Recently I have been addressing this issue with many clients. It appears for many that the model is either (i) some hourly rate that covers costs with a markup; or (ii) some markup over costs. Does this fit with your model? However, there are many models concerning your pricing, and I challenge you to think differently.
I think the key is to start from two points:
- What is the value that you are providing: and
- What is the customers’ BATNA (Best Alternative To a Negotiated Agreement)
The first is to identify the value you provide, and the second is the customers’ next alternative to you. Your pricing needs to fall between these, but even within this space, there are many options.
Here are a few examples.
Selling products on the web.
If you are selling products on the web, what is the value you provide your customer? If there is no value other than a low price, then your customer’s BATNA is whomever else is selling the same products. Now you are competing on price, availability, and shipping costs. If their BATNA is Amazon, how much margin do you have if you match Amazon’s prices? Probably not much. Therefore you need to find a way to distinguish yourself so that you are not competing on price.
Some companies provide lots of information on the products they offer so customers can make more informed decisions. We have all seen Amazon’s reviews being increasingly filled with fake reviews. The company provides more value by providing this information; however, how does it ensure customers purchase through it versus using it for information and then buying from Amazon.
Stopping customers’ switching is especially hard if they are Prime customers or this is not an impulse buy. In many cases, having got the information, whether on the website or through a phone line, the time to switch to Amazon and find the same product may not be worth it, and so they will purchase from such a company’s site. However, I am sure many sales are lost because the customer reverts to the company they know or look at the price and, having obtained the information, no longer value it to justify the price difference.
If the information is on the company’s website, that may be a cost of doing business. However, if there is an option to phone a support line and get advice on determining the appropriate product, maybe this service can be sold on a subscription basis. If customers pay for the advice line, they may become more “sticky,” preferring to buy from a company that provides excellent advice rather than purely on price. Also, since they are tied into the advice line, they may go there more often, increasing the volume of repeat business for the company.
Recently talking with a company, “Z,” with a great deal of expertise in the manufacturing sector, Z is often retained by customers to solve their problems. However, once provided with a solution, the customers use other lower-priced manufacturers to produce the product. The company was struggling to price this service because using an hourly metric, the rate seemed excessive to get the return on their expertise.
Returning to the two points I mentioned above, the value this company provides is enormous. Their customers’ BATNA may be six months of delay and thousands in costs to correct the production process. In such a case, it is hard to justify an hour rate, but in such cases, I am constantly reminded of the story of Neils Bohrs.
“A company’s machine breaks down. The company’s owner, an old school friend of Niels Bohr, calls in the physicist to help fix it. Bohr examines the machine. He draws an X on the side and says, “Hit it right here with a hammer.”
The company’s mechanic hits the machine with a hammer. It springs into action. The company’s owner thanks Niels Bohr profusely and sends him on his way.
A few days later, the owner receives an invoice from Bohr for $10,000 and gets on the phone with him immediately: “Niels! What’s this $10,000 invoice? You were only here for 10 minutes! Send me a detailed invoice.”
A few days later, the company’s owner receives this from Bohr:
|Drawing X on the side of your machine||$1|
|Knowing where to put the X||$9,999|
So do you price your services because you know where to put the “X.” In discussion with a company on this point, they were concerned that charging the value of their knowledge on where to place “X” would put off the customer. However, it is critical in such moments to realize the customers’ BATNA. If a six-month production delay would cost them $100,000 on top of $150,000 of costs in getting the production process right, then the customer profits from any option less than $250,000.
Realizing that in such a case, even a price of $225,000 might cause the customer to walk, price it differently. If the cost to produce the product is $20, then charge 25c per product made. The cost would increase production costs by 1.25%, which barely moves the needle. However, provided the customer is expected to produce more than a million of them, it is better for the expert and maybe more palatable for the client.
As a Vistage Chair, I am often asked by possible members how to justify the membership price. What they are looking at is a monthly fee that equates to about $20,000 per annum. However, what we are providing is value, and the BATNA is very large.
Members are CEOs of companies with revenues of $5 million and up, so my response is, “What is the value of your average decision?” If, as CEO, you decide on new ERP systems, hiring key executives, determining strategy, then I would argue that those decisions have a value of at least $200,000 or more.
So to make a better decision, the CEO would either have to hire a consultant or go with what they know. Assuming they hire a consultant, the cost comprises:
- time required to find the consultant who doesn’t gain from the decision (i.e., the consultant is not selling you the system or getting the recruitment fee);
- time required to brief the consultant on the issue; and
- the consultant’s fee.
I estimate that this cost would be $40k to $50k. Therefore, your Vistage group provides you with an answer for 50% or less of the consultant’s price. Not only that, but you can have the group help you with many such decisions during a year. So your ROI on your Vistage membership is probably 200% or more. Where else can you get such a return on investment?
So what are you going to do?
For all CEOs and salespeople, the answer is to slow down and look at what you provide to the customer. What is the value of that product or service, and what is their BATNA. Determining this may take time, but it is well worth it. Because once you have completed this exercise, you can price your products and services in such a way that maximizes your margins while providing profit improvements for your customer.
So, sit down with your product team and salespeople and start brainstorming on the value and BATNA. You may find opportunities to increase your pricing or realize that a particular product or service is not worth offering as it is a commodity.
If you want help with pricing better and increase your margins, contact me, and I can help you.
(c) Copyright 2021, Marc Borrelli
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