article | June 21, 2017
What B2B Companies Can Learn from Uber’s Pricing Strategy
Uber is a fascinating company. Love them or hate them, they are one of the few “poster-children” for business model innovation, and have changed the taxi industry for good. Their approach to pricing has also never been far from the headlines. In the wake of the recent public backlash around their planned 1st degree price strategy, what can B2B companies learn from Uber’s approach?
In my experience, the vast majority of pricing case studies are from B2C. This can be frustrating for B2B companies who want to learn pricing best practices. The natural assumption is that a B2C example is not relevant. There’s no doubt that pricing in B2B is different than B2C. But that does not mean that no learnings from B2C can cross over. Particularly as business buyers are increasingly behaving like consumers in their buying behavior.
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.
Uber’s New Pricing Methodology
In May 2017, Uber announced that they would be implementing “route-based pricing.” The principle behind this is that they want to charge customers different amounts based on what they are willing-to-pay. The algorithms will attempt to calculate the willingness-to-pay for a route at a certain time of day. For example, if you are traveling late at night to a wealthy residential neighborhood (going home?) you may be asked to pay a higher price than someone traveling to a less affluent neighborhood.
Net-net, you will be charged more if Uber suspects you have deeper pockets.
The reaction to this has been overwhelmingly negative. Partially this is due to the controversy around driver pay, since drivers haven’t benefited from the higher rates so far. The part which is more relevant for this discussion is the more internally-focused reaction of consumers, who don’t think it’s fair. The term “price discrimination” has been used.
What is Price Discrimination? Is it Value-Based Pricing?
“Why are people so upset?” I was asked recently. “People say this is price discrimination, but isn’t this just value-based pricing? That’s what we should all be doing, isn’t it?”
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Let’s answer the price discrimination question first. Yes, this is price discrimination. But price discrimination as a concept should not be viewed as negative. It simply means charging different prices for customers based on willingness-to-pay. Many companies do it, and it is essential to pricing excellence. I prefer the synonymous term Price Differentiation, due to the negative connotation of “discrimination”
Now, Value-based pricing. Value-based pricing means “setting your price based on the value delivered by your product.” Actual value informs the customer’s perceived value, which informs willingness-to-pay. Hence, value-based pricers try to price to the willingness-to-pay of the customer. In a situation where willingness-to-pay varies across a customer base, price differentiation/discrimination is a mechanism to price to value.
So, in sum, what Uber is implementing is an extremely sophisticated, and potentially highly lucrative pricing strategy.
So why the negative backlash?
To understand the negative backlash, you must go deeper into the connection between willingness-to-pay and perceived value.
A common misunderstanding is that Perceived Value = Willingness-to-pay. It does not. Perceived value influences willingness-to-pay (e.g. if value increases, willingness-to-pay usually increases) but they are not equal. There are several reasons why this is the case. Customers expect an ROI, so they will generally pay less than the full value they perceive. The customer may simply have irrational expectations for how much a certain product should cost, irrespective of its value. And of course, competitor pricing will reshape how much a customer will pay for a certain amount of value.
But for this case study, the most important reason to consider is that of budget. How much money you have at your disposal influences how much you will pay. A frequent traveler may think a 1st class ticket is incredibly valuable, but if his/her bank account doesn’t stretch that far, his/her willingness-to-pay will not allow the upgrade from economy.
All this means that 2 customers may have the same value-perception for a product, but have a completely different willingness-to-pay.
The reason: Price Differentiation without a Value Change is seen as unfair
My experience in value-based pricing suggests the following:
This is the source of the PR problem for Uber. Their announcement clearly states that they are trying to price to wealth. Getting home in the evening is likely no more valuable for a wealthy person vs. a less affluent person, but the price will be higher, regardless.
It doesn’t pass the sunshine test. And customers may not stand for it.
An example here. A friend of mine – a typically well-dressed man – recently went on vacation and was bartering for a suit with a merchant. He ended up paying ~$400 for the suit and considered he’d gotten a great deal. That was until he found a guest at the same hotel (less well-dressed) paid $200 for an almost identical garment at the same store.
Did the vendor do something wrong? Not really. He made an assumption about my friend’s willingness-to-pay and he was right. My friend was willing to pay an extra $200 for the suit. The vendor did a great job extracting the value received. But, upon realizing the price differentiation, there was no value-based reason to support why my friend should pay more. He paid twice the amount for (in his eyes) the same amount of value. Consequently, he felt completely cheated.
You can get away with this when you’re selling to people you may never see again. You cannot when you’re trying to build a relationship with repeat customers.
Learnings for B2B: Make your Price Messaging about “Value Delivered” not about Willingness-to-Pay
B2B companies absolutely should price differently to different segments with different willingness-to-pay. But they will be more successful if their messaging ties the pricing to the value the customer will receive.
Take, for example, a B2B provider that sells a revenue-generating software to companies. Enterprise companies probably have higher willingness-to-pay than companies with fewer than 50 employees. Still, the Enterprise company may push back on a higher price at the time of sale. They may ask why their price should be higher than that for a smaller company. After all, “we’re buying the same thing.” If the response they get is implicitly “you are bigger, so you should pay more” the software provider is in trouble.
But the software provider will be on a solid footing if they message the following:
This philosophy also extends into discounting. Sales people can be quick to discount to get a deal with a shrewd negotiator. It can be beneficial to do this, but companies must make sure there is value-based reason to support the high discount. Otherwise (especially in industries where buyers may talk), a difficult conversation may arise when Buyer A realizes that while he only received a 10% discount, his peer received 15%.
Price differentiation is tricky, but hugely valuable. B2B companies who support their price differentiation with a value-based message generate higher returns and customer loyalty.
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