Setting the price for your offering is critical. Price dictates whether or not your offering will succeed or fail in the marketplace. A price that’s too low can cause you to operate in the red or leave profits on the table. However, a price that’s too high could create drag on the sales cycle or make it tough for your salespeople to close deals.
Why Common Pricing Strategies Fail
When setting price, you’re looking for the optimal price to maximize profitability. That number is not the highest price possible nor is it based solely on what your competition charges, yet I hear many marketers talk about pricing in exactly those terms. Here are the two most common approaches to pricing I see.
- The price is set based on what competitors charge. For example, let’s say your competitor charges $10,000. You take that number and tack on an arbitrary 10 percent increase or decrease.
- The price is set based on the cost to deliver the product. In these cases, marketers simply look at their costs and tack on what they think is an acceptable margin.
It makes me shudder when I hear marketers talk about pricing in these ways. Why? None of these approaches take the fundamental issue of value into consideration.
Truthfully, the best pricing strategy is based on the value that your offering creates for your customer.
The maximum price that you can charge is the cost of the next best alternative plus the incremental value your offering creates:
Maximum Price = Cost of Next Best Alternative + Value You Create – Value the Next Best Alternative Creates
If you do not first understand the value you create, you limit your ability to set a price that achieves the maximum earnings possible from your offering.
But beware: the maximum earnings does not stem from charging the maximum price. Setting your price at the maximum creates no incentive for prospects to buy from you. That’s because the net value (value – price) of your offering is the same as the net value (value – cost) of the customer’s next-best alternative (which could include creating an in-house version of your offering).
How to Set Your Optimal Price
Your optimal price will maximize the Present Value of the lifetime earnings from the offering. To find that number, start by asking these questions.
- How differentiated is your offering?
- How sustainable is that differentiation?
- How much value does that differentiation deliver to customers?
- What are your competitors likely to do based on various price points?
- How much cash does the customer have available to purchase your offering?
- What is the best pricing mechanism to capture value (initial purchase price, price and maintenance, subscription, gain sharing, etc.)?
- Can you charge different prices to different segments of the market?
Will you have perfect information to answer these questions? Probably not. But the answers will lead you to an answer that is far closer to your optimal price as opposed to a price that’s purely based on what the competition charges or, worse yet, yours costs. Again, either of these strategies can truly have harmful impacts.
For example, in my consulting work helping B2B companies understand value, I’ve actually seen cases where cost-based pricing led to prices that were actually far lower than the actual value the company was creating for customers. In some cases, the prices were too low by more than a factor of a thousand! I have also seen cases where the price, even with a “significant” margin was too low relative to the value created to get anyone interested in selling it.
By contrast, when you set your optimal price, you are in a much better position to justify that price, which is essential to enabling your sales team to successfully close deals. Armed with an optimal price, sales is able to show differential value against your competitors and then create a rock-solid business case that will persuade high-level decision makers (usually a financial officer) to invest in your offering.
In the end, you’ll never really know if you’ve set your optimal price. However, if you go through the exercise of asking the right questions, you’ll greatly lessen your chances of leaving money on the table or losing money.
