A few weeks ago, I was leading a pricing workshop with a large tech company. As a guide, we used the new Pricing Strategy section of the How to Make Your Number in 2018 to review Pricing Strategy emerging best practices for B2B sales forces. Turn to the Pricing Strategy section on pages 142 – 235.
The workshop topic turned to price differentiation: charging different amounts to different customers based on willingness-to-pay. Companies that do this successfully raise average prices, profits, and market share. After explaining the benefits, I noticed one product leader looking sad. I asked why. “This sounds great,” he said. “But it’s not for us. We can’t price differentiate because we publish our list prices.”
I was taken aback by this exchange. Until then I had not considered that executives may think price transparency precludes price differentiation.
The truth is, price differentiation is possible when you publish prices. Very much so.
But it is also true that transparent prices do prevent certain forms of price differentiation. And that deserves to be clarified.
What types of price differentiation does published pricing prevent?
1st Degree Price Differentiation
Published pricing reduces your ability to do significant first-degree price differentiation. What does that mean? Basically, setting a unique price for every single customer.
When your pricing is public, it is almost impossible to specify a different price for every customer. The number of factors that would need to be included would make the price list impossibly complex. And this would nullify the biggest benefit of the transparency – clarity around your pricing.
So, if you are in a highly concentrated market, price transparency may hurt you. You would be less able to capture the maximum value from big accounts. And since those accounts are highly important, this is an issue.
But we have been talking about “reducing” your ability for 1st degree price differentiation. Not eliminating it. How is that the case?
The answer: discounting. In B2B sales, the “list” price is rarely equal to the sale price. There is usually a negotiation, and that usually results in discounting. This means that, should you choose to, your list prices could be thought of as a ceiling. The real pricing comes in the level of discount applied to the list. Think of car sales – a B2C example, but a relevant one because of sales involvement. Practically nobody pays the sticker price. The sale price reflects the sales person’s estimate of the customer’s willingness-to-pay.
Price Differentiation That Doesn’t Pass the “Sunshine Test”
The “sunshine test” is an expression for something that feels “right.” Rightly or wrongly, businesses can get away with price differentiating on factors that do not pass this test when pricing is opaque. For example, without public pricing, a vendor might very well be able to charge more to someone who he feels has deeper pockets. But explicitly stating that strategy on a price list would be folly.
So, in this way, pricing transparency forces organizations to price in ways that are defensible.
So, what price differentiation options are open to companies with published pricing?
In short, everything else. There are a multitude of ways that companies with public pricing can price differentiate.
Firstly, companies can use product versioning or packaging to create options with different price points. This is called “indirect” price differentiation. It allows customers to pick their own price point that aligns with their willingness-to-pay. If these options are well-constructed, lower price options will take away features that are unimportant to customers with low willingness-to-pay, but valuable to those with high willingness-to-pay.
Such optionality is common, and is highly effective. You have only to look to B2B software providers for a series of examples. But, unless your product is complex and you have chosen an “a la carte” approach, the number of price levels will be few. This means that value capture will still be sub-optimal.
So how else can you price differentiate?
You could use a price metric. A price metric is a factor that allows you to scale a price level to a customer. In its most simple form, a metric could be a sale quantity – you buy more units, you pay a higher price. More sophisticated metrics correspond to the willingness-to-pay of the buyer. “Number of employees,” for example. The price goes us as number of employees increases. Which means bigger companies, who (generally) have higher budgets and higher willingness-to-pay, will pay more.
Picking the right metric is far from trivial. To be truly effective it must work for your company and for the customer. But tying price to a metric is something that it is very simple to do when pricing transparently. The metric can be clearly stated on your price list.
Finally, companies could consider a “price fence.” This means setting different prices for different customers based on which category they fall into. Companies often assume this option is not viable when pricing transparently. But that is only true if customers would object to fence, and that is not always the case. Let’s assume we are selling financial news to multiple industries. The finance industry will likely value the information more than, say, the technology industry. Would it not be appropriate and defensible to charge finance companies a higher price?
Needing to price openly does not prevent price differentiation. There are still a great many methods for charging differently to different customers. The art is in deciding upon the right combination to balance simplicity and value capture.
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