Why pricing based on value is better than pricing on cost
Simple question. Is your business making enough money? No? Are your margins disappearing as inflation bites? Maybe it’s time to look at the way you price.
When we start working with them, most clients are pricing on cost. They calculate inputs and add what they think is a reasonable margin. Too often, they have no real idea of what their competitors charge and whether their pricing is competitive in their market. Even worse, there’s no handle on which customers are the most profitable and where they should focus on growing their business.
As a result, they struggle. Everyone’s working flat out, but profitability is dropping like a stone. And it’s particularly tough now with inflation at a record high.
We suggest they start thinking differently about pricing. Instead of looking through a cost lens, we encourage them to shift their mindset to the value they’re offering. This can yield incredible results.
Clarity on proposition
Before you start thinking about pricing, you need to be clear on your proposition. Who is your core customer? What problem do they have? How can your product or service solve this?
Whilst this sounds great in theory, it can be challenging in practice. That’s why we use a tool called ‘attribution mapping’. This will give you a full picture of your market position and a practical roadmap of activity for the next three years.
The aim is to get you to a place where your company isn’t competing with any other. That way, you won’t come under price pressure, and customers will be happy to pay based on your value.
A great starting place if you’re interested in value-based pricing is to read ‘The Win Without Pitching Manifesto’. An insightful quote from its author, Blair Inns, ‘Expertise is the only valid basis for differentiating ourselves from the competition. Not personality. Not process. Not price. When the client has few alternatives to our expertise, we can dictate pricing, set the terms of the engagement, and take control.’
That is really good advice. Your customer has a problem, and you need to position yourself as the only expert that can help them. There is value in solving their problem, and you need to quantify this value. For example, a CEO will call me and ask for my help. Before we get into any detail, I ask them what it’s worth to them to solve this. I like to think they’ll get a 10x return from my fee. If they find this, my price becomes an investment, not a cost. I price by working back from the value I offer.
Be the most expensive in your market
Another good read is Andrew Griffiths’ book, ‘Someone Has To Be The Most Expensive – Why Not Make It You?’ I agree with his sentiment. If you can cultivate expertise and a differentiated strategy, you can charge more than your competitors. This will also force you to obsess about creating enough value.
I spoke to Hermann Simon for our Melting Pot podcast a while back. A well-known author and speaker, he’s just published an updated version of his book ‘Hidden Champions’. In it, he profiles 3000 highly successful businesses that are market leaders in what they do. They have a 15% higher sale price which translates into three times the profitability of their competitors. And this is all down to their expertise and focus.
Adjust your business model
You may need to change your business model to move towards a value-based pricing method. If you’re selling a commoditised product, there will be a price for that in the market. This may go against you if you’re trying to switch to value. If your customer sees you as a vendor, they’ll have a price assumption.
Many of our clients have products that are similar to others. They’re engaging customers too late – when they’ve gone to market to look for a solution. If they were to sell their expertise further upstream, they could target these customers before they go to market. By helping them understand their internal problem earlier in the process, there’s an opportunity to demonstrate their expertise. And charge more based on their value to the customer. Not only this, there’s more control over lining up core customers – the ones for whom their products are an ideal match.
Price differently depending on the customer
You get on a flight and start chatting with the person next to you. You discover they paid £200 less than you. Does that bother you? Probably not, because you know you booked late. Airlines are open and honest about this. The CEO of Delta Airlines once said if two passengers on the same flight are charged the same, then Delta is not optimising its pricing strategy. You know that prices vary according to where you buy them, the times of the year and even your profile. But the input costs haven’t changed.
Why do so many businesses charge all their customers the same if this is a fact?
When all your customers pay the same price, you leave so much money on the table. You’ll also find that profitability by customer varies hugely. Most of our clients have an element of service wrapped around products. And customers will consume this service differently. Some will need loads of support. You make little to no money from them.
Do you know which of your customers are the most profitable? Yes, you’re making money, but from where? And which parts of your products or service do customers value? Are any parts of your offering costing you more, and would it make little difference if you removed them? Don’t give your customers one price and one option. If you went to a restaurant, would you expect to see one option for wine? No. There will be different wines at different prices for different occasions.
Give customers a choice
Every moment of every day, we’re presented with things that give us choices. So consider introducing different pricing options. Some customers may say they want X. Give them a price for that but also for Y and Z. They may come back or spend more.
Value-based pricing assumes that some customers will be prepared to pay more for the same thing as a different customer. Like buying a car with a different set of options, offer them the opportunity to pay more.
Using options will ensure that customers compare one of your prices against another rather than something external. My suggestion is to use three options – high, medium and low. Most will pick the middle option; some will choose the most expensive. The perception tends to be that the best value is in the middle, and you can manipulate this to increase your profits.
There’s a great deal of psychology involved in purchase decisions. You can use this knowledge to your advantage. Let’s say you’re negotiating a new contract. You know your customer will want to feel they’ve done a deal. So give them that opportunity.
Consider some outrageous terms and conditions. Something startling that takes people’s breath away. Maybe an automatic 10% uplift every year. You know they’ll likely single this out, and you’re happy to remove it for them. This all distracts from any negotiation over the price you’ve quoted. So they call you to say, ‘I’m not happy with this uplift’. You say, ‘No problem, let’s take that away. Which option do you want to go for? Number 2? That’s great. We’ll start in two weeks!’ Bam! Sale agreed at a price you’re happy with. And you maintain your profitability.
- NAVIGATING AND COMMUNICATING CHANGE
- BUILDING COMPANY CULTURE
- CHOOSING THE RIGHT OPPORTUNITIES
- ORGANISING YOUR A-TEAM
Written by business growth coach Dominic Monkhouse. Find out more about his work here. Read his book, ‘F**k Plan B’ here.