Pricing is the moment of truth in value capture
3 ways to approach pricing.
The most common pricing approach is to look at existing prices and decide to follow or go a little higher or lower. This is called competitive pricing and is very practical in cases where products/services can be easily compared, and prices are transparent. Also, when prices are very dynamic this is an important logic. Of course, there are limits. On the low side if prices fall below variable cost (for example raw material costs) every unit sold creates more losses, not a very good business approach. Many commodity players (oil, petrochemicals, building materials, farmers) are very aware of this and use cost curve analyses to guide their pricing. On the high side, for example in case of a near (or temporary) monopoly or undersupply, prices can go up a lot, but the number of buyers will go down and often regulators start to step in. Think of the big internet companies, the pharma example, tulips in the 17thcentury. Deep understanding of demand-supply curves and competitive regulations is needed here.
The second is based on the logic that the price should at least cover all the relevant costs, i.e. cost plus based pricing. This makes sure that any sale is at least positive for the company. Sounds simple but has many challenges. Which costs to take into account? Do you include the 10 years of R&D spend that went into the product? Even if you say yes, then do you divide the costs by last year’s sales, or by the projected total volume over the lifetime of product (as if you know that …). Sophisticated finance teams can spend a lot of time on this. Another favorite is how to allocate unoccupied manufacturing costs to the products sold? For well-established products this is complex but doable, but for new/innovative products there are usually too many unknowns to make a well-informed choice on costs alone.
And that is also one of the prime examples when to start thinking about pricing based on the value you deliver to your customer as compared to the next best alternative available to your customer. This is called value based pricing. In general, this is seen as the most complex but rewarding pricing approach.
A quick search for ‘value selling’ on Google shows over 2 billion results, 520.000 books, 200 thousand plus videos and more than 10.000 consultants.
And still most companies, marketing and sales managers and teams consider as their biggest challenge.
Can you always use value selling?
Well, in many more cases than most people practice today. Any one of the below conditions is a good starter:
- When the product or service is customized
- When costs and value have large differences
- When there are variations in customer needs (segments)
- When the value to the customer is at least a little transparent
- When customer relations are important (multiple interactions)
- When very diverse products/solutions exist
But your capability and desire to push for a value selling approach is also determined by the relative importance of the transaction to you and your customer. If both see it as a necessary evil, then the most logic approach must be simple, efficient and likely cost plus. If both parties, see high value circumstances are ideal for value selling. When the value to you (and your competitors) is high, but low to the customer you will very likely end up in a competitive pricing mode. And interestingly when the value to you is low but it is high for the customer, you can often create the highest value capturing approach.
Customer Value can have many forms.
When looking for ways to create value for your customer, you probably know some elements of the top of your head. But it is important to look at all possible elements, the most common categories are:
- Cost saving at the customer or further down in the value chain
- Higher prices for the customer’s products/services
- More growth for the customer (or the end consumer)
- Investment avoidance at the customer
- Better reputation/ brand image
The toughest part is to really quantify their (relative) impact relative to the next best (competitor) offer. Not all effects will be positive, on some elements you may well have a lower value then the alternative you are comparing with. This analysis is often referred to as Economic Value to the Customer (EVA)
Examples of value selling/pricing
Examples of value selling can be found in any and every type of business: high volume commodities, super specialised technological products, all kind of servicesservices, consumer goods, etc…
Some nice cases are summarised in the below table
Exploring these examples (some under development):
Value pricing is everywhere also in SALT
Everybody knows what salt is, the chemists call it NaCl and it has been around as a life-saving product for all of human history. Its value is well recognized and, in the past, has been very expensive. Our word for income payment – salary – even comes from the Roman times ‘sal’ where legionnaires sometimes got paid with salt. Still many people would call it one of the most basic commodities.
In todays world salt is easily available and used in the millions of tons per year. Most of it goes into chemical processes for the making of thousands of different chemical products, ranging from PVC to pharmaceuticals. And with these large volumes it is not surprising the buyers look for low cost. Still the chemical processes are very sensitive to value pricing. Certain impurities create extra costs and lower efficiencies, so it is worth to pay more for a purer salt. Actual prices can range by a factor 4! The most expensive being 300% higher priced and still being a better economic solution for the customer
Another well-known use of salt is road de-icing in winter. Safety first, but still, large volumes and no incomes are generated by from using it, so low prices are crucial. But some differentiation is possible – and therefor value pricing. Most trucks and salt spreaders need an optimal particle size distribution and even form to be able to drive as fast as possible and still spread the salt evenly. Also, enough slat at the right place at the right time is very important. Here the value premiums can be 50 to 100%.
The third group of uses is in human (and animal) consumption. And here differentiation reaches extreme possibilities. Our normal kitchen cooking salt is bought by the kilo. But for on the table, we are tempted with the many beautiful, packaged sea salts, with many claims of better taste and health benefits. Some top of line products, recommended by well-known chefs, are pyramid formed crystals, kosher salts, dead sea salt, and the so temptingly pink colored Himalaya salt (apologies for not mentioning your favorite here). These products are no longer priced per ton (=1000kg) or even per kg, they sell by package (of often not so easy to see weight).
Not to forget the use of salt in hospitals around the world for infusion – saline drips. Of course, the purity and safety for this use is paramount.
From the lowest priced salt at €10 per ton to the highest of €10 for 20 grams (= €500.000 per ton) is a whopping 50.000 multiple. Ok there are some extra costs, but still.
Now of course these extreme prices address only small markets, and my point is not to go look for these. But I do claim that value pricing is everywhere, also for high volume commodities, and has huge potential for improving your (and your customers) results.
Value pricing water – from floods to specialized aqua’s
Without water no life, without clean water no civilization. Most of us consider water the omni- present commodity. After all Earth is the watery planet with over 70% of the surface covered by oceans. Too much water through rain, storms, avalanches, floods and tsunamis can create major disasters. Our current climate challenge is most often expressed in cm’s increase of the sea-level. But at the same time lack of (sweet, clean) water can create disastrous droughts, failed crops, animal and human suffering. The increasing size of the worlds’ largest desert the Sahara is well known (and being fought with some modest success).
Clean water and hygiene systems in all our societies depend on the smart use of water. Irrigation, water energy from dams, but also the toilet and safe drinking water from the tap are some of the biggest life savers we have created.
So, what is a good price for water? Well -it depends. It depends on the circumstances. If we look at actual prices charged for H2O as the chemists like to call it varies enormously. Probably fair to say that for free is the lowest price. Though some theorists would argue that (just like oil recently) a NEGATIVE price is certainly possible in some special circumstances, but for today I will let that go.
Normal pricing for tap water in most countries is charged in cents per cubic meter (1000 liters). In my home country it is actually close to 1 cent. So, let’s take that as the bottom price.
As we all know we also buy a lot of bottled water, at a really good price of 10-50 cents per bottle of 1 liter. That is already 10-50.000 times as expensive. And in some countries, it can be defended as safer, purer, better … but in many countries there is no chemical or physical difference from the municipal tap water. Lots of the value is perceived! And the important lesson for value pricing is that perception is reality.
And this is before we come to the real fancy marketing and branding. Because if you want to go all out you can also buy a very special water for $400 (there are much more expensive bottles but that includes jewelry on the crystal carafes, so also on this extreme high side let’s leave them out of the equation). Still, we now have a range from 1 cent per 1000 liter to $400 per 0,75 liter an incredible value pricing range of 500.000.
Maybe not the top of the range in price per liter, but close! are the laboratory and pharmaceutical grades and the cosmetic aquas. Any water to be used in hospitals or for the making of vaccines must by extremely pure and safe, so here a high price can be defended on rational/economic arguments. Cosmetic waters are closer to perception again. Special tattoo cleaning waters or facial cleaning products using special formulas give ample opportunity for branding and emotional arguments.
Value pricing – from sand in the desert to silica chips
Value selling – from natural odors to heaven scent
What is your favorite outdoor experience? Most likely it involves a special scent, the cleansing salty seaside wind, the slightly moist and green smell of the forest, the lovely fresh cut grass early in the season, the crisp mountain air, the explosion of smells in a tropical jungle, the dry smoothness of the desert, and the list goes on and on. And although you need to go there the experience is for free.
Smelling is also well known as the most powerful of our senses in creating memories. And we all have read the stories about pheromone type scents influencing mood, attraction and behavior.
In our ever more enclosed lives in big cities we have an incredible craving for nice smells. First to mask the unhappy odors collecting in the towns and villages of the middle ages and later ore and more to create our own bubble of special experiences.
And therefor it is maybe not so surprising to see the great efforts that companies do to create special perfumes, deodorants, etc… And yes, a lot of research goes into finding the right fragrances and mixes to delight us, but as much effort goes into communicating the special experience that the perfume will create.
When looking at the value pricing opportunity the base line could be said to be for free, but for sake of calculation I have looked up the lowest priced version and I found some at €2 per 100 ml. Many perfumes sold on airports are in the range of €30-100 per 50 ml. More specialty fragrances with very elaborate packaging range well into the €1000 per 30 ml and some rare extremes are priced at €10.000 per small bottle of 30 ml. this gives a huge price multiple of more than 15.000 times on a base price that is not cheap.
From a value selling and pricing point of view it is crucial to realize which buyer and final consumer you are targeting and how much you want to sell. For perfumes to a limited degree so called ‘champagne marketing is applicable: the higher the price the more you sell 9for the economists an upward sloping demand curve). This is counterintuitive and of course does not apply over the whole pricing range. You need to find the sweet spot and also support the pricing with the right product and communication ánd right channel. Here the value is in the experience of the buyer, the user and the audience of the user. The whole value selling approach needs to be synchronised.
Value selling sports shoes – from easy walkers to iconic sneakers
Value selling Lego – From simple plastic block to top selling movie
I must admit to being totally biased on this example of value pricing and selling. I still have my 50+ year old Lego box from my youth and my family are avid collectors of the Harry Potter series. Still few companies have succeeded to create so much value from such a humble material.
Currently all Lego pieces are made from ABS a very normal polymer, going for about €1 per kilo. And if you go looking for unsorted Lego blocks sold by weight the price is already about 10 times higher.
The real value selling starts in the beautiful boxes with smart design and marketing. Weather it is the police station or the mini farm with animals, prices start to shoot up. And interestingly finding huge audiences around the world. Lego is in several overviews the most successful toy company; despite the fact they sell really only one product. Going even further up the value chain you come to the movie related co-marketed sets. For the top-level sets prices move into the hundreds of euro’s. this translates into numbers like €800 per kg.
But the story does not end here, there is a large after-market of unique pieces either made in small series or needed to fill out the dream set for an avid collector. Here prices go as high as €1800 per piece, and if I assume at 10 grams that is €180.000 per kilo.
Segment the market
By any definition Lego has succeeded to segment the market and use value selling to reach each group with a very compelling product. Here the customer journey is also not simple, because who are they actually selling to? The children yes, but it is the parents buying and paying. Or the grandparents or the friends. And interestingly the popularity of Lego with adults is maybe even higher then with the kids. Most countries have extensive Lego fares/events with thousands of participants and guess what the majority is definitely over 30, mostly even over 50. The appeal of being able to create your own versions of buildings, cities and even events is enormous. On YouTube you can find countless examples of stop-gap movies, painstakingly (hundreds of hours!!!) made by fans of rock concerts, soccer or other sports games and historic events. Go find your favorite.
The ultimate Lego format is now virtual, now Lego has huge incomes from movies and games based on the ever so simple pieces. The price per kilo has no more meaning .
So, what can we learn from this?
First value is in the eyes of the beholder. And when it comes to buying something for children there are almost no barriers/limits. Especially if you can defend the purchase with a noble goal of stimulating creativity and self-expression. Still endless segmentation pays off.
Second it is great if you can join others in doing the marketing (deliberately or indirectly), but make sure you control the pricing.
Thirdly get you customers so involved that they help you develop your product (Lego actively supports customer design groups and initiatives.
Consistency can pay off, my 50+ year old pieces work fine with those just bought this year in one of the flagship Lego stores.
And for the future
Now after close to 65 years working with ABS the Lego team is working on the next generation material, totally sustainable and circular, but I am sure they will still fit with the oldest pieces. But at the same time, I might be tempted to replace my whole collection with the new material, and I guess that the company will come up with a smart way to stimulate that …
– from a simple tune via exceptional experiences to collectors’ items
Value pricing – from outsourced routines to transformational experiences
None of us can be great at everything and therefor the advice / consulting market is huge (more than €100 bln per year) and so far, continues to grow through all economic cycles, crises and pandemics. What you (will or want to) pay for your advice is not so easy to predict. It depends on many factors, how special and/or urgent is your need, how much can you pay, do you need only advice or help in executing the advice, etc …
There are also many kinds of consulting ranging from more repetitive routine type activities that need to be done but need a special expertise not available in your company – via special projects solving a new problem and helping create new decisions/plans – all the way to a unique experience that creates a motivational shift in your company.
So not surprising that from a value selling and pricing perspective there are large ranges. Some of the most competitively priced offers are/seem close to minimum wage levels (but often need less time than billed , also here automation is making big impacts). Gone are the days of young analysts (like me 30+ years ago) lugging calculators, pens and transparencies to make presentations. The professional multinational consultancies charge several hundreds of euros per hour.
Some consultants also offer a sharing of the risk (and the value) by having part of the fee dependent on the results at the customer.
As example: I could offer value pricing advice at half my normal fee, if my client would be willing to share for example 1% of the increased price with me. In implementing this there are many definition and measurement challenges to be overcome and a strong mutual trust is needed to make this work. Still, it is being applied, especially in the M&A field.Finally, there are the rock stars of consulting, the motivational speakers. Famous or exceptionally strong performers with high impact messages can charge exceptional prices easily ranging to €25.000 per speech. So here the value multiplier goes up to 2000. An important lesson here is, that next to content and quality, reputation and mutual trust are key elements to be strong in value selling and pricing services.
Value selling R&D – from routine analysis to Nobel prized projects
My experiences, how to do it and lessons learned
Of course, it is inspiring to see examples of value pricing in the real world for products and services. It is important to realize that they are the outcome of many years of trying and failing and trying again. So how to approach it for yourself?
From my own experiences I have learned to see it in 4 major steps, that are not perfectly sequential and have several feedbacks loops.
- Understanding the customer needs
- Comparing your own offering versus competitors
- Embedding value pricing in a value selling journey
- How to create fair sharing as a foundation for long term equitable economic benefits for all parties
The whole process starts with your own belief that you (can) create real value for your customers. The challenge is that what you think the value is may, not be (fully) correct. So, you need to be a little schizophrenic about this. On the one hand fully convinced and driven that you can bring superior value, but at the same time open and self-critical to want to learn what your customer really needs.
- Understand what different customers need
Most teams have not done good enough customer needs quantification, nor competitive product/service comparison to allow solid value pricing. Also, value pricing is powerful for segments of the market, sometimes even individual customers, not the market as a whole (standard pricing is the enemy of value pricing). Key steps in the journey are:
- Build a standard starting list of customer needs that are often relevant for example speed, accuracy, reliability, customization [ref: Blue Ocean Strategy]
- Try to group customers into segments with similar needs profiles
- But allways be on the lookout for special needs
- Use your own knowledge but certainly add outside inputs from
- Other suppliers to the customer, not necessary your direct competition
- Multiple people at the customer, try to find out who are the decision makers/influencers
- Customers of the customer – if you understand what makes your customer successful you have much more leverage
- Involve your own marketing and sales teams, they know your customers (and this will help a lot later when you want to implement changes)
- But also use an outside agency to get more objective and systematic inputs, but make sure to go beyond the standard Net Promotor Scoring type of surveys, ideally have telephone interviews)
- What is the best alternative to your offer and how does it score on the needs?
- Can range from do nothing, use competitor, do in house, or follow a radically different approach [ref: competitor analysis] and go to step 2
- Comparing your own offering versus competitors
It is very difficult to be objective about your own product versus the competition, still this is second important ingredient for high impact value pricing. Part of the challenge is who/what to compare to. Sometimes there is an obvious market leader or standard product but be careful often there are two or three major offers in the market. And these offers are not always close to your offering. Different technologies or different customer operations can position alternatives differently. For services the in-house solution is a competitor to always take seriously.
- Make a detailed comparisson between your offer(s if you have choices) and the best alternative(s) identified based on the needs from step 1
- Be ruthless not rose-colored when comparing, get outside opinions and inputs
- Try to quantify the effects for the customer as much as possible, especially when claims of costs savings or higher performance are used [ref: Economic Value Analysis, cost curve analysis] and do not forget to subtract those elements where you score below competition
- Weigh the different needs against each other, this weighing is often different for different customers (segments).
- Conclude what the extra value is that you can create for the customer
But realize this is your homework before the rubber hits the road when you start your interaction with your customer in step 3 (parts of step 3 will feedback into 1 and 2!)
- Embedding value pricing in a value selling journey
Value creation does not start or stop at the sale, it needs to be during the whole customer life cycle. Especially a great product or service needs selling and value communication – perception is reality.
- First, Do not talk about the price, ask about the customers needs and how they are met or not met
- Second, Do not talk about the price, talk about how your offer is different
- Third, Do not talk about the price, show how the difference adds value
- Still do not talk about the price, but listen to the reaction
- Think about how to proove your extra value before discussing price, use a pilot or some small testwork
- Ok, now you can start talking about how to share the value created
- What is fair? – see the next step below
- And finally you can start talking about the price
- The price is not a number, it is a mutually agreed way to share the value created
- In every communication – before and after – the negociation make the value come to life, every time
Next to the steps in the process it si good to recognize who is responsible for value pricing. Of course, this will need to be different across companies. Size, B2B or B2C (or any other 3-5 letter combination you like to use), geographic complexity will influence exact choices. Still some fundamentals can be described:
- Value pricing is not exclusive to marketing and also not to sales, a close cooperation is crucial – a careful balance of centralized knowledge consolidation and decision making helps rigor – but front-line input and execution are fundamental to success [ref. roles of sales and marketing in pricing]
- Many more functions need to be involved to truly create and communicate the value proposition. Technical service, intelligence roles, RD&I, operations, finance, etc …
- Organizations with strong (key) account management should use the power of these teams [ref. (key) account organization]
- Organizations with deep brand and marketing communication teams should leverage them in the whole process (and not only at the beginning and the end)
- When (re-)introducing value pricing/selling it best treated as a transformation type change with a top- level steering, a dedicated change team and all functions part of the project. [ref. transformation approaches]. But a lot of attention needs to be given to avoid transformation isolation, the teams stay in the working organization and are the ambassadors of lasting change.
- Value selling/ pricing has best long-term impact when fully embedded into the core company processes and culture, it is crucial driver of customer centricity [ref customer centricity]
- Creating fair sharing as a foundation for long term equitable economic benefits for all parties
Capturing your fair share needs to combine the analytics, the power balance and the cultural sensitivity to what is considered fair. A quick google search gave me 400+ million references, so enough definitions to choose from. Fair pricing is also defined in many laws, usually to make sure that for example monopolists cannot create extreme pricing. Still most definitions use the freely agreed transaction between a supplier and a customer as basis, often with a form of market reference. And if you reflect on this, this is exactly what value pricing strives for!
- What is fair is determined by the balance of power and relative size of the effort versus value
- If it takes only 2 hours work to create €2 mln value this will not likely allow a 50/50 split, but why not ask €100k?
- For a 20 man-years project (I guess €3-4 mln costs) for €20 mln value maybe you can get 25-30%
- Pricing can be different kinds of money – direct payments or indirect payments
- One-time payment, installed payments, pre-payment, post payment, performance related payment
- Value sharing can also use other currencies besides money:
- Repeat business, extended work
- IP ownership, or allowed to use (part of) results for others
- references, publications, introductions to other customers
Remember, every product/service has opportunities for value pricing – even the most hard-core commodities. Repeat business, long term relations, are built on fair sharing of the value.
Want to learn more or discuss your situation ?
Contact firstname.lastname@example.org I am happy to take on the challenge to help you introduce value-based pricing and will use it in my quote to you.