Archive for 1. Pricing Fundamentals
A student wrote in to ask the following question. It was fascinating enough I want to share it with you. All identities and industries are modified to protect the privacy of the actual situation. Here’s the question:
Hi Mark, I’m wondering if you can assist me with something I’m struggling with. I’m working on a deal right now and trying to price it based on value but the customer is pushing back very strongly saying that it’s not worth the fee we’re trying to charge.
We’re a private B2B company. With our magic, the use of our product will allow this particular client to increase revenue in an area of their business from about $90k to $260k, without having to charge their customers any more money or to fundamentally change the way they do business; they do what they’re doing, charge their customers the same amount of money, yet they almost triple their revenue. We have built a compelling economic model, which they worked with us on, and which they agree will have a significant impact on their bottom line.
Our product is a license based service that will help them realize $180k in new annual revenue. Using what I learned in the pragmatic marketing pricing course, I applied the 10% principal so our license fee should be $18,000 / year = $1500/month. Despite showing them a strong economic model, which they have said they agree with, they have only offered to pay us $2500 annually for a license.
I’m not really sure what to do now. They love the product, and want it. We know the value that we add to them, but they are simply refusing to move off that number. We don’t want to walk away from the deal, but we’re also conscious that the value that we’re delivering them is substantial and they should pay a reasonable amount for it. No way we’re going to accept a $2.5k license, so we’re not really sure what to do.
Any thoughts/ideas/suggestions? Thanks, Jason
From what you describe it seems you are spot on. Here are a few thoughts on what may be happening.
First, make sure this is a Will I? type product, meaning you have no competition. Assume for a second that your buyer decides to not purchase from you. What will he do instead? If the answer is nothing, then your thinking is correct. If the answer is purchase a competitor’s product or build something similar himself, then you’re probably not going to be able to capture 10% of the economic value you deliver.
Second, we have to make sure the customer believes the economic value we promise. You said your customer agrees with your numbers so that’s probably not the issue. But we will only get 10% of the economic value our customers believe they will get.
Third, although our costs don’t drive our pricing, often our customers think they do, or at least should. Your customer may be looking at what they think this costs you and don’t feel your price is fair. Alternatively, they may be looking at prices of similar (not competitive) products that are priced much lower. In these cases the buyer has a price he expects to pay and you are asking a much higher price. This is often very difficult to overcome. It may take a little time for the buyer to get used to your price.
Fourth, maybe your buyer is simply a tough negotiator.
Here are my suggestions.
1. Change the structure of your offer. In conversations, offer to give him the product for free and share the upside 50-50. This looks fair and is essentially free money to your customer. However, your customer will never go for it. The purpose is to get the customer focusing on how much of the upside he wants instead of how much he’s paying. (By the way, these incremental profit sharing plans are extremely difficult to enforce. You really don’t want them to accept it so don’t push too hard. Instead, you are using it as a tool to make the 10% number look inexpensive.)
2. Be patient and walk away. In negotiations, patience pays. If you show you are anxious to close quickly, the buyer will not budge. If you look like you’re willing to walk away the buyer will likely move his price up. It would be foolish of the buyer to walk away from the additional profit you can deliver to him just to spite you because he doesn’t like your price. If it appears the buyer walks away (which looks like a couple of weeks of silence) then you can always go back and accept a price closer to his offer if you want.
Oh, and you probably don’t want to just hold your price. Find a reason to give a little to show you’re not unreasonable, but don’t give much. Maybe a 3% discount. It looks like you’re trying, but you don’t have room to go.
3. Offer a free trial period. If the implementation isn’t too onerous, the customer may be willing to try it out and then find out if the additional profits do appear. Then, when you go to take it away the decision becomes much easier for him to make. However, if the implementation is challenging, then the company may not want to invest that much of their own resources for the test.
And to close the story, here was Jason’s reply:
Hi Mark, Thanks for writing back so quickly… I really enjoyed my 3 days with you, and I appreciate you taking the time to help me out; I owe you a steak and a beer the next time you’re in my town
I think he’s on the right track. Hopefully he will write back and let us know how it ends.
Photo by Leo Reynolds
It is a great feeling when readers tell me they’ve implemented good, better, best because of what they’ve read. (Actually it’s a great feeling that people read the blog, let alone take action.) Then, when they went on to describe what they had done, it became obvious I left out an important detail.
Several times in the past couple months I’ve heard from people who implement good, better, best by creating low, medium, and high priced offerings. The low priced product had the least number of features, the medium had more and the high even more. So far so good.
Then they went on to describe what features made up each package. It almost seemed random as to how the features were assigned to which offering. As an example, the low end product had some features that were not in medium or high. This is not best practice in good, better, best.
The problem with this implementation is we force buyers to make a difficult choice. They must choose between a lower end package that has a feature they want and higher end packages that also have other features they want. They are trading off features between packages, trying to decide which package has the features that are most important.
The power of good, better, best comes in its simplicity. Buyers who have a hard time deciding, buy the one in the middle because it’s better than the good product and less expensive than the best. However, this only works if the product offerings build on each other.
In other words, your better product should be everything that is in good plus more. Your best product should be everything that’s in better, plus more. Don’t make your buyers think too much.
Let’s take a look at iPhones. Apple always offers 3 versions of each model of iPhone based only on the amount of memory. This is a wonderful implementation of good, better, best. When someone buys the one with the most memory, they get everything that’s in the lower offering plus more. It’s simply a price for feature decision.
However, Apple also gives you the choice of the iPhone 5s, the 6 or the 6+. This is NOT good, better, best. Even though they are low, medium and high priced, they do not build on each other. If you want a phone that is not “too big” you will purchase the 5s or the 6, but not the 6+. Even “rich” people may prefer the 6 to the 6 plus.
Good, better, best is a powerful technique to structure your products and prices, but you want to be sure to do it right. One goal is to simplify the decisions your customers need to make. The only trade-off they should be making in their minds is price for features, not choosing between features. We do this by making sure the best product has everything the better has plus more and the better has everything the good has plus more. Good luck.
Pragmatic Marketing’s December activity/box of the month is Referrals and References. What does this have to do with pricing? Plenty.
If you are systematically executing the activity of creating and collecting referrals and references, then you probably have a formalized program on turning customers into valuable marketing tools. If you don’t then you are hopefully collecting and organizing data about customers who like you, at least when they fall in your lap.
We gather referrals and references to help us sell more product. Referrals help us find new customers while references help us close deals. But here’s where pricing comes in:
Referrals and References increase new customers’ willingness to pay.
Since pricing is all about creating and capturing value (i.e. customers’ willingness to pay) then anything we can do to create value helps us win at higher prices.
Think about your own decisions. You are thinking about buying a new kitchen appliance, say a panini press. You haven’t shopped yet, but in a conversation with a friend he tells you about the one he has, brand X, and how it makes great sandwiches. He is extremely happy with it. Now once you decide to buy a panini press, wouldn’t you pay a few dollars more for brand X over brand Y just because your friend has it and loves it?
Just like you would pay a little more because one brand comes highly recommended from a friend, so will your customers. Think of a referral as one more “feature” your product has that your competition does not. Your customers value that feature and would pay a little more to have it, all else being equal.
When we put together a program to systematically collect and use referrals and references, we increase both the volume of sales and the price at which we can win. Sure seems like a win-win for us.
This article in the International Business Times reports that Walmart may match lower prices from on line retailers. Walmart already price matches other retailers, but so far has not ventured so deep to match prices with Amazon. Is this a wise decision or not?
First, the key reason companies should offer price matching is to reduce price competition. When one company says they will match competitors prices, then there is no incentive for competitors to lower their prices. As a general rule these clauses reduce incentives to compete on price resulting in higher industry profits.
However, it seems highly unlikely that Walmart is thinking this. Even a behemoth like Walmart surely can’t think they can influence Amazon’s pricing strategy. So there must be another explanation.
This is more understandable when we break the market into segments.
1. There are a group of people who believe Walmart has great prices and just shops and buys without comparing to online prices.
2. There are a group of people who will buy online and won’t even consider shopping at Walmart.
3. There are a group of people who shop at Walmart, but still check Internet prices to see that they are getting a good deal.
Segment 1 will purchase at the regular price. No discounts needed to win their business so the price match makes no difference. Segment 2 will not buy from Walmart so the price match makes no difference.
The big question is what happens with segment 3. If Walmart doesn’t price match, then these guys will not buy from Walmart if they find the same product cheaper on line. By offering price matching, Walmart wins customers they wouldn’t have won otherwise. These customers may purchase at prices lower than Walmart wants, but they are likely still profitable.
So, without price matching, Walmart wins segment 1 at full price. They probably don’t win segment 3. With price matching Walmart wins segment 1 at full price AND they win segment 3 at lower prices. Overall Walmart makes higher revenue and higher profits, but a lower average gross margin.
The article says that Best Buy recently offered price matching with Amazon and their margins went down by 4%. The article implied this is bad. However, this could be a positive because Best Buy is really winning customers they wouldn’t have won otherwise, those in segment 3. This result is the same result Walmart should expect if they offer price matching. Margins will go down a little.
The article provided another big reason Walmart may want to offer price matching. Walmart has an image of the low price leader, but this image can be damaged if buyers can consistently purchase on line at prices lower than Walmart’s. Price matching helps Walmart maintain their low price brand.
Price matching, at least for Walmart, seems to make sense. What about your company? Presented here were three reasons you might consider offering a price match: reduce price competition, win new market segments, and enhance your image as a low price leader.
The question: Does price matching make sense for you?
Pragmatic Marketing’s October highlighted activity is personas. So how does this relate to pricing? In many ways, but let’s split this topic in two’s, buyer and user personas. Recall that in general, we build products to solve problems for user personas and we market our products to buyer personas.
But before we start pricing for personas, remember the general rule, Charge what our customers are willing to pay.
User Personas and Pricing – Different user personas have different willingnesses to pay. This is logical because different users have different problems they are solving which drives a different value proposition.
For instance, imagine we are selling lawn care products to two different personas, a homeowner and the greenskeeper of a high end country club. The expectations of results are very different. The homeowner’s problem is to keep the lawn green enough that the neighbors don’t complain. The greenskeeper on the other hand needs the lawn to look perfect so new members will join and current members will not go find a better place. Two different user personas, two very different problems, two extremely different willingnesses to pay.
The solution to charging homeowners and greenskeepers two different prices is usually to create two different products. This is one reason why in many industries we see the “handyman” versions and the “pro” versions of products.
Buyer Personas and Pricing – To price well for buyers, we must understand their buying process. Different buyers use different processes. Although it is very difficult to generalize on this topic, here is one of my favorite examples.
Imagine buyers at two different companies, a huge multinational conglomerate and a small company. If you were to ask which one is more price sensitive, the answer may surprise you. The huge company hires purchasing agents that are brutal negotiators. They get the best deals possible on everything that matters. Note the last three words, “everything that matters”. For large volumes and large dollar values, the huge company is very price sensitive and will undoubtedly get the best price possible.
However, for small volumes, huge companies are horrible at negotiating and finding the best deals. It’s barely worth their time. Yet, for small volumes, our smaller company cares a lot about the price, because they only buy in small volumes. The small company will shop around for the best price, stock up on cheap inventory, anything they can to keep their costs lower.
When you understand the buying process each buyer persona uses, you have the opportunity to capture higher prices. In PragmaticPricing history you will find many posts on how price segmentation works. These are the techniques we need to employ to charge different buyers different prices.
To summarize, knowing your user and buyer personas will effect your pricing decisions. We frequently create different products (at different prices) for different user personas and we should use price segmentation techniques to charge different buyer personas different prices.
Photo by marketing facts
A friend and fellow pricing expert, Jon Manning, posted this article, “Comedy club charges customers per laugh” in the Pricing Propheteers LinkedIn group. If you click on the link and scroll to the bottom of the article, you’ll see a video that describes it well.
To summarize, they hooked up cameras to the seat back in front of each patron and used that camera to count laughs based on facial expressions. The show was free to enter, but entrants were charged approximately 30 cents per laugh up to a maximum of 24 Euros.
Imagine you run a theater company and when you decide how to price it, the most logical choice is to set a price for the seat. After all, it’s common. We see that pricing model in other shows, in movie theaters, in airplanes. We are used to charging and paying by the seat. It’s easy. If you run a theater of course you are going to charge by the seat.
But these guys went way beyond what was obvious and answered the question, what are people really buying? Patrons are buying the entertainment, not the seat. That’s what they charged for, the entertainment, not the seat.
What about your company? Most companies do what is obvious. Charge for the product. Charge by the seat (in software). These are obvious and it’s what your customer expects. But what if you could charge directly for the value?
What are your customers really buying? Do they really buy the right to use your product or software? Probably not. They are probably buying some function, some result. Their value comes from that function or result, not from the right to use your product.
Now the hard question: Can you find a way to price your product based on the value your customers receive instead of simply taking the easy way? Think hard. Be creative. If a theater company can charge by the laugh, surely you can come up with something too.
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.
Those of us not in sales often make fun of salespeople, well … because it’s fun. Our first gut reaction says of course we can’t give pricing authority to sales. They will only sell on price and we’ll be giving huge discounts to too many clients. Unfortunately, a lot of salespeople do sell on price. Besides, every customer asks for a discount and it’s easiest for sales to give them one.
However, who better to figure out how much a customer is willing to pay than sales? They have the relationship with the client. They have direct knowledge. If only we could find ways to keep salespeople from selling on price and instead use their close knowledge of the customer to discount when it’s needed.
The hard part is balancing these two opposing forces. The trick is to provide incentives and tools to help the sales people sell value instead of price. Here are four tips to help.
- Distribute authority throughout the sales hierarchy. You may give your salespeople the ability to discount 5%. Your sales managers can go to 10% and your sales directors down to 15%. Anything lower than 15% off has to be approved by headquarters. (The numbers are an example. Use what makes sense for your sales team.) The good thing about this is that one salesperson alone can’t do a lot of damage.
- Monitor, on a salesperson by salesperson basis, how much discount they tend to give away. Report it. No salesperson wants to be on the bottom of any list. Hopefully those salespeople who discount less can help the rest of the team learn how they do it.
- Talk to your sales team about NOT jumping to the maximum discount. Instead, start small. Every percentage can have a big impact on company profit.
- Create an incentive program that rewards the salespeople with the smallest discounts. We often hear the saying, “salespeople are coin operated” meaning they do what they are paid to do. Let’s pay them to not discount.
Finally, it is our responsibility to make sure sales has the right tools to be able to sell on value. Take a hard look at what you give your sales people and how that helps them sell value.
When we give sales the tools to sell value and the incentives to not discount too easily, we maximize our chances of winning business at the highest possible prices.
Picture by 92Five