From a sales perspective, pricing has three objectives:
1. Raise profit by capturing a greater percentage of the value your customers get from your products and services
2. Increase revenue by attracting more customers
3. Reduce friction in negotiations by anchoring your price to value and talking about price when qualifying opportunities and prospects
Too often, pricing is determined in large part by the amount of time and effort it takes to deliver the product or service. This is the wrong way to look at things.
Just as you sell with value in mind, you must also price with value in mind.
Let’s look at the four elements of pricing: costs, value, versions, and customers.
Pricing costs
Every company knows how to price costs (add up your costs and add a profit margin). But the resulting price has no relation to value. Nor does it take specific customer situations into account.
Obviously, you can’t completely ignore your costs when you’re setting prices, but this should be the beginning of the process rather than the end.
Pricing value
Let’s say your product enables customers to earn an additional $1M per year in profit, relative to your competitor’s product or the status quo (the customer’s current situation).
If your product costs $20,000 to build, and you add a 50% margin to costs, you end up with a price of $40,000. At this price, the customer gets a 25X return on their investment every year.
However, if you price your product at $200,000—just 20% of the additional $1M the customer will earn—you’ve added $160,000 to your bottom line and the customer still gets a 5X return in twelve months.
If you think a $200,000 price is “gouging” the customer, ask yourself: In what world is a 5X return not reasonable?
Base your prices on a percentage of the improved business results (revenue and profit) a customer gets, relative to your competitors and the status quo.
This makes it so much easier to justify your prices. You’ll know you’ve done it right when you can honestly tell your customers something like: “For every dollar you spend with us, you’ll get five in return.”
Pricing versions
Almost everything we buy is versioned, and for good reason: People like having choices and dislike being told to “take it or leave it.”
From cars to gasoline to mobile phones to restaurant menus, versions are everywhere, and there are some real advantages to offering them.
• Versions appeal to the three “buying groups” inside every customer company: 1) executives who sign large purchase orders, 2) supply chain people who negotiate prices, and 3) users of our products.
Each of these groups has a different motivation for buying.
Offering versions enables them to weigh the pros and cons of each and come to an internal decision regarding which version they want to buy. They pick which tradeoffs they want to live with.
• Versions attract more customers. A customer who can’t afford or won’t pay for your “best” product might be willing to pay for a more affordable “good” version of that product.
• Versions allow you to discuss tradeoffs throughout the sales process instead of waiting until the end. This helps customers get used to your prices and what they get for them and reduces the chance they’ll be surprised or shocked when you finally hand them a quote.
You should generally offer three versions. Think of them as Good, Better, and Best.
If you’ve priced them correctly, the lower-priced options will be profitable because they entail less time, effort, and cost for you to deliver.
Pricing value and offering versions also leads to less hostile negotiations down the line. By discussing value, versions, and prices throughout the sales process, you reduce or eliminate surprises. Buyers can’t suddenly claim that your prices are outrageous when they’ve been exposed to them from the start.
Pricing customers
No two customers are the same. Some spend a lot of money with your company, and some don’t. Some are transactional customers, and some are partners. Some cost more to serve and support than others.
Almost every company I’ve worked with has one or more unprofitable customers. A customer is unprofitable when the annual cost of building and selling products plus supporting and servicing the customer exceeds the annual revenue from the customer.
The only way to improve the situation with low or no margin customers, other than cutting them loose completely, is to raise prices. This is something you can do gradually over one or more years.
There is a lot of leverage in pricing, as even small improvements can result in large increases in profit. For example, a company that earns 10% net profit can increase that net profit by 10%, just by capturing an additional 1% in price.
The takeaway? Do more than just price your costs. Price your unique value, develop versions of that value, and raise prices on unprofitable customers. Make pricing work to your advantage for once.