Ibbaka is a strong advocate for value-based pricing, especially when it comes to innovative new offers that have real differentiation. The foundation of value-based pricing is the value an offer provides to a customer relative to an alternative. Value of course has emotional and economic components. In today's world, both are essential.
To price on value (and not on something like willingness to pay, which is not a good proxy for value) one has to create and communicate that value. Your customers will only accept your value claims and your pricing if they think you are being fair to them. What does it mean to be fair? In pricing, the perception of fairness is based on three things: transparency, consistency and value.
One of our customers is dealing with fairness. They have brought a new offer to market and a segment (just a segment and not all) of their customers do not think the pricing is fair.
Your pricing needs to be transparent. This does not mean it has to be published on your pricing page. Publishing your pricing to the public is often a good idea, especially if your pricing page also communicates value and helps people choose the offer or tier that is best for them. This is not required for transparency. To be transparent, at the appropriate point in the selling process, you have to be able to explain to your customer how you set your price and how the specific price being offered to them has been calculated. We have all seen pricing pages that are so complex or opaque that they reduce rather than support transparency.
Some software companies seem to pride themselves on the complexity of their pricing and provide their sales teams with complicated pricing calculators that are basically black boxes, for the sales person and the customer. The pricing calculations are often based on obscure technical criteria that only the seller really understands. Some very powerful, quasi monopolies, can get away with this, but I doubt that anyone believes this pricing is fair.
Some people believe that cost plus pricing is transparent and therefore fair. Large procurement departments often believe this. One result is that they often demand that vendors share their costs. There are a couple of challenges with this. What costs are to be included here? Just the variable costs or some combination of variable and fixed costs? How does one account for sunk costs in R&D or staff training? Should there be an allowance for future R&D or staff training that may or may not benefit the client. Costs seem clear and transparent but for most businesses they are a slippery thing. Of course, cost plus pricing does not reflect value and puts the incentives in the wrong place. Good pricing design should work to align value for buyer and seller and create a positive sum game. Cost-based pricing does not do this.
Have you ever been frustrated when buying an airplane ticket online to see the price change as you try to make the purchase? The same thing often happens when making a hotel reservation. How does this make you feel? If you are like me, you get annoyed. It is even more annoying to learn that your friend got the same ticket for 20% less. Procurement people have the same reaction to this sort of inconsistency, only in their case their job can depend on it. The cardinal sin for a procurement officer is to have a competitor drive a better deal with a key supplier.
Consistency is a key component of pricing fairness. Treat similar buyers in a similar way. Do not change prices without considering the impact on your customers and partners. Avoid rapid and unpredictable price changes (especially those triggered by pricing algorithms or AIs that may be interacting with other algorithms and AIs to cause spikes and cracks).
The best way to ensure that prices are seem to be fair is to create great differentiated value and then share that value with customers. Price is not usually included in Economic Value Estimation (EVE) calculations as the EVE is usually used as an input into pricing strategy and value communication. I do like the representation below as it shows how differentiated value, total economic value and price interact to define the economic value provided to the customer. If you are not providing value, there is no price that will be fair.
How much of the value that you create do you capture back into price is a question of pricing strategy but you should always be providing additional value over what the buyer can get elsewhere.
You need to communicate this value as well of course. Value communication is actually a part of pricing transparency.
Impact of discounting
Discounting is the sword that cuts both ways. It can be used to improve pricing fairness but it often contributes to a lack of transparency and inconsistent pricing. Which is true at your company?
I know of several companies that offer discounts to customers who will not be getting the full value of a solution. Sometimes this is accompanied by the removal of parts of the solution that are not providing value (this is generally thought to be the best practice) but in a few cases these companies are discounting to make sure that the customer is receiving fair value.
This is the exception though. In most cases, discounting is either a negotiation ploy, and is factored into the the initial price, or is the outcome of negotiations. This is not always a bad thing. Sometimes the negotiation process leads to conversations that improve transparency and mutual understanding of value. The discount is a reflection of this conversation. One can see this in the bargaining that takes place in the souks or even in online trading sites. Too often though, discounts are erratic and depend on the skills and relative power of each player. Sales gives a discount in order to close the deal even if this reduces pricing consistency and fairness. Uncertainty about discounting (pricing transparency) gives rise to the fear that someone else is getting a better deal.
A well designed discounting program can improve pricing fairness if it is based on value-based principles and applied consistently. A reactive and ad-hoc approaching reduces the perception of fairness and will tend to drive prices down without creating happy customers.
Build fairness into your pricing strategy.
Fairness should be part of your pricing strategy. Look at your price setting methods and how you communicate price and ask the following questions"
- Is it clear how we set prices? Can we explain this to ourselves? Can we explain this to our customers? Is our website clear on this? Can sales communicate it?
- Is our pricing consistent? Do we treat similar customers in the same way? Is our discounting policy clear and consistent?
- Are we creating differentiated value? Do we use this to set prices? Do we adjust prices based on the value we are creating? Are we sharing that value with our customers?