how to sell & charge for more? value based pricing strategy for small business owners
The. Most common pricing, mechanism. Or strategy, that companies, apply, is called cost base pricing, that, means that you, have a cost. Base all. The. Money you spend on getting the product to the customer and then you add a certain markup. To it like. In the retail store you buy something for five dollars you sell it for ten dollars that will be cause based pricing value-based. Pricing doesn't, just add a markup, to your cost but. It. Sets the price, depending. On what customers. Actually, value, the, best example, for value-based pricing is, probably, Google. With the ad. Sank, and cost, per click because. At, Google there is no fixed price of how much you pay for a click, you rather. Submit, your willingness to pay to Google, you, say I'm willing to pay up to 2 francs for a certain, keyword in a certain country and there, are other companies bidding, for the same keyword, and whoever has, the highest bid. Will. Get a high, ranking, in in the Google Ad so Google. Says if you pay me, $10. For it click and someone. Else pays me $1 I want to make sure that the, one who pays $10. Per click gets, a higher ranking, because their can make more money so, Google. Charges. Not, a fixed fee per click but, tries to capture the. Willingness to pay of every customer in the market that's what I call. The, Google is the world, champion, of value-based pricing. You. So. Companies. Who are using. Cost. Based pricing I want to go into value-based pricing, usually. What they do is first better. Customer, insight you need to understand, what is it that customer, actually value, and then. Based on that inside, you. Find. Out what is the solution what, what, is the value, that customer, want from you that's the second step the third step is you. Need to be able to communicate that, value, through, a superior. Value proposition. And the, fourth step then is you need to be able to capture, that, value. Differential. So it's it's, these four step customer, insight better. Solution, better value proposition, and value-based. Pricing to, capture, that value companies. Usually don't, move from, 100%. Cost, based pricing to 100%, value-based, pricing okay. You have different approaches, charging. For the value, rather than just. Passing the cost on to the customer. The. Reason, why, not more companies, use, value-based, pricing is. Because. It requires a set of capabilities that, are not obvious, so in my research and in my practice I have, identified four. Distinct, capabilities. That, peak that companies, need to have in, order to be excellent, in pricing, the, first capability. Is. Superior. Customer, insight so you need to understand. What, customer. Value, what. Different, segments, you have, in a market, and what, the different, willingness to pay is of those segments, so that's that's, kind of the I call this the house of pricing that's the base okay. You need to know before you can actually do the, second capability, is pricing. Economics. So you need to understand, the economics, both internally. What. Are you cost what are the fixed costs what other variable cost what are the opportunity, cost what is the margin and you, need to understand, the economics, in the market, how, big is the market what is the price elasticity. In. The market, and all those what is what drives demand in a market so you need to have a good understanding of the economics, in a market that's, no surprise that's, what you would find in every textbook. But. Again. This alone doesn't. Lead. You to pricing, excellence, the. Third capability. Is pricing, management. And pricing, management, is the question, of when. You set your price, how, well are you in. Executing. All the functions, to. Actually, capture the price till you have the money in the bank account and one. Example here, that often uses, we. Often leave a lot of money on the table through, discounting. And they're, only two types of discount, smart. Ones and stupid, ones so one. Way, to think about pricing, management. As a capability, is, to all. The discounts, that your customer, get make, sense or not and that would show, you that would be a good indicator, of whether, you are good in pricing. Management and the, fourth capability. Is pricing psychology. And there, to, me is the most interesting. But. Also the most. Underestimated. And. Underutilized. Capabilities. So, that you understand, that pricing. Is always. A question of price perception. The. Second capability, we're talking about is pricing. Economics. So, you need to understand, the, different aspects, of your cost structure that does not mean that you should base. Your, price solely. On cost that would be cost based so you still want to capture what the customer, is willing to pay but, you need to understand, the costs, of your company, in order to figure. Out the best price just, to give you one example out. Of many if you are a, book, seller.
You Have a bookstore and you. Bought a book for five, dollars and the regular price is ten dollars but it's in the Shelf no one bought it for a year which. Price should, you charge for this book now you can say well I cannot, go below, five. Dollars, because then I would lose some money because I paid I paid $5.00, for it but, if you think about it the five dollars, you have paid already, where. Do you sell it or not so, actually, these, five dollars, are considered. Sunk costs, and they should not matter so for you being, the owner of that book that apparently, no one wants, what, you can do is you can sell it for one, dollar you. Can sell it for four dollars or, you, can keep it in the shelf for. Ten dollars and wait till, someone buys it or you can throw it away and just say this, book will never sell so there, are different costs. That, apply, and it's not just the variable costs how much you paid for the book but, also the. Opportunity. Cost of using the bookshelf or a book that apparently, no one wants to buy so, one aspect of pricing, economics, is to have a better understanding of, which, costs. Are relevant, for. A pricing decision, and which, costs, are not relevant. The. Third pricing, capability. Is price, management and, price, management. Kind. Of shows, the difference, between the price we, set as the price we. Want to charge and what, is actually in the end in our bank account so, there's always some leakage, of what do you want to charge them and what we get and this. Leakage, is often, a result of discounts, so if you understand, which, discounts. Make sense you keep them and you. Try to get. Rid of the discounts, that, make no sense and that would be one aspect of price, management. So. I did a project for, a, bank, and we, realized, that some customers, are very, profitable some other customers, are less profitable and then, we figured out so what drives the profitability. Per. Customer and what, you realize is that the, unprofitable, customer. Got. A lot of discounts, so they, got volume, discount, also there were small customers, they get special deals, also.
They Didn't deserve the special, deals so we tried to figure out how is it possible that these customer, get these low. Prices despite. The fact that they are small and not, strategically, relevant, and then what we find out is that these customers are often, good friends, with the relationship. Manager, at, the very same bank so we try to optimize. The, profitability, of those customers, by taking. Away some of the discounts, that they received, which, they did not deserve that would be one example of, a stupid. Discount, that you can eliminate. The. Fourth capability. Is pricing, psychology. And pricing, psychology, is important, because in the end it's. Not the price that, drives the customers, behavior it's, the perception, of the price that drives the behavior so so in a sense every price manager, is also. A, perception. Manager, and there. Are few psychological. Principles, that, are well known well established, well researched, that we can apply to pricing, just. To give you one example a low-end. Camera, and the, mid-range camera, and I. Described, the price and the features of the camera and about, 25 percent go for the low-end camera and 75, percent go for the mid-range camera now, the other group gets three cameras, the. Low end and the mid-range but. I add a third camera on the top level and this. Camera is. Very. Expensive but, not better so. In other words the third camera makes. No sense right so no. One who. Decides rationally. Should buy this now, funny enough about five percent of the, respondents buy, this camera, also it makes no sense they just go for the most expensive one but, that was not the point the point was the, moment, I introduced, the top-end camera, about. Half, of those who would have chosen the low end now, buy the mid-range, camera, so. What I want to show is this and this is called the decoy, effect this, the, moment you introduce a. Top-end. Camera, the. Mid-range camera, looks, better okay. Again, from a rational perspective this, makes no sense because no, one buys the top-end so, the result should be the same but this is the. Way of our. Mind. Tricks, us that, the second camera looks better in the presence of a third camera, so. That will be the decoy effect another, effect, that. I often use is called loss aversion, loss. Aversion is a theory, that says. Losses. Count heavier, than gains or. To. Make it more practical if, I'm buying. A car. Options. That you take away from me, have, a higher value. That options, that, you give to me and I give you an example here so I'm in the market for let's. Say BMW, which is a dream, because I don't have a BMW, and I go into the, dealership. And I. See all the beautiful spume, W in front of me and the car, salesman. Starts. If he knows the theory, he starts with the most expensive one not with the cheapest one so, he, goes to the most expensive BMW. We. Talk about families. And kids. And talks and where we spend our vacation and, then he would show me this, beautiful, car, BM, x 5 IX, drive whatever. That is and he, says you know it has leather seats a moonroof iphone. Docking station seven loudspeakers, and Swiss. Edition, I don't. Know what the Swiss Edition is but I know it's, gonna be expensive so he shows me this wonderful car I fall in love absolutely. Fantastic, but, it's expensive so I said what else do you have so he goes to the next car shows, me the next car still a very good car. 270. PS, no. Moonroof, but leather seats so, still, a very good car then he goes to the next car and. To. The next so every time we. Go from one car to the other down. In. The price but also down, in the options I suffer. Ok my heart is splitting but every time I give up something that I really like the, moonroof, the leather seats the Swiss Edition, ok so there's a point where I say ok I don't want to go further down I'm, hurt enough so let, me sign the contract, now, let's think about a car salesman, who would start at the other end he. Would show me that the the, cheapest version first, and. Then I would ask what else do you have and he would show me the next one and he. Says this has hundred. 70. PS and I, would ask so how much is 170. PS and he would say well you can. Still drive uphill but you know with a family it's kind of it's not so powerful so, anyway he would go, from one car to the other and now, my. Heart is kind of happy, because I get a better car but, I feel, the pain now on my wallet, so ever car he shows me is more expensive than the one before so. Now. If we are irrational it, wouldn't matter whether, he starts from the top going down or from the bottom going up, but. Because. We. Are not, rational, but. Psychological. We, know from studies that if, you, start selling high go low you sell, more options, then, if you start.
Low And selling, up high why because. Of loss aversion the moonroof, you. Take away from me has, a higher value, than the moonroof you put in for me so, if you go from high to low, my. Heart suffers if I, go from low to high my. Wallet. Suffers, and you always want to have to pain on the heart not, on the money so, that will be one way another. Way of explaining pricing, psychology, there, are many more of those principles, and I haven't. Seen them applied in in many of the companies, that's why I think this is the, most underrated. Capability. In pricing. You. Now. Another reason why, some, companies are not able to apply. Value-based. Pricing again, the first one is they don't have the, required capabilities or they don't even know what the capabilities, are now, the second, reason why some companies are not, applying value-based pricing is, because they, have, objectives. That are not aligned, so a typical conflict. Of objectives, and companies is, market. Share versus, profitability, okay. Because. Traditionally. What, we learn in business school is the, higher you market, share the more profitable the company is now if it comes down to an effective, pricing. Situation. These. Two objectives, often. Compete with each other because. If I have a customer. Who wants to give me a very big deal very big order, at, a low price I can. Increase my market share by taking, it at order but, I suffer on profitability or I can. Go for profitability, and, and don't, accept this offer. Because, the price is too low and the. Analogy I make is a, Swiss. Poker okay. So if you play a, game of poker and you get your hands, and if. You play every hand that you have, you. Will lose on the long run okay. Because. Poker. Means that some of the cards, you get out you just don't play you fold there, are some deals that you should not take. Just. Because it ruins your profitability, but, you must be willing, and. Able to walk away from, bad deals but as long as some, stakeholders. The. CEO, the CFO in. The company, wants. To go for, market, share at any cost. The. Price will. Go down. Usually. It starts. With some kind of segmentation. Where, we separate, the price buyers those. Who just go for the lowest price from, the value buyers those customers, who are willing to pay a little bit more if they, get more, value so this type, of segmentation I, call this segmenting.
By Willingness, to pay is often. The first step. Into value-based, pricing in, practice. So. In reality that. Means that you have different. Prices, in the, market for more or less the same product, now, you. Cannot, charge, different. Prices for, exactly. The same because. That's often illegal. Its price discrimination. Or its perceived as unfair if you, and I both get the same book but we, are charged differently and we would perceive this as unfair so two strategies. To go around that and still, be able to charge. More from. One segment than from the other two. Strategies, around that is the, first is fencing, and the second is versioning. A good, example for fencing, are the, coupons that you find in your newspaper. Okay. Because, the convenience. Buyer, the. Ones who appreciates, the convenience, wouldn't bother about the coupons she. Or he just goes to the store and buys the orange juice and paste the full price however. The price seeker, a different, segment in the market who wants a low price he. Or she would actually care. About the coupon clip it out drive. Through the store and redeemed, the coupon for a discount, so. In, this sense the coupon, is a way to fence. Price. Buyers from, convenience buyers, and for. Me the coupon, is almost the best fence, there, is because, the, retailer, doesn't, need to segment customers. By. Their willingness to pay, you. Don't need market research to figure out who, is a convenience. Buyer in to is a price buyer because, the, customer. Themselves. Segment so if. You, come with the Koopa well your price by if you don't come visit Koopa and pay, the full price your, convenience, buy so, the, idea is here that the coupon, serves as a fence between, the. Two different segments. Versioning. Is another approach, of. How we can charge different prices for, more or less the same product, a good, case would be a precision, scale you. Can sell a precision, scale, that. Is FDA, approved to. A pharmaceutical, company, for. $1,600. And you can sell almost the identical scale. That. Is not FDA approved to. University, for $400. Now the beauty, is you have served both segments, with, the scale they want at the, price they're willing to pay and it, seems that the pharmaceutical, companies are willing to pay four, times more. Because. They need this FDA approval, also. Essentially. It, is the same scale so. The. Two strategies. That I just explained, a fencing. And versioning. Are just. Two ways of how, we can address different. Segments. With, a different, willingness to pay at a, different price point so, we can capture the. Willingness to pay from the price buyers with. A low end offering, and at the same time we, can capture the willingness to pay for, the convenience, buyers. Or, the, value buyers and charge, a much higher price in that segment so we can serve different segments, at different, price point and that increases, our profitability. So. In fact price, negotiation. Actually, turned into discount. Negotiation. And the. Biggest problem. That. Happens is if you give too. Many discounts. Without, getting something in return so what I say often is pricing is, pain. Management so, every time you, ask for a discount. You. Must suffer for it so whenever I give you a lower price I must, take something, away from you it, could be that if you want a low price I only do weekly deliveries, not. Daily deliveries, or if. You want to have a lower price you need to buy in larger, quantities, or you, need to pay in advance so every, discount, should, have a pain, associated, with, it because, if if you're. Asking. For discounts, and, you. Don't suffer a pain for it you. Just ask for more and that's, something very important. So so you can give, a lower price, but. You. Have to get something in return and that's really one. Of the important, lesson pricing, is pain management if they want to have a lower price they, have to suffer for it because if they don't suffer they. Will ask for yet another discount, and yet another discount, so this is really something of how, we. Can use the same ideas, of fencing, and versioning. Into, a b2b. Negotiations.
One. Important, aspect of, the. Second capability, pricing, economics, is price. Elasticity, so, price. Elasticity, measures, the. Change of the, demand. Depending. On the change of a price so for example, if. I increase the price by five percent and the, demand goes down by. Five percent, then. The elasticity would, be minus one because five. Percent, decrease, minus, 5 percent demand, divided. By five percent, price increase, equals, minus one now. We, say a market is more elastic, if, this. Number is, greater, so if I increase my price, by. Five. Percent, and the. Demand goes down by 25, percent that, means I have minus. 25. Decrease. In demand divided. By five percent, increase in price so, the elasticity is minus. Five so. This would be a more. Elastic. Demand why, is that important. That we understand, the elasticity well, if the. Elasticity was, zero, we. Could increase the price without. Losing. Any customers, because, the demand would be unchanged, so, the, higher the demand the. More customer. We lose with a price increase so. It's important, that we understand, the elasticity, to figure out to. Which point can, we increase, the price without, losing, too many customers so, it's a fundamental, question for every, pricing, decision, now, what's interesting is that in reality, and this is what I observed, over, and over and over again is that executives. And. Entrepreneurs. Drastically. Overestimate. The, price elasticity, so why. Do so, many executives. Overestimate. The, price elasticity. And. That means they fear that they lose too many customers, if they increase the price I have two explanations, for them. One. Is the, customers. Always tell. Them that they are too expensive, okay. When I negotiate with my clients, I never had a client who said how much do you charge oh that's good I would have paid 25 percent more No, you never hear this ever say all rights too expensive for our dumb comments too expensive and so so you get biased information for, your customer, but even worse, typically. You, get biased, information, from your sales force think, about the large company, take, a consulting, company who. Pitches. For a big project three. Consulting, companies, go to the client, everyone. Does a pitch and your people come back and they have not won. This, project, so they lost a pitch now. Which, explanation, will. They give to. The to. The CEO I'll give you two options a, they come back and say we. Really screwed up their presentation. We had no clue what the customer, wanted and we were not well prepared or B we. Lost because we were too expensive, so of course. I accelerate, here a little bit but typically. The. The information we, get from the market, always tells. Us that we are too expensive, even. In cases where, we are not there's. An interesting study, in Germany who, asked. Representative. Of of an. Industry, of the whole industry, about their. Price positioning. They asked do, you think your, company is. Less. Expensive or. Neutral. Or more expensive, than than. The competitors, now. Logically. The. Average, should be the. Same you have some that are less expensive and, some, that are more expensive but what turns out in the study is, as. Predicted. The. Maturity. Of the companies. In a given market, thinks. That. They are more expensive, than the average which, is logically. Impossible but. This has to do with the perception, that we are already too expensive and, this, wrong, perception. Prevents. Us from charging, a higher price why. Again, because. We assume that the, demand will, go down drastically. Even. If you increase the price a little bit so. So this is why many companies leave money on the table because, they overestimate. The negative, market demand they. Don't really capture that the. Value that they create is the customer. Another. Important, aspect that, combines. I think the, capability, of price, management, and price psychology. Is price negotiation. And and I, often see how companies, large. And small from, a freelancer. Who sells, an, advertising. Job. To a large, company with a multi-billion. Dollar contract, at. Stake where, they really leave money on the table and it has to do with what I call pricing. Anxiety. Or the opposite would be pricing confidence, so, what do I mean by that you go into negotiation. And you have a counterpart. And often this is a very experienced. Buyer so. The moment that they spy, your nose, that. You fear, a rejection, that you want to win this deal at any cost, actually.
You. Will get it at any cost meaning. The, price will go down so, I often say, that fear. Is the most expensive feeling, in your company, the, moment, you fear a price, negotiation. And on. The other side you have an experienced. Buyer. The. Price will. Go down and I often see this that companies. Sales, people, entrepreneurs, freelancers. Are so anxious, to lose a deal, that. The, customer, just takes. Them on a road and drives, the price down therefore, another important, aspect of price management is to, build, the. Pricing. Confidence. In, your. Team in your company, that, you know that you. Have, better insights, you, create more value you. Communicate. More value so that you deserve. To. Charge more value. So this price confidence, leads, to capturing, the price to deserve and on the other side, fear, of pricing. Anxiety, actually leaves. Money on the, table. You.