there are software applications vendors can use to automatically reprice products on Amazon, eBay and other online retail sites. These applications monitor competitors’ prices for products and then adjust the vendor’s prices up or down based on the situation. As examples, check out Appeagle, Feedvisor, and Repriceit.
First thing to know, about a year ago Amazon ran out of stock of my book and the publisher decided against a reprint. Amazon no longer has stock. The only new paperback versions you can buy are the ones in inventory at some smaller resellers.
Even with limited inventory, no sane person would price my book for $236 (even though it is surely worth it.) Instead, every Amazon reseller that has inventory of my book is also using one of these these software repricing applications. The software, without human intervention, slowly worked their price points up to unreasonable levels.
When I saw this, I decided to sell what small inventory I have just so more people can have a reasonably priced book, and because I wanted to watch what happened. I priced the book at $22 plus $3.99 for shipping and handling.
(As a quick aside, it was very easy to set up an Amazon reseller account.)
In the week since I listed my book at $22, the other resellers have started slowly lowering their prices. As of this writing, the next least expensive vendor now sells it for $118.50. It would not surprise me if within a few weeks other resellers have undercut my price. That would actually make me happy both because I was able to manipulate other vendors’ prices and because more people will get the chance to read it.
The lesson: Is it possible to use some algorithm to constantly adjust your prices relative to competition and the market conditions? If so, it is probably a better bet than using the set it and forget it strategy (i.e. never change your price). However, even if you can use automation, you should still monitor the prices for ridiculousness. Although I’d like to believe that the information in my book is worth way more than $236, I doubt anyone buys it at that price.