Thursday, March 20, 2008

Money on the table

If doing statistics is like eating paste, pricing is analogous to chomping on Crayons. A bit tastier, but still sticky-mouth dry. While it’s easy to chomp on a few Crayons – my five-year-old son’s class is evidence – doing pricing (and doing it well) is hard. Very hard. My soiree through several dozen bplan presentations last week was evidentiary.

When companies build financial models they block and tackle through a great majority of their model building. It’s like math: Apply logic, assumptions and comparables into a template, with equations, and you’re set.

Pricing is different, and it’s confusing. Warren Buffett had a great line: Price is what you pay, value is what you get. Paradoxically, Buffett highlights the root of most company’s pricing strategy misfortunes.

Cost-plus pricing is the most common strategy. It costs me a quarter to make a bagel, I’d like to make 35 cents per bagel, and thus I charge 60 cents. Most companies do this, with a dash of comp-based pricing tossed in for good measure: If our competition is charging 60 cents, we’ll charge the same (or a few cents less). During last week’s myriad presentations, company after company took this approach.

Which is logical, but it’s an apathetic way to march forth. Smart companies employ a value-based pricing strategy. They understand value by focusing on what people are trying to do, not what they say they wish they were doing. They aim to master the current problems or critical priorities of their most viable (and underserved) customer segments. Textbook stuff, but it takes a lot of work.

Simply stated, your solution is worth what a customer is willing to pay. In B2B environments, it can be determined via a simple equation:

Worth (what a customer will pay)
Economic Gain
Strategic Value

[Perceived Risk]

Nail this algorithm and you will not only remove the Crayon crust from your mouth, but also ensure you do not leave money on the table.

1 comment:

AJC @ 7million7years said...

In almost all of my businesses my LARGEST customer always paid the HIGHEST price because they seemed to understand the VALUE in what we provided ... sweet!

Right on the money [pun intended]. Thanks!