Value Pricing - Establishing the “Right Price”

Ask people the definition of marketing and you will get a wide variety of answers. Invariably, the most common definition focuses on only one component of the marketing function: promotion. A more complete definition of marketing is when it is defined as the business operations that seek opportunities, convert potential solutions into products and services, and then deliver solutions to end users profitably.

For smaller businesses, the costs associated with conducting full scale market research, identifying profitable segments and developing the right message to targeted customers can be seem prohibitive. Actually, what is prohibitive are the costs associated with not doing any research.

Feeling your customer's "Pain"

The most important element of a sales call is to clearly understand what your potential customer sees as its immediate problem. Instead of trying to push your product by describing all of your product’s features, take a more consultive approach by listening first. This way you will be able to better understand what is causing that potential customer “pain”. “Pain” is defined as an issue that costs buyers time, money and/or aggravation” and everyone seeks to eliminate pain. The higher the “pain” level the more valuable your product becomes if it eliminates that pain. So, how does this have anything to do with setting the right price?

Obviously, the more valuable your product is to that customer, the greater the potential for a sale at a higher price. The problem is that by not segmenting customers into groups with similar “pains” you leave a great deal of money on the table or lose sales to customers with lower or different “pain” points. Different customers have different perceptions of value. Therefore, product pricing should reflect these differing perceptions.

Being competitive

In order to compete effectively in a global market companies must develop better pricing strategies for a larger and more complex marketplace. In the B2B world every purchase is an investment to raise revenue or lower costs. Therefore, assuming no other competitors, buyers would be willing to pay up to the cost of the existing “pain” less, of course, their target ROI for the investment. In the real – competitive – world, buyers first segregate offerings into two groups; those with values that deliver at or above the target ROI, and those that do not. The final determination is based on the perceived value to price ratio; that is to say the product that yields the highest ROI relative to its price will be purchased. This process provides the offering firm with two choices to make the sale: lower prices, or increase the perceived value and maintain price integrity. Either method will increase the value to price ratio.

Here is a form for calculating price elasticity under various conditions:

Price Elasticity Analysis - One Product (xls, 166k)

Market research techniques for the ideal price

Traditional marketing research techniques such as focus groups, surveys, and conjoint studies do not help the seller identify how the new product will drive revenue or reduce costs for customers and thus create value for the buyer. Focus groups are designed to elicit feedback on the types of benefits a customer seeks in a product. Surveys validate how those benefits vary across customers segments, and conjoint studies attempt to provide statistically significant results for how much customers are willing to pay.

The most effective way to assess the value a company's products bring to its customers is through in-depth interviews, which enable the company to understand its customer's business model. Through these interviews the seller obtains a better understanding of how its product impacts the customer's business. This understanding allows the seller to construct an economic value model that becomes the foundation for effective pricing and sales strategy.

The dangers of discounting

Unfortunately, many mature firms and especially startup firms fall victim to the belief that discounting is the road to market penetration and profitability. Discounting effectively communicates to the buyer that the value of the product is ethereal. Defensive marketing strategies to counteract a competitor’s discounting strategy should be designed to reinforce your product’s value to the end user. Following a competitors price cut leads to a downward spiral of price cut after price cut. Ultimately, margins are razor thin or non-existent; just look at what has happened to sales of computer hardware equipment

Studies conducted by the Product Development Management Association and the Strategic Pricing Group in 2004 revealed that there is less than a 50% chance that new products will hit their volume and profit goals. Ineffective pricing strategies were shown to be one of the most overlooked aspects of new product development and marketing campaigns.

In an article written by John Hogan & Tom Lucke, and published in the Journal of Business Strategy, the authors stated:

“During the recession of 2001-2004, entire markets were consumed by ad hoc discounting by companies trying to defend their piece of a shrinking pie. In the process, companies sent a clear signal to customers that price was negotiable and value would be given away when pushed hard enough. Many companies also began bundling additional products and services into their core offering to "sweeten the deal" and make the sale. By giving away services, these firms drove up their costs and taught customers that their services were not highly valuable. These short-sighted pricing approaches may have helped sustain sales, but they also taught customers to focus on price and ignore value.”

Three common pricing traps

According to Hogan and Lucke, three common pricing traps often derail new consumer or business-to-business product marketing success. By avoiding these traps firms improve their chances to drive new earnings and profit growth:

Pricing benefits instead of value
Understanding the economic value that a product brings to different customer segments is an essential ingredient to launching new products. Moreover, economic value must be understood in relation to the value delivered by competitors, because customers are comparing competitive offerings when making a purchase.
Managing customer risk with price
New products involve some risk to customers because they represent un-tested solutions to their perceived needs. Discounting or Introductory pricing on innovative products fails to address the problem of customer risk and creates low price expectations that reduce margins on future sales To maintain price develop a separate strategy to manage customer risk. ” In technology markets, usage-based pricing metrics are rapidly becoming the norm as customers balk at paying for a fixed number of licenses, many of which do not get used and become shelfware. A usage-based metric that tracks the number of users, degree of functionality used, and/or the time of use, removes the customer's risk of overbuying and helps control costs.”(Hogan, Lucke)
Failure to manage the post-launch price trajectory.
Global competition creates the immediate erosion of value of a given product upon its launch. Your investment in gaining that intimate understanding of the customer’ pain can disappear as quickly as product knockoffs appear. The key to managing your price position (ie. delaying the eventual commoditization of your product) is to: continually seek to upgrade value but not by overbuilding the product with nice but low value features; augment the value proposition of a product and resist price pressure is through carefully planned service enhancements; shift your focus from acquiring new accounts to capturing a bigger share of current accounts. By focusing on share of wallet instead of market share the firm captures new sales in a less threatening way and will less likely invoke a significant competitive response.

Working with empowered buyers

The likelihood of a seller having better knowledge than the buyer of current market prices and competitive offerings is virtually non-existent in today’s Internet enabled world. Consumers know the price and make their decisions based on perceived value. It is therefore incumbent upon the seller to be ready to convince the buyer that the product offered addresses the buyer’s most significant “pain” points at a cost that yields the highest ROI for the buyer and at a price well above the reservation price of the seller.