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How Pricing for Value Drives Profitable Growth

Maximize B2B profits with pricing for valueThe subject of pricing can make business people uncomfortable – including those involved with new products. No surprise there since many organizations keep the responsibility for pricing in either finance or product management. But not including pricing strategy as a key, early element of your new product process is a serious mistake that leaves money on the table at best. And what’s worse – it can squander your constrained R&D resources. Quite simply, the best time to get pricing right is at the start – sometimes it’s the only chance you get.

The first pricing question I ask

The first pricing question I ask highly engineered product companies is whether they price for value or for margin – Note: We’ll cover consumer markets in a later article. I find that the majority of industrial companies price for margin. That’s unfortunate because pricing for margin is all about you instead of the customer. It starts with estimating your cost to manufacture; it finishes with setting a price to deliver either your target or minimum acceptable margin. The process isn’t quite as slavish as it sounds though. Some companies look at the competitive situation and tweak the price up if they can. Others start somewhere above their target margin in order to provide themselves a cushion.

Pricing for value starts with what’s in it for the customer

Starting with the value created for the customer you can then determine whether there is anything in it for you. Pricing for value starts with fieldwork to understand the customer’s problem including what it’s costing them and how much your solution will help them. The best way to quantify value is to estimate the impact in terms of increasing their sales Throughput (cash flow), reducing their Investment in working capital or reducing their Operating Expense. Those familiar with Goldratt’s Theory of Constraints will recognize this as ∆T, I, & OE.

But pricing for value is not a selfless act of charity

Once you understand the value created, your next step is to determine what percentage of that value you can expect to capture. The best way to start is from the customers’ perspective. Pretend you’re the customer and evaluate the new product based on the financial gain it provides. That usually means doing a cost-in-use analysis and calculating either a payback period or a return on investment (ROI). Most companies expect to see a fast payback – 12 to 18 months – before they’ll buy. With a little trial and error, you can quickly determine the highest price that gives customers a payback high enough to incent adoption. Of course, now that you know what’s in it for them, you can estimate the margin and ROI to ensure that it’s a win for you.  You can also see this outlined in Chapter 8 of Unlocking Innovation Productivity

Pricing for value helps better exploit your constrained new product development resources

Doing the upfront work to understand the value created and what price delivers an attractive payback for the customer defines commercial feasibility. It also helps you evaluate beforehand whether the new product project is a good investment. If that work shows the value created generates a margin at or above your target and a high return on development resources equal to or better than other options, the project deserves a place in your new product pipeline.

The argument for simplicity

Doing the upfront work necessary to price for value is an investment in itself. So, some will argue that pricing for margin is simpler and that you can still plug your price into a customer value-in-use model to see if it is attractive. But pricing for margin doesn’t include the customer’s perspective and can leave huge margin on the table. Why settle for a 40% target margin, when your value work shows a 75% margin would still delight the customer with a 12-month payback? Furthermore, pricing for margin fails to weed out the products that will ultimately fail because they don’t deliver enough value.

So what’s your pricing strategy and does it include pricing for value?  Join the conversation and let us know what you think.

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