One of the best questions we are asked is 'OK, you are pricing experts, so how do you price your own services?'
A fair question and we don't answer this by giving a price. We advise our clients not to get into a price discussion until they have established value. We follow that advice ourselves!
So what do we mean by value? Value is always for a specific customer (or segment) relative to the alternative. Value has economic and emotional components. At Ibbaka, as we are providing a service meant to drive pricing performance, we start with the economic value.
Pricing can impact several critical metrics, but one cannot optimize for every metric. That is a recipe for failure. There are tradeoffs and we have to understand your strategic goals in order to deliver the value you are looking for and get our own pricing right.
Generally, pricing is designed to optimize for one of the following:
- Unit sales - this is important when the market is expanding and when there are important scaling effects
- Market share - in some markets the dominant player ends up with most of the profit and market share is a critical goal
- Revenue - many companies, especially early-stage companies with access to investment capital are top-line driven
- Gross Profit - this is the most common target of pricing operations, at least over the short-term
- Net Profit - this is a good target for the long-term but there are usually many other factors that determine net profit
- Profit Margin - can be a very useful metric when costs are a factor
Many people want to optimize for 'all of the above' but this is generally not possible. The best approach is to (i) pick one and then (ii) understand the dependencies between the main objective and the other objectives. These differ depending on the revenue model and the market dynamics. For example, if the top goal is to grow Unit Sales one may also be winning Market Share, but not necessarily. One could take actions that accelerate one's own unit sales but have an even bigger impact on market growth. This can happen when a software company opens its APIs, creating demand, but making it easier for alternatives to enter the market. Sometimes one has a goal, grow market share, and a limiting function, maintain a unit profit margin of 20%. Understanding the goal, tradeoffs, and limits is critical in designing a project that will deliver value.
Once we understand which number you want to move, we test to make sure that we can actually have an impact. There is no point doing work where we cannot help you to achieve your goals. Sometimes we can't. Maybe you are already doing a good job on your pricing, segmentation, and targeting. Sometimes there is some other area, like product-market fit that you should focus on first. Or maybe we are just not a good fit for your culture. That is fine. We would rather know this early to save you money and us both time.
When we can have an impact, we scope a project with you, paying close attention to goals, how they will be measured, and the process we will use, together, to achieve these goals and to measure the metrics.
These are the three pillars that we use to build and price our proposals.
We generally work on a fixed-price for the proposal and not time and materials. We are willing to take the risk that we will invest more time than we expect. In return for this, we often have a performance component to the compensation. If we achieve a goal as measured by the metrics, we will receive a project bonus. We do this for two reasons. (i) It helps build long-term relationships between our companies, and we are interested in working on our clients' long-term success. (ii) It helps to keep everyone aligned on what matters.
Of course, this should also optimize Ibbaka's long-term profits. We will on average make more per project when we share risk and when we deliver. We accept the risk because we are in a better position to manage risk than our customer. There is a general principle here, see note below, and because it puts pressure on us to deliver the promised value.
Price and Risk: When investing, it is generally accepted that there is a relationship between risk and return. The higher the risk the higher the potential return. The same applies in pricing. Prices can be increased by reducing risk. For any solution, there is uncertainty as to whether it will deliver the promised economic value. The more uncertainty the lower the price. There is a risk discount implicit in B2B prices. There are two ways to address this. One can reduce the uncertainty (this is why predictive analytics and machine learning are likely to lead to higher prices; they can be used to reduce uncertainty). Alternatively, one party can take on more of the risk. The more risk one accepts, the higher the reward should be. At Ibbaka, we are applying both approaches. We are developing predictive analytics systems and gathering the data to feed them and we are willing to share risk by committing to fixed-price projects and including a performance component in the fees.