Look beyond costs when modelling value
Steven Forth is a Managing Partner at Ibbaka. See his Skill Profile on Ibbaka Talio.
I spent last Thursday and Friday at the Professional Pricing Society’s annual spring conference in Chicago. This event is important for the pricing community, drawing people from many industries together to discuss key issues. The theme for Friday morning’s keynotes was pricing and sustainability, with Nick Nalepa from Michelin giving a keynote ‘It’s Not Easy, Pricing Green” and Chuck Davenport from Bain & Co. asking “Consumers will pay for ESG, but what about Businesses?”
Note, my talk was later on Friday, and was on “How New Pricing Functionality is Getting Priced.” Mark Stiving and I will investigate this topic in our May 23 webinar.
Sign up for the webinar here. We will share the recording and some special resources post-webinar.
Nick Nalepa’s talk was focussed on how we can communicate the value of green or sustainable solutions and then capture part of that value in price. Let’s pause, the narrative for sustainable solutions has changed, and green solutions are no longer being positioned as emotional value drivers. Sustainability is good for business.
We see this at Ibabka where some of our customers, like HydroPoint, have Value Models, Pricing Models, and Sustainability Models on Valio. Variables that drive economic value also show up in the sustainability model and the equations (value drivers for value, sustainability drivers for sustainability) are correlated.
As I listened to Nick’s compelling talk I was impressed by this slide.
From Nick Nalepa’s talk at the spring PPS conference ‘It’s Not Easy, Pricing Green.’ Used with permission.
Let’s look at what is happening here.
The slide compares two different value drivers for the same solution (Michelin tires are more sustainable for several reasons, they run more efficiently, last longer and the manufacturing process is becoming increasingly more efficient). There is a cost value driver and a revenue value driver. Compare the bottom line. Savings per truck month of $90.47 versus additional Revenue per Vehicle Month of $1,170.
The key thing to note here is the difference in the value metric.
The cost metric: savings per truck per month
Key variables are ‘cost per gallon’ and ‘miles per gallon.’ (Miles and gallons are units of measurement still used in the US, miles are a measure of distance like kilometers; gallons are a measure of volume like liters).
The revenue metric: revenue per vehicle per month
Key variables are ‘P&D breaks’ (the number of times a truck stops for pickup and delivery, which is a value creation point along a value path), ‘revenue per P&D break’, and ‘monthly days in service.’
Now there is a subtlety here worth calling out. In a formal value model, it is not the revenue that matters but the profit, and in most cases the gross profit. Assuming that the shipping company has a gross profit of 30% this value driver is worth $351.
That is still a big difference, $351 to $90.
Why do people focus on cost-value drivers?
Given that the revenue or performance value driver is much more powerful, why do so many pricing and sales teams default to the cost value driver?
In my experience, many companies gravitate towards cost value drivers and downplay revenue and risk reduction value drivers. Why is this?
Cost value drivers are perceived to be ‘hard’ and other value drivers ‘soft’
They have not done the hard work to understand their customers businesses and are more comfortable talking about costs
Costs are seen to be something that suppliers impact while revenues are attributed to the customer
Vendor is selling to a cost center and not a revenue center
Let’s go through these objections one at a time.
Cost value drivers are perceived to be ‘hard’ and other value drivers ‘soft’
Costs are seen to be something that suppliers impact while revenues are attributed to the customer
Cost reductions are seen as more certain, revenue increases as more speculative
They have not done the hard work to understand their customer’s businesses and are more comfortable talking about costs
It takes empathy, research, and open conversations with customers to understand their business
Buyers do not always see the relevance of sharing information about revenue, which is seen as ‘none of the vendor’s business’
Costs are seen to be something that suppliers impact while revenues are attributed to the customer
As a vendor you are creating a cost (your price), so you are expected to be concerned with costs and how to lower them (by. lowering your price)
The vendor is selling to a cost center and not a revenue center
This is one of the deep roots of low prices, selling to people who are only concerned with costs
If a buyer has no responsibility for revenue, revenue value drivers will not be compelling (this happens when selling to cost centers rather than profit centers)
Some of these are valid objections, but all of them can be changed. The way to change them is to be genuinely interested in your customer’s business. This means understanding how they make money and how you can help them to make money. Costs are only one-half of the equation, and for growth companies, they are not the important half.
In some cases, by emphasizing revenue value drivers, even to cost centers, one can help the buyer get a seat at the table. Businesses are about generating revenue, not about costs. Helping buyers show how what they do contributes to revenue can strengthen their position in the company.
Nick Nalepa is right to call our attention to performance or revenue value drivers. Companies that can connect sustainability to growing revenue at their customers are more likely to succeed with their sustainability programs and win market acceptance.
