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Making the Move to Value-Based Pricing

December 20, 2018

Making the Move to Value-Based Pricing

Many b-to-b organizations improve their products each year but fail to increase prices in accord with the increased value that the products provide to buyers

Organizations often fear that shifting to value-based pricing will cause unhappy customers and a loss of revenue. To overcome this fear, moving from cost-plus or competitive pricing models toward value-based pricing requires a step-by-step approach. Value-based pricing must be supported by the development of internal skills and systems as well as a clear understanding of buyer needs and their willingness to pay. In addition, the transition to value-based pricing often works best when it focuses on specific markets and buyers before being expanded. In this issue of SiriusPerspectives, we define the benefits of value-based pricing and present recommendations for starting a transition to this approach.

 

Pricing Approaches

There are three common approaches to pricing, each with its own advantages and disadvantages.

  • Cost-plus pricing. This approach – the most common – involves setting the offering’s selling price by adding a markup to the product’s variable cost (as well as traceable fixed costs) to achieve a margin goal. For example, an organization that seeks a $20 margin on a product that costs $50 would set the price at $70. Cost-plus pricing is simple, and as long as costs are well accounted for, this approach should produce a profit. However, it ignores offering value and the buyer’s willingness to pay, potentially leaving money on the table. It also fails to account for the pricing of each incremental unit of very low-cost offerings (e.g. some types of cloud-based software).
  • Competitive pricing. With this approach, the organization determines the selling price according to the prices of comparable products and the features and functionality that the offering provides. This approach generally reflects the offering’s value more accurately than cost-plus pricing, and it is more easily supported through competitive sales strategies and marketing materials. However, organizations risk leaving money on the table if the offering’s value and the price that buyers are willing to pay are greater than the competitive-based price. Additionally, competitive pricing lacks an approach for pricing the incremental value of the unique benefits an offering might provide.
  • Value-based pricing. Value-based pricing is based on what buyers value and their willingness to pay – not on costs or competitive pricing. This approach is less likely than others to leave money on the table, so the offering’s revenue and profit potential are greater. Additionally, because the adoption of value-based pricing assumes an ongoing conversation with customers about needs and value, it drives the development of customer-focused products. However, this approach requires more resources than the others (e.g. the time and expense of meeting with customers and understanding the economics of their business). Product managers also must know more about customers than with the other approaches, potentially increasing costs. In addition, the organization must plan for the sales enablement costs required to ensure sales can support value-based pricing and to obtain the messaging and support tools (e.g. ROI tools) needed to support and prove offering value. Finally, the move to value-based pricing often results in higher prices, which can create customer challenges and lost business. To help organizations develop their packaging and pricing strategies, SiriusDecisions created the Packaging and Pricing Blueprint. Organizations should take the following initial steps to move toward value-based pricing.

 

Understanding the Offering’s Value

Organizations can’t move toward value-based pricing if they don’t sufficiently understand the financial value their offerings provide to their customers, as well as the customers’ willingness to pay for that value. Product managers often make the mistake of asking buyers about the price they are willing to pay for an offering without first identifying the offering’s financial value.

  • Select a product that stands out as providing superior value. Value-based pricing is not appropriate for every product; it is best applied to offerings that demonstrably offer superior financial benefits. Furthermore, some products offer superior value only for specific market segments, so identify a specific segment as well as a high-value offering to focus on.
  • Create a plan for identifying buyer value. An effective plan for understanding buyer value drivers requires planning and preparation, including creating a hypothesis for how the offering provides financial value, selecting customer candidates for interview, preparing for and conducting customer interviews, and adjusting the buyer value-driver hypothesis as findings from the interviews are summarized.
  • Talk to buyers about value. Talk to buyers about the value of solving their problems or addressing revenue growth opportunities – and establish the costs of the problems or need – before connecting the offering to solving those problems. This approach establishes value for the offering before discussion of acceptable price ranges.

 

Build the Offering Structure

Product configuration provides a path for organizations to design the right products for the right buyers at the price that provides the best fit to value. By offering a product with the features a customer is willing to pay for, the organization can move to a value-priced approach.

  • Create good, better and best offerings aligned to customer segments. With this approach, buyers that value the expanded level of features pay for them. The key requirement is to match features or capabilities to buyers’ needs without providing too much or too little. Providing too many features can cause a product to be overpriced, and customers might not be interested in having or paying for all of them. Define the level of offering sophistication and complexity required for the good, better and best offerings, create configurations that correspond to those needs and price them accordingly.
  • Create value-added options that can be monetized. Select added-value offerings, such as services, that some buyers want and will pay extra for. For example, enabling services (e.g. configuration, training) are often expected to be provided free with an offering. However, customers understand these services have significant cost and value, and are often willing to pay for them. These additional products also can be used for upsell or as price levers during negotiation.

 

Monetize High-Value Offerings

Monetize high-value features as they are added by identifying their unique offerings and placing a modest price increase on those that should be premium-priced.

  • Increase prices when new, high-value features are added to an offering. As long as additional value is provided in exchange for the higher price, customers tend to accept these price increases. Alternatively, consider reconfiguring the offering so that that customers must move up to a new product/price tier to receive the new feature in addition to current capabilities.
  • Identify products ready for a price increase. Organizations currently using cost-plus pricing can begin moving to a value-based approach by identifying products that offer unique value but only provide average or below-average margins. Categorize offerings according to their differentiation in the market (e.g. low differentiation for copycat products, medium differentiation for products with limited unique capabilities, high differentiation for products with numerous unique capabilities). Consult with customers and sales to identify the value each offering provides, and indicate the margins realized on each offering. Increase prices on high-value, high-differentiation projects being sold at average margins. Consider implementing the price increase for new customers first and measuring the results. If the offering truly provides unique, high value, pushback should be limited.

 

Ensure Price Increase Acceptance

Because the move to value-based pricing often entails a price increase for current customers, consider the following best practices to ensure price acceptance.

  • Set a policy for the customer base. Consider the install base when implementing a value-based price increase. For example, some organizations may have a loyal group of customers paying prices well below the new target price. Create transition plans for customers that will see a steep increase, or provide a lower-value option for customers that prefer to stay at the lower price. Additionally, consider that some customers acquired early may no longer be in the target market for the offering; ensure that they have enough time to transition to another option.
  • Develop a communication plan. Support the new approach with a communication plan targeting customers, sales, channel partners and internal audiences. The plan should provide the playbook for communicating with customers based on the impact of the price increase. Include executive communication for the most heavily affected customers.
  • Create messaging. Develop concise and candid communication that describes the rationale for the price increase or change in offering structure by linking it to the additional value buyers receive. The messaging for a value-based price increase (vs. a price increase resulting from a market shift or cost increase) should be clear and unambiguous; it should communicate the idea that increased revenues are driven back into research and development to continually enhance offering value.

 

The Sirius Decision

The move to value-based pricing must be embraced by product, marketing and sales. To streamline the transition, product managers should identify areas to implement the new approach, such as when they are developing a new, highly innovative product. The move to value-based pricing and the accompanying conversations with buyers about value provide support for marketing to develop stronger value propositions and ROI tools to help sales support the new approach. Finally, the product team must spend time with sales to ensure that sales leaders and reps understand how the new value-based prices were developed and how they connect to buyer value.