Why is your Value-Based Pricing Strategy not working? Because it isn’t truly Value-Based.
Value-based pricing is a hot topic among B2B companies. Promises of higher profits and market share have been made credible by numerous success stories. Who wouldn’t want to share in that success? There’s little wonder that we are seeing more and more companies making the move. But, we also frequently see a lot of frustrated companies. Those who have launched value-based pricing strategies without seeing the results. Why? Their value-based pricing strategies are not truly value-based.
To receive a preview of SBI’s new 2018 Pricing Strategy workbook, simply email Jeff.Grice@salesbenchmarkindex.com and request a brief call with me to review the latest pricing best practices.
It’s not surprising that this is the case. Like anything that offers superior returns, value-based pricing is challenging to do well. It takes market understanding, rigor, and discipline to get it right. There are several reasons why an intended value-based pricing strategy can fall short of expectations. We have listed some of the commonly-seen pitfalls below.
1. Inward-Out Value Calculation
Frequently the source of the issue is inward-out thinking. The value the company calculates is an internal perception of value, not the customer’s.
For example, imagine our company sees our solution as being an efficiency play. It allows users to complete tasks more quickly and saves them time. In that case, we may calculate the value as being the cost of the users’ time that has now been saved.
This is great if the customers share our perception. But what if they don’t? What if the customer doesn’t place any value on time savings? Perhaps employees just end up leaving work earlier. In this case, the customer will not agree with the measurement of value, and will push back on any prices communicated this way. So, adoption and margins will follow.
It is important to remember that in value-based pricing customer perception is everything. These perceptions are not static – you can change them through education. But you must know them, and you must address them through your pricing strategy. Otherwise, your value-based strategy will not be value-based for the customer. Which means it is not value-based at all.
2. Lack of Value Communication
Sometimes, a pricing strategy truly is value-based, but it is not communicated to the customer.
A company I worked with went to great lengths to calculate the value a new product delivered to a customer. They used this methodology to produce a custom value-based price for each major account.
But, they were afraid to show their workings to the customer. They feared the customer would push back on the assumptions. Consequently, they didn’t show any part of the calculation to the customer. They elected to just show the price to the customer without any rationale. Needless to say, the prices were rejected.
Without a frame of reference for the price levels, customers would resort to their expectations. These would likely be based on similar types of solutions, which were lower priced. Customer willingness-to-pay was therefore based on an uninformed perception of value. Since this was lower than the true value, willingness-to-pay was lower than the prices set.
For the customer, the way you price is often just as important as the price itself. Your pricing strategy tells your customer how to think about the value you create. If a product’s value is not well understood, it is up to you to clarify. By doing so, you raise value perception, boost willingness-to-pay, and can command higher prices.
3. Cost-Based, Not Value-Based
Sometimes companies believe they are pricing to value when they are actually pricing to cost.
This may be surprising, but is actually quite understandable. So many price strategies are cost-based that we often think of cost as value. We think a jacket should cost more than a t-shirt because there is usually more material. We may think 10 hours of professional service should cost more than 5, even if the outputs are comparable. Look at Samoa Airlines, who now charge more for a heavier passenger.
Given this line of thinking, we frequently see companies confuse their cost-plus strategy with value-based pricing. It is usually coupled with having high margin goals. The rationale is that the high margin is due to the high amount of value added. Hence, “value-based” pricing.
In reality, such a strategy is not value-based. While value-based strategies typically result in higher margins than cost-plus, this is not what defines them. What defines them is that the price is set based on the willingness-to-pay of the customer. A strategy which determines ideal price and then backs into the margin is value-based. A strategy that starts with a margin goal and then sets the corresponding price is not. The price is still determined by the cost. It’s cost plus, just with a large “plus.” Such strategies are potentially missing out on higher profits from those who will pay more, and on profitable business from those whose willingness-to-pay wouldn’t meet the margin goals. Value-based pricing does not have that shortfall.
Cost-plus strategies can be made somewhat value-based by setting a different margin goal for different products and/or different segments. This is often a great approach for companies with a large number of products. Here, full value-based pricing at the product level would be too complex to be realistic. Instead, margin targets can be customized by product line and customer segment to better capture the value delivered.
Value-based pricing is not the right approach for every business. To capture that value requires rigorous strategies and strong execution. But for those offering a high-value, differentiated product, it can offer huge returns. Decide whether you are willing to invest in setting a value-based strategy. And if you are, take the steps to ensure that it truly is value-based.
To receive a preview of SBI’s new 2018 Pricing Strategy workbook, simply email Jeff.Grice@salesbenchmarkindex.com and ask Jeff to schedule a brief call with me to review with you.