Many industries and many products are sold using some form of cost-up pricing. The issue with this approach is that it misses completely on the point of view of the customer and all the benefits of other pricing approaches.
Let’s review there 5 fundamental elements to pricing before looking at the approaches, the models and strategies you can use to deliver maximal value to your customers.
The 5 fundamental elements of pricing
The first fundamental element of pricing: understand value
Understand the value the organisation creates for its customers and translating this into a price. Value is delivered mainly through the product but other elements play also a role: the support, the after-sales services, the channels, the different ordering possibilities, the payment terms, etc… And remember from above, the value is linked to how success you help your customer achieve.
At this stage, you’ll stop me and tell me there are other approaches to pricing: cost-plus or competitors’ based. And you’re right. While these are commonly and probably appropriately used in many industries, my focus is rather on products that are innovative or at least have some level of (perceived) differentiation vs the competitors. These are products that are perceived not to have direct substitutes. For these products, pricing based on the value delivered is usually the winning approach.
The second fundamental element of pricing: measuring value
Measure how much success you help your customer achieve. Go and check with the customer how much value you actually deliver and how much she is willing to pay for this value. Different customers have different willingness to pay for the same value delivered and measuring this is important to set-up the right pricing model and metrics.
The third fundamental element of pricing: capturing value
How you will capture that value? This is the pricing model. It is very tightly linked to the previous element. The choice of pricing model in itself carries value because of two main characteristics:
- the transfer of ownership and associated risk (low in a pure buy-sale relationship; higher with subscriptions)
- the level of commitment to the customer achieving success (low in a pure buy-sale relationship; very high with performance or outcome-based model)
The fourth fundamental element of pricing: the value ex-change rate
Define what you price and about capturing part of the value you deliver to your customers. This is actually the exchange rate you set for what you deliver: how much € or $ you ask for your product. As any ex-change rate, this is not fixed and will evolve over time.
The fifth fundamental element of pricing: value communication
Communicate the above four elements both internally and externally. The key here is to communicate on value again. This is often overlooked and assumed everybody knows the value, especially by pricing people with a more figure-oriented back ground. But pricing needs to be anchored deeply in value. And people need to be reminded often. Communicate often, explain the why-how-what again and again and you’ll create adhesion to your pricing. Failing to so leads to low adhesion, frustration and people perceiving pricing as hindering good sales.
Pricing approaches, models and strategies
Now let’s have a look at the different pricing approaches you could use, what you are going to price and how the choice of a pricing model goes beyond the frequency of invoicing but also says a lot about the relationship and the commitment you make to the success of your customer.
You might price it based on its cost using the cost-plus approach. Or use the average price of a basket of similar competitors. Although these approaches need to be taken into account into any pricing exercise, I prefer a value-based approach for distinctive or innovative products. The more differentiated your product is or the more innovative it is, the more value (read the more success) it delivers to you users, the more value-based your pricing should be.
Pricing is a key component of your offer as ultimately users will compare the benefits they will enjoy vs the price they will have to pay. Pricing is not just sticking a price to a product but it needs to translate the customers benefits (= the success you help your user achieve) into monetary terms. Customers need to be able to understand the relationship between your price and the benefits.
What do you price?
This is about the product attributes and their related benefits you price and how do you explain them to your customer. A good price is understood by the customer and clearly communicated. This ensures easier acceptation.
At what level do you price?
Using different methods such as quantification of the user benefits, perceived value and willingness to pay will help you determine the optimal price for your customer based on your strategy. Your pricing strategy will support your business strategy: maximise profit or sales; penetrate a new market; skim for the top of the customers.
How do you price?
The pricing model says a lot about the kind of relationship and the commitment you make to the success of your customer.
A buy-sell relationship is a fairly loose customer relationship model that create the lowest level of commitment from the seller about the success the user will achieve.
A subscription model implies an on-going relationship with value being continually and consistently delivered to the user. As a provider, your commitment to the success of your customers is stronger than in the buy-sell relationship as the risk that your customer does not achieve success shifts partially on you: you only ask for a small (price) commitment at the beginning with the expectation that your customer keep being successful by using you product in the long run.
A performance or outcome-based model implies a tight on-going relationship where the customer and you work closely together to achieve the desired outcome (the success). Value is being continually and consistently delivered with the user and the final price paid is variable and is based on achieving that value. The risk of not achieving the customer success is born in big part by the supplier.
Although pricing uses methods, approaches, analysis and lots of figures it is first a tool to be used to translate value into monetary funds. But pricing and the chosen model goes further than just applying an ex-change rate: it does convey a message about how far you’ll go to help your customers be successful.
For your latest new product launch, how did you chose the price model and the price level?
Elithan Consultancy is a consultancy and interim management company that helps B2B technology
companies create, capture, position and launch customer value. Elithan Consultancy helps you make
informed and better decisions that lead to lower business risk and more positive outcomes.