In 2018, we helped companies from very large medical technology companies to scrappy startups rethink their pricing strategies. Doing this work, we deepened the tools and data we can bring to help you with your own pricing challenges in 2019. Our key areas of focus are market segmentation, pricing design and gathering the data needed for pricing evolution. In 2019, we will be doubling down on each of these key levers.
Understand your unique market segmentation
If you spoke to us in 2018, you know that all of our work builds on market segmentation. Good market segmentation is the foundation of all marketing, especially value-based pricing. A list of targeted industries organized by size is NOT a meaningful market segmentation. Simple firmographics (the company equivalent of demographics) does not dig deep into how opportunities that look similar are essentially different. A good market segmentation is based on two things:
Look for clusters of potential customers that get value in the same way (considering both emotional and economic value)
Look for potential customers that buy in the same way (follow the same buying process)
Check that the clusters you find follow a similar customer journey
At Ibbaka, we are investing in our own software platform to do this. Existing marketing and analytical platforms are not designed to answer the critical questions around market segmentation. The Ibbaka platform, which we codenamed Geode, has been designed ground up to do this. It draws in data from the CRM , invoicing and other internal systems and combines this with data from surveys and coded interviews (coded for emotional and economic value drivers).
We can see patterns that are not easy to detect using other approaches. We can quickly cluster data on multiple dimensions using several different algorithms and the adjust variable to find the most compelling patterns. You can think of this as a kind of electron microscope that looks deep into your data and applies different filters to find the clusters that show your differentiation. This is a powerful way to segment your market.
This year, we will continue to develop this platform and make it more available to our closest clients. One main area for investment will be improved handling of unstructured data using natural language processing and sentiment analysis. This will help us get even deeper insights into emotional value drivers, which are key to effective pricing, even in B2B.
One area, we will investigate is conjoint analysis. Conjoint has long been a favourite tool among certain pricing consultants, who have used it to try to understand the contribution of different feature sets to value. This can be helpful in making product development and packaging decisions. In our experience, it is less helpful in designing pricing. Whether is is useful for segmentation is something we want to investigate. It was a popular subject of research in the 1990s but commercial applications generally under delivered. We think it is time to go back and put this earlier work in the context of our evolving understanding of market segmentation and pricing. We expect to do a number of conjoint studies this year and add the data from these studies into Geode to see if we can deepen and sharped the insights on which pricing is designed.
Too often pricing models are copied from competitors, pricing levels are set using an ad hoc process and get locked in, and then pricing becomes a frozen accident, where the reasons for pricing decisions have been lost. This anti-pattern can be seen at companies large and small, early stage and mature. It is a recipe for failure.
Start thinking of pricing as something you design, and this means applying best practices in design including design thinking and service deign. Design thinking is an approach to solving complex problems that has been promoted by companies like the global innovation and design firm IDEO and applied at places like IBM, AirBnB, SAP and many other companies large and small. O’Reilly (one of our favourite publishers) has published a lot of good material in this area and we manage the LinkedIn Design Thinking Group (which has more than 118,000 members). Ibbaka has pioneered the application of design thinking to pricing.
Going beyond simple price model design and price setting, we need to look at how value is communicated, delivered and captured (through price and revenue model) across the entire customer journey. Service design has developed tools that help us to do this, especially the customer journey map. At Ibbaka, we have designed a customer journey map that layers in value and price. This helps us understand where and how to communicate and deliver value and capture part of that value in price. On January 17, the Value Innovation and Pricing Meetup Vancouver will be sharing ideas about this approach.
One of the most important pricing design challenges is compound or bundled pricing. Increasingly companies are offering comprehensive solutions to business or health problems. These solutions often combine multiple pieces of hardware with software platforms, data and professional services, all provided on an ongoing rather than a one-off basis. Design thinking becomes critical here. The conventional pricing models for equipment, software, data and professional services are all quite different. To make things even more difficult, they also are treated differently under revenue recognition rules (which are evolving with the implementation of IFRS 15) and most customers will allocate these to capital or operating expenses in different ways.
Devising a flexible and scalable approach to compossible or bundled pricing is one of the most pressing challenges for many of our clients. The long term solution will be to create a set of design patterns that can be easily combined to create the pricing answer that will be compelling for a specific customer. This answer must not only work for the customer, communicating value and allowing for scaling and ongoing delivery. It also has to align with revenue recognition rules and be implemented in CRM and accounting or ERP software. We will be doing a lot of work in this area in 2019 with a goal of publishing a general design pattern solution over the coming years.
When and how to change prices (managing risk using Monte Carlo models)
Pricing changes are one of the most powerful ways to achieve business goals. They can be used to grow markets or market share, accelerate revenue growth, or to optimize gross profit. In recent years. there has also been a focus on the impact of pricing on unit economics, such as lifetime value of a customer (but see our thoughts on the value to customer or V2C) and customer acquisition costs (CAC). Powerful levers come with risks though, and pricing changes can be some of the difficult decisions made by executive teams. Part of our work is to clarify the risks of pricing changes so that they can be better managed.
We do this with Monte Carlo modelling. Monte Carlo models were originally developed during the Manhattan Project, where physicists needed to model the very complex (and risky) interactions in the atomic bomb. The math was too hard to solve by brute force (it still is in most cases) so Monte Carlo modelling was developed to explore the range of possible outcomes. Pricing changes lead to a range of possible outcomes and not to just one known outcome, and Monte Carlo methods are one of the best ways to explore the outcomes of a pricing change.
Once you have clustered your customers, you design a number of alternative interventions and investigate the range of possible outcomes for each intervention, recognizing that the outcomes are on a probability distribution. Then you run your Monte Carlo model (the more variation the more rolls of the dice are needed) and explore the range of possible outcomes. This gives insight into the risks and rewards and what is generating the most risk and uncertainty. Possibilities include the following:
How will your competitor respond?
What is the price elasticity of demand?
What is the cross-price elasticity?
What is the Willingness to Pay for each cluster?
Will your current customer accept the price increase?
Forewarned is forearmed. Understanding the level of risk and where there is most uncertainty is critical to making effective price changes. Consider starting to use Monte Carlo models to explore this.
What are your critical pricing challenges in 2019? We are keeping our Pricing Innovation Survey open until January 11. Share your insights with us and get a first look into our results from this important survey.