Archive for 1. Pricing Fundamentals
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
This past Thursday I taught the first fully released pricing course for Pragmatic Marketing. The day was better than I could have hoped. The students were energized, asked great questions, contributed their own stories and I’d like to believe they all walked out with a smile on their face and several action items to help them in their pricing endeavors.
However, about three quarters of the way through the class, I put up a slide and to emphasize its importance said, “this is my favorite slide.” A lady in the front decided to make fun of me by asking, “how many favorite slides do you have?” Embarrassingly, I had to admit that I’d said that line many times during the day. And it’s kind of true. There are so many great concepts in pricing that can help companies be more profitable. So many concepts that aren’t obvious and produce aha’s in the students. Many of these concepts seem to be my favorite.
But it did prompt me to think, “what should be my favorite slide? What is the most important concept in pricing?”
The answer: The most important concept in pricing is to price based on what your customers are willing to pay, not your costs.
I teach that concept first thing in the morning. Companies must use Value Based Pricing. Charge what your customers are willing to pay, not costs. There is a little pushback at first, but soon everybody nods their head and has accepted the concept, almost. Throughout the day, students sometimes make reference to why they needed to use costs to price. Of course I’d have to correct them. By the afternoon, they were catching themselves whenever they were about to mention costs again. It’s amazing how ingrained pricing based on costs really is.
What about you? You may nod as you read this, agreeing with me, but then do you go talk to your company about costs and pricing? It is fascinating that pricing based on costs has penetrated us so deeply that it’s hard to let go. That’s one reason I think Value Based Pricing is the most important concept.
The other reason though, if you don’t accept value based pricing, then you lose the power of all of the pricing strategies that come with it. There’s no need to segment pricing based on willingness to pay if you only price based on cost. You can’t take full advantage of a good-better-best strategy if you only price on costs. There’s no reason to think of pricing portfolios if you only use costs.
Yes, value based pricing is without a doubt the most important concept in pricing. But that doesn’t mean I can’t have more “favorite” slides does it?
Photo by Valerie Everett
The ability to price higher than your competition comes from having differentiated products. Your products must be better than your competitors’.
When we think of positive differentiation, we usually think of what features can we build that our competitors don’t have (yet). However, one very powerful “attribute” of a product that can create positive differentiation is brand. If your brand name becomes synonymous with trust and quality in your industry, you have earned the ability to charge more. People pay more for well known brand names.
Here is one of my favorite examples:
Take a walk with me down the vodka aisle at your local liquor store. You will likely see something very similar to what I’ve seen at my local Beverages and More. Stolichnaya Elit Vodka is priced at $59.99 for 750 ml, Grey Goose Vodka is $26.98, and Nordic Star Vodka costs $7.99 for the same size. Three different brands, three different prices. We assume three different quality levels.
This doesn’t seem unusual until you read Section 5.22 of the U.S. government’s Standards of Identity for Distilled Spirits which defines vodka as “neutral spirits so distilled, or so treated after distillation with charcoal or other materials, as to be without distinctive char- acter, aroma, taste, or color.” In other words, by law you should not be able to tell one vodka from another. In this case (or bottle) it really may all be in the brand.
Brands are expensive and time consuming to build, but as you can see, they yield strong pricing power.
Photo by Hippietrail
We often think of pricing as putting a price on a product. This is true, but it’s so much bigger. Here are several examples.
Scope: When we sell one item, we can probably sell more. Think of this as complementary products. By pricing low on the products our buyers use to make the decision, we may be able to win the deal and then make real profit with complementary products.
Scope: When large companies negotiate with large companies there are usually multiple transactions happening at once. Imagine Dell and Intel. Dell buys from Intel. Intel buys from Dell. Dell could also buy AMD. Intel could also buy from Acer. Dell could purchase a multitude of different products from Intel. Intel could do the same. When purchasing for one company is negotiating a part and a price, they almost always make it bigger. More parts. Total spend.
Deal size: Sometimes our customers use more and more product over time. This is true with consumables and when selling parts to manufacturers. The bigger deal is to buy more, commit for a longer period of time. Sometimes buyers will offer to do this to get a better deal. Sometimes sellers will insist on this when buyers ask for discounts.
Deal size: We often see volume discounts. If a buyer is willing to commit to more, they can get a better per unit price. The game is bigger.
Loyalty: Think lifetime value of a customer. If you can gouge them today, you might lose them as a customer in the future. By maintaining loyalty they buy from you over the long term.
Strategic relationships: A purchasing agent might say, “If you give me a better price I’ll help you get designed into the next product.” Similarly, a salesperson might say, “I might be able to get you that discount you need if you can help me get designed into the next product.” Instead of the next product it could be a joint white paper, an introduction to another company, a referral, anything that’s strategic to the seller.
There are many more examples. The point is that it’s almost never simply one product and one price. There’s almost always a bigger game. Can you identify the bigger games you play? The goal is to play the big games as well if not better than you play the small ones.
Photo by Ytoyoda
The Pragmatic Marketing theme for this month is “Requirements”. As their pricing blogger I wanted to write on how pricing should help when defining product requirements. Here are my thoughts. What are yours?
Let’s start by defining “requirements” as what the product team gives the development organization to work on. These are the next features or products the company will develop. So when does pricing care about what development does? I’d say the answer is two-fold.
First, we’d rather development develop the attributes that have the most value in the market. Given a choice between two attributes, we’d prefer to develop the one that has the biggest return. That may be measured in number of new customers or the extra amount someone is willing to pay or a combination of these. Our knowledge of pricing should be able to help with these decisions. Possibly the most powerful tool to help with understanding the value of an individual attribute is Conjoint Analysis.
Second, we care a lot about the product portfolio. As product people knowledgable about pricing, we want good, better, best portfolios. Development won’t create them unless we write the requirements. It’s our job to define what goes in each version. The good product should be barely good enough so only buyers who can’t afford to buy up will purchase this. As an extreme example, in the late 1800’s, third class train service didn’t have a roof just to be sure that anyone who could afford it would buy second class. Your best product should be expensive and full featured, while the better product is what most of your buyers will buy.
Still on product portfolio, we want complementary products. Often we have to compete aggressively for business, achieving lower margins than we would like just to win. It would be great if we could have additional products we can sell to the customers we win so we can increase profitability and margins. Again, development won’t create complementary products unless we write the requirements.
In the end, the product team is responsible for deciding what development should develop. Should they build the next generation of your current product? Should they build good and better versions? Should they build complementary products? Using our knowledge of the market and our knowledge of pricing, we can guide them to build the most profitable products.
Photo courtesy of Pixabay.
This Motley Fool article nicely describes the what and the why of Chipotle’s price increase, but what lessons should you take away for your business?
Why are they raising prices? The article gave us three reasons: increasing costs, need to raise same-store revenue, and demand (because they can).
As the article pointed out, they are considering raising prices more than what is justified by the cost increases. However, increasing costs is the single best (if not the only) excuse your customers will accept for price increases. It should be part of every price increase strategy.
The second reason is they need to increase same-store revenue. Chipotle already serves such large portions to each customer it will be challenging to increase the amount or number of items a customer purchases. To increase in-store sales they need to find ways to raise the average purchase price over the current $9 per customer. One way to do this is through a price increase.
Although this is a reason, it’s not a very good one. This is based on inside-out thinking, meaning what does Chipotle need? This is not rooted in what the market is willing to pay. There is nothing wrong to set increasing same-store revenue as a corporate goal. However, it is not justification for a price increase. Price is just one tool they may use to achieve that goal.
Finally, the third reason is the best one: because they can. Chipotle has long lines at meal times and they feel it is very unlikely that they will lose many customers due to a price increase. This is pricing power, the ability to raise prices without a big hit on demand.
We should always base our pricing on what our customers are willing to pay. The high demand and long lines are indicators that Chipotle customers may be willing to pay more. Hartung, Chipotle’s CEO, said, “We’re currently reviewing our menu price on a market-by-market basis compared to competitors and based on our analysis.” This is the right way to think. Different markets likely have different willingnesses to pay.
Finally, here’s a piece of pricing advice for Chipotle (in addition to the general price increase). Offer a discount during off-peak hours. If they have long lines at lunch time but not dinner, offer 10% lower prices after 2:00. This way price sensitive buyers with flexibility will come after the peak time, making the lines a little shorter during peak hours so fewer people will see long lines and walk away.
Your 2 key takeaways:
1. Use cost increases to justify price increases.
2. Price based on willingness to pay, not internal corporate goals.
Equal pay for women has been in the news a lot lately. Depending on what research you read, women make only 77 cents for every dollar a man makes. Presented like this it certainly seems unfair. And it seems to imply there is a bias against women in business.
In my view, your salary is the price you put on yourself. If you are worth more (i.e. add more value), you can charge more. Your customer (which is your employer) decides if you are worth your price.
Here’s the secret: Businesses are greedy. They want the best workers for the least amount of money. Most companies and managers couldn’t care less about your gender, race, hair color, height, etc. If you can make them more money than your competitor (another possible employee) they want you. They will pay to hire you if you can convince them. They will pay to keep you when you demonstrate it.
Imagine what would happen if this wasn’t true. If managers or companies intentionally underpaid high performing women, just because they are women. In this situation there would be a lot of low-priced talent waiting to be snatched up by an enterprising company. We should see companies who only hire these women out of their under-appreciated positions become wildly successful, because they are able to land great talent.
Business people are more greedy than biased.
Here’s an example. Most Americans would probably prefer to purchase things that are “Made in America”. And most US companies and managers would surely rather hire and manage Americans than go overseas. However, manufacturing moves overseas. Why? Because companies get similar quality work at lower prices. Making more money (greed) overpowers bias.
I’ve worked with some amazing women, who were much smarter and more talented than me. I took a negotiating class with a woman who beat her counterparts every time. I’ve seen women work far more hours than me. I know many women who make far more money than me, and they deserved it.
On the other hand, I’ve also known very talented and aggressive businesswomen who, once they had a baby, wanted to work fewer hours so they could be with their children. Nothing wrong with this. It’s a choice.
I’m not an expert on all of the social issues, the biases that happen while raising girls vs. boys. But I am very experienced in business. Businesses are greedy. They want to pay the lowest price for the highest quality in every situation. Labor is no different.
If you, woman or man, want to make more money, add more value. Companies pay more for value. If yours won’t, another will.
From a reader:
Currently, I carrying out a graduation project for a company in Ethiopia. The graduation project is the final part of my study BSc. Business Engineering which I follow at the Utrecht University of Applied Science (the Netherlands).
The pricing strategy of the products of our company (mainly fresh vegetables) is a main subject of this project. I find out if it is possible to use a fixed price for our products. My question for you is:
1. can you provide some scientific information about the flexible/fixed price topic?
2. what are your opinion necessary conditions for handling a fixed price?
I am looking forward to your response. If you require any further information, feel free to contact me..
Thank you in advance
I’m not aware of any experiments or empirical data on fixed vs. flexible pricing.
I’m typically a strong proponent of flexible pricing. This makes sense because pricing is about charging customers what they are willing to pay, and different customers have different willingness to pay. That said, when would fixed pricing make sense?
When there is price transparency. In other words, everyone knows what someone else paid. Some companies who sell to government agencies face this because the information is available to the public. Not many other industries have this.
When there are many low value transactions. When you go to the grocery store, you don’t haggle prices over a bag of potato chips. You either buy them or not. In this case, the cost of paying trained salespeople to negotiate over little items exceeds what little additional gross profit we might make with flexible pricing.
When your competition does it. If everyone expects you to negotiate and you don’t, your customers will leave you and go to your competitors. To succeed without negotiating in these markets you would need a new and compelling business model.
Most B2C (Business to Consumer) business is done without negotiating. In fact there are very few examples where consumers negotiate here in the US. That’s not true around the world though.
The above are examples of when we don’t negotiate prices, but it doesn’t mean we always charge the same customer the same price. So what is your definition of flexible? In your case, selling fresh vegetables, I wouldn’t negotiate every transaction, but I would be flexible. Here are two techniques to consider.
First, do you offer a volume discount? The more someone buys, the bigger the discount.
Second, you may want a different price on vegetables that are “ripe today” vs. “ripe tomorrow” vs. “ripe yesterday”. I would assume the “ripe yesterday” would be least expensive, but it lets you move the product while still serving those with very low willingness to pay.
It’s likely there are other techniques for you as well. Think about when customers are willing to pay more and what differentiates that situation.
Harro, if your definition of flexible means negotiate every deal, that gets challenging, as you can see by the examples above. However, even if you don’t negotiate every deal, you can have a set price list for different situations that truly captures more of your customers willingness to pay.
Hope that helps.
Photo by Rootology (Own work)
While talking with companies about how to set a price at launch, I frequently hear the following comment, “We need to start high because it’s harder to raise prices than to lower them.” In fact, this comment passes my ears so often it needs addressed.
First, it’s true in some situations. For example, if we have a recurring revenue stream, like DirecTV, nobody complains if we lower our prices (except our shareholders), but try increasing prices and we hear from far too many customers.
However, most markets are not like that. What if our product is such that people buy it once and don’t purchase again for a long time (say more than a year)? Those who purchased at one price may not remember the price they paid when they go to buy it again. But even more important, new buyers typically have no idea that you once offered the product at a lower price.
Customers won’t complain if they never knew about your lower price or if they don’t remember the price they previously paid. In these situations, which are far more common than recurring revenue situations, raising prices after launch is not hard at all. Of course, if you have a big splash product, like the iPhone when it first came out, your prices are reported all over news and many people are watching. Raising prices then is hard.
Now let’s revisit recurring revenue business. When we raise prices, it will likely cause pain with our current customers. However, we don’t have to raise prices on everybody. What if we held the low price for everyone who signed up early, but raised prices for new customers. New customers rarely know there used to be a lower price. Even if they do, they are typically forgiving because they didn’t sign up earlier when those rates were available.
This is not an argument for pricing low at launch. In general I’m a huge fan of higher prices. However, this is an argument for not over-emphasizing the difficulty of raising prices later. You want to be forward thinking in your launch pricing decisions, just don’t limit your possibilities.
My answer: “Yes!” Effective pricing requires participation from all of these departments.
Finance must provide margin guidance and help with monitoring of actual results against the expected results. Finance and other executives are often involved in crafting the right pricing strategies. They run what-if analyses to help predict the results.
The product lines must understand the market and the value the products have to the market. They must be intimately involved in setting the price. They are also the last level of escalation to approve deep discounts for important strategic customers. Since profit and loss responsibility typically lies with the product line, they must have a lot of say over pricing.
Marketing needs to understand pricing exceptionally well so they can communicate the value to the customers. They need to create the tools that empower salespeople to win at the highest possible price.
Sales Operations or the deal desk quotes individual deals. They are often the front line to the customer for price. They execute the pricing strategies and levels so they need clear guidelines to follow. They are often involved in the monitoring of the success or failure of pricing.
Salespeople are truly the front line of value communication. They negotiate with the largest customers. They MUST believe that the value delivered by our product is far more than the price we are charging. Sales has a huge impact on whether or not the company achieves the prices set by the product line.
Back to the original question, “Who owns pricing?” Every department owns a piece of pricing. If you decide to bring on a pricing team, they need to have influence over every one of these groups. That means one of two things: 1. You bring on a team of highly influential leaders who can lead and generate change without authority or 2. You put pricing in the most powerful department in the company, possibly even reporting to the CEO.
My preference is #1. Hire true leaders. Then it doesn’t really matter where pricing sits.
Picture by Colleen Simon for opensource.com