Pricing experts are in wide agreement that the best approach to pricing is value-based. In value-based pricing you understand your economic and emotional differentiation and use this understanding to segment your market, target prices and design pricing. For a good summary of the value-based approach see Dr. Thomas Nagle's article for the Professional Pricing Society "Price Versus Value Management - Know the Difference."
This is all well and good, but how do you go about creating differentiated value?
Differentiated value is value that a potential customer cares about, and is willing to pay for, that the customer cannot easily get from another source. There are two main categories of value driver, emotional and economic, both are important.
Emotional Value Drivers
At Ibbaka we structure emotional value drivers using Maslow's Hierarchy of Human Needs. Mapping these to B2B buying processes, these are as follows.
Self Actualization: The buyer or company are able to realize their vision or mission.
Self Esteem: The buyer or company are able to feel that they are achieving their goals and succeeding.
Belonging: The buyer or company are able to feel that they are a valued and accepted part of their business or industry.
Security: The buyer or company is confident that they are managing risks appropriately and that they are secure.
Baseline: The basic functions of the business are working smoothly and effectively.
Economic Value Drivers
The focus on B2B is generally on economic value drivers. This is understandable. In business delivering financial results is fundamental. In value-based pricing, the price reflects the economic value provided to the customer relative to their next best competitive alternative. Pricing is based on the impact of the offer on the customer's business model. Think about how the customer's profit and loss statement or balance sheet will be improved by the offer.
There are six basic categories of economic value driver and many sub categories.
Increased Revenue: Grow market share, access new markets, grow the overall market, improve pipeline metrics, and so on.
Reduced Expenses: Lower costs, more efficient workflows or processes, more effective workflows or processes, less rework or waste.
Reduced Operating Capital: Faster inventory turns, faster collections, lower inventory.
Reduced Capital Investment: Defer capital investment, reduce the cost of capital investment, get higher returns on assets.
Reduced Risk: Compliance, legal, financial, cost volatility.
Increased Options: Avoid lock in, preserve choice.
The latter two, reduced risk and increased options are often used as emotional value drivers, but in businesses such as finance, insurance, energy and certain parts of healthcare the economic impact can be quantified.
How to Increase Differentiation
There are basically three ways to drive differentiation: improve an existing value driver, find a new value driver, apply an existing value driver to a new market segment. The type of differentiation will have a big impact on marketing strategy.
Improve an Existing Value Driver
This is the most common way of improving differentiation. One takes a well known and understood value driver and improves on it for the existing set of customers. This is what Clayton Christensen would call Sustaining Innovation. It probably represents 80% of the work we do at Ibbaka. From a pricing perspective, there are several key things to be done:
- Validate the extent of the improvement
- See who cares most about the improvement (from an emotional and economic perspective)
- Find a better way to track the value metric (the unit of consumption by which the buyer gets value) with the pricing metric (the unit in which the price is set)
- Design a better pricing architecture, to capture more of the value being created
Find a new Value Driver
This is what is more commonly thought of as innovation, but it is in fact relatively rare. A new way of improving the customer's business is discovered and delivered. This is difficult. Most of your customer's have been in business for years and they know, or think they know, their business well. Discovering, developing and then communicating a new value driver is not easy, but when it can be done, the results are often transformative leading to the development of whole new industries.
Sometimes, when one has a new value driver, it is worth going beyond the current set of customers to their customers, to see how the new value driver will impact the whole value chain and what opportunities open up. In a way, that is that Uber and Lyft have done to the taxi industry (and are threatening to do the logistics) or what AirBnB has done to the hotel industry. We sometimes call this disintermediation, a long word for the simple act of cutting out the middleman and making value chains more efficient.
Find a New Market
Sometimes the best way to go to market is to compete against non consumption. This idea is at the heart of Clayton Christensen's theory of disruptive innovation. In his view, which is not without controversy (see for example this issue of the MIT Sloan Management Review), In disruptive innovation, the new technology often underperforms on well established value drivers but offers a new value driver that is relevant to some underserved market. One sees this a lot these days in B2B SaaS and Internet of Things offers. Let's take pricing software as an example. Traditionally, the large pricing platforms have been very expensive and most relevant to companies that have many SKUs (stock keeping units) and transactions. The vast majority of small and innovative companies could not access these services as (i) they could not afford the six or even seven figure price tags and (ii) they did not have enough transactions for these complex applications to get traction. We expect this to change rapidly over the next decade as new approaches to pricing based on data mining and predictive analytics become available.
Your pricing strategy and the work leading up to it will be very different depending on which of these value creation strategies you pursue.