This publication is broken up into three sections:
TL;DR - For those wanting a quick take
Summary - For those wanting a bit more context and high level points
Article - Main body of work containing full detailed article and explanations that you might want to consume over several readings
TL;DR
Depending on your context value can take different forms and shape
Bain & Co. identified 30 “elements of value” for B2C from their three decades of experience. The model they developed traces its conceptual roots to Abraham Maslow’s “hierarchy of needs” and extended his insights by focusing on people as consumers
Within a B2B context Bain identified 40 discrete “elements of value,” which fall into five categories: table stakes, functional, ease of doing business, individual, and inspirational
Despite how buying customers or clients and end-users might perceive value. We have one normalizing factor to try and capture value information succinctly which is fiat currency as a unit of account which denominates profit as well
Pricing models and approaches are critical to monetizing and capturing the value an organisation creates
Profit though is an imperfect but necessary measure of how well an organisation has been able to meet customer needs, create value, deliver against its’ brand promise and capture some portion of the value it has created for now
When it comes to pricing there are generally three common pricing approaches:
Value based pricing - Pricing based on your products perceived worth
Competitor based pricing - Pricing based on your competitors pricing
Cost plus pricing - Pricing based on cost of goods or services plus a markup
Pricing from the outside can appear to be a black box. The pricing black box can only be illuminated through a defined pricing process
A business that pays no attention to pricing or has no control over pricing is not in a strong strategic position, has no real long-term moat or defensible positions and has question marks about its’s long-term survival
Summary
A 2003 McKinsey & Company study, a follow-up to an earlier 1992 study, found that for the average S&P 500 company a price rise of 1 percent, if volumes remained stable, would generate an 8 percent increase in operating profits — an impact nearly 50 percent greater than that of a 1 percent fall in variable costs such as materials and direct labour and more than three times greater than the impact of a 1 percent increase in volume.
Pricing models and approaches are critical to monetizing and capturing the value an organisation creates.
Depending on your context value can take different forms and shape.
Bain & Co. has done some great work helping to create some nuanced language on defining value for both B2C and B2B businesses though not as much work has been done to define Government to Consumer/G2C value propositions.
Bain & Co. identified 30 “elements of value” for B2C from their three decades of experience. The model they developed traces its conceptual roots to Abraham Maslow’s “hierarchy of needs” and extended his insights by focusing on people as consumers: describing their behaviour around products and services.
Within a B2B context Bain identified 40 discrete “elements of value,” which fall into five categories: table stakes, functional, ease of doing business, individual, and inspirational. The elements range from strictly objective—those related to pricing and specifications, for example—to more subjective ones, such as reducing the buyer’s anxiety and enhancing his or her reputation.
Despite how buying customers or clients and end-users might perceive value. We have one normalizing factor to try and capture value information succinctly which is fiat currency as a unit of account.
“Ultimately profit is the perpetual rent companies pay to justify their existence.”
Profit though is an imperfect but necessary measure of how well an organisation has been able to meet customer needs, create value, deliver against its’ brand promise and capture some portion of the value it has created for now.
A pricing strategy is one of the most commonly overlooked and undervalued revenue levers in business. Carefully selecting the right pricing strategy whether you're starting a business or growing an existing one, takes a deep understanding of your product value proposition, market niche, and your customers’ needs or jobs to be done.
When it comes to pricing approaches there are generally three common pricing approaches.
Value based pricing - Pricing based on your products perceived worth
Competitor based pricing - Pricing based on your competitors pricing
Cost plus pricing - Pricing based on cost of goods or services plus a markup
The three above approaches are the workhorses of pricing that will get you 90 percent to a useful pricing approach.
Businesses trying to make superior pricing a source of distinctive performance need to execute at three levels specifically having a deep understanding of pricing models and approaches employed in your industry, the product and market strategy level and finally the transaction or moment of truth level.
Pricing from the outside can appear to be a black box. The pricing black box can only be illuminated through a process.
A business that pays no attention to pricing or has no control over pricing is not in a strong strategic position, has no real long-term moat or defensible positions and has question marks about its’s long-term survival.
Article
“Pricing is the most important aspect of your business.” – priceintelligently
A 2003 McKinsey & Company study, a follow-up to an earlier 1992 study, found that for the average S&P 500 company a price rise of 1 percent, if volumes remained stable, would generate an 8 percent increase in operating profits — an impact nearly 50 percent greater than that of a 1 percent fall in variable costs such as materials and direct labour and more than three times greater than the impact of a 1 percent increase in volume. The 1992 study established similar findings.
A more recent study by Price Intelligently that covered SaaS firms found that a 1 percentage point increase in pricing resulted in a 12.7 percentage point improvement in overall firm profit. These findings are in line with the landmark 1992 study conducted by McKinsey & Company. The more things change the more they stay the same.
How you think about pricing can have real-world business impact. In Scaling Up by Verne Harnish he gives the example of Perceptionist which was able to achieve industry beating revenue metrics.
Pricing models and approaches are critical to monetizing and capturing the value an organisation creates. In the book Scaling Up, an entrepreneur by the name of Alan Rudy was able to shift the trajectory of a call center business he owned.
He did this by shifting the basis of the pricing model. The industry norm was to value a call at a per minute level. To arrive at the change in pricing model he had to spend some time visiting the call center operations he owned to understand the reality on the ground.
In his visits, one of his clients complained about having to pay monthly rates equivalent to $1 per minute to have calls answered, especially for mis-dials. The client continued to complain about the problems of playing phone tag with clients who just wanted to make an appointment. The customer got so frustrated that they exclaimed to Rudy, “Forget the buck per minute; I’d pay you $25 to take over my calendar and book appointments!”
This interaction served as a catalyst for Rudy. Rudy sold off accounts that needed only answering services and shifted the company’s direction to booking appointments for its clients. While the industry focused on achieving a certain profit per minute, Rudy focused on attaining a targeted profit per booked appointment.
Changing the basis of pricing turned around a situation in which Perceptionist had been struggling to compete with offshore business processing call centers with rates equivalent to $0.50 a minute. Focusing on this new pricing model and a handful of targeted industries, Rudy helped the company bring in revenue averaging $5 per minute which was 4x the industry average.
A well-considered pricing model can be a way to leverage up a product or service offering especially if the pricing model aligns to key problems or pain points that a customer has.
If you do your pricing job well, customer’s will be fighting to give you money…
”I’d pay you $25 to take over my calendar and book appointments”
Optimizing pricing strategy is probably the surest way to achieve sustainable long-term profitability.
In prior articles, I have covered some fundamental product development concepts like defining a product taxonomy, creating a marketecture for your offerings, whole product thinking, figuring out how brand architecture builds upon core product development concepts.
In this article I would like to begin teasing out how pricing is linked to positioning and product packaging and how they feed into one another.
In very simple terms positioning is about making sure you are clear on who your offering is for (i.e., customer segmentation), product packaging is about making sure you create clearly defined bundles of value that your targeted customers value and understand (i.e., value proposition and product packaging) and pricing is how you capture part of the value you create and deliver (i.e., monetization approach).
So how is positioning, product packaging and pricing linked?
Before we can answer this question there are a few background concepts we need. The key outcome from a product development process is to ensure we have created a sustainable stream of value where we have at a high level, the following key activity areas of value creation, delivery and capture.
At this point you may ask, is this another article talking about this amorphous concept of value that can’t be well-defined?
Without boring you with details I will say the following:
The Logic Model is a great conceptual framework that can practically help you think through the key factors you need to consider for your organisation when it comes to defining value.
At its core, the value creation process is about turning labour skills and resources through key activities into outputs that customers are willing to pay for.
We can associate the following high-level function areas with the value stream process:
Value Creation – Functional Area/s: Value creation via Product Development
Value Delivery – Functional Area/s: Delivery and Servicing via Operations
Value Capture – Functional Area/s: Monetisation of key business activities and resources via Pricing and associated Finance and Accounting areas
What is value and its associated sub-concepts?
Depending on your context value can take different forms and shape. The below content references consumer studies conducted over the last few decades.
Value within a B2C context
Bain & Co. has done some great work helping to create some nuanced language on defining value for both B2C and B2B businesses though not as much work has been done to define Government to Consumer/G2C value propositions.
According to research from Bain & Co., from several decades worth of consumer studies, what consumers truly value can be difficult to pin down and psychologically complicated.
However they state there are universal building blocks of value. The existence of these building blocks creates opportunities for companies to improve their performance in existing markets or to break into new markets.
The right combinations of the elements of value, according to the authors’ analysis shows, those elements will pay off in stronger customer loyalty, greater consumer willingness to try a particular brand, and sustained revenue growth.
Bain & Co. identified 30 “elements of value” from their three decades of experience. The model they developed traces its conceptual roots to Abraham Maslow’s “hierarchy of needs” and extended his insights by focusing on people as consumers: describing their behaviour around products and services. They arrange the ‘elements’ of value in a pyramid according to four kinds of needs, with “functional” at the bottom, followed by “emotional,” “life changing,” and then “social impact” at the peak.”
Some elements of value are more inwardly focused, primarily addressing consumers’ personal needs; for example, the life-changing element motivation is at the core of Fitbit’s exercise-tracking products. Others are outwardly focused, helping customers interact in or navigate the external world. The functional element, organizes is central to The Container Store and Intuit’s TurboTax, because both help consumers deal with complexities in their world.
Value within a B2B context
A question you could ask is, are there analogous elements of value for B2B customers? The answer is yes.
According to research from the Bain & Co. team as B2B offerings become more commoditized, the subjective, sometimes quite personal considerations of business customers are increasingly important in purchases., Bain analyzed scores of quantitative and qualitative customer studies to discover what matters most to B2B buyers.
Bain identified 40 discrete “elements of value,” which fall into five categories: table stakes, functional, ease of doing business, individual, and inspirational. The elements range from strictly objective—those related to pricing and specifications, for example—to more subjective ones, such as reducing the buyer’s anxiety and enhancing his or her reputation. Understanding this full range of rational and emotional considerations, and tailoring the value proposition to the ones customers prize most, is critical to avoiding the commodity trap.
For a strategist, a product manager, product designer, mastering the intangibles of the customer’s total experience—all the service, support, interactions, and communications wrapped around an offering—is much harder than making an offering faster, cheaper, or more durable.
Value within a G2C context
A question could arise how goods and services provided by government should be evaluated given the notion of value? This is a difficult issue to address but the scale of impact for society is massive given the out-sized roles governments across the world play in our daily lives.
The value of great public goods and services is keenly felt but difficult to value since you have no real market-based choice in providers when it comes to getting access to public goods and services.
The main challenge from this evaluation is that within the private commercial world at least customers or clients have the option to select alternative goods and service providers unlike with governments who face no real competitive threats.
What mechanism do we use to summarise value?
The key take-away from the work of Bain & Co., is when we think of value we have to think about ‘value’ being perceived either through
Quantitative factors or
Qualitative factors
Despite how buying customers or clients and end-users might perceive value. We have one normalizing factor to try and capture value information succinctly which is fiat currency as a unit of account.
Denominating value using fiat currency is the simplest approach. Fiat currency aka money prices act as a unit of account which enables us to use it as the base numeraire against which all the various ‘values’ are compressed into.
Some may say that compressing points of value into currency terms is not the most nuanced approach but capturing value in currency terms helps to simplify completing deals and transactions. At the end of the day businesses account with currency and not abstract values like utility.
The pricing mechanism acts as the tool that has a lot of value information encoded into it.
At the end of the day commercially oriented organisations can only justify their existence if they have business profitability. Every business that wishes to continue existing as a going concern is oriented towards making a profit despite what some VCs might say or fund.
“Ultimately profit is the perpetual rent companies pay to justify their existence.”
Profit though is an imperfect but necessary measure of how well an organisation has been able to meet customer needs, create value, deliver against its’ brand promise and capture some portion of the value it has created for now.
A practical way to visualize how to think about value using a fiat currency basis is to reference the value stick popularized by Harvard Business School.
A value stick represents the perceived value captured by an end consumer, called consumer surplus.
In the middle of the stick is the value captured by your organisation, called the firm’s margin. At the bottom of the stick is the value captured by your suppliers, called the supplier surplus.
A value stick comprises four components: willingness to pay, price, cost and willingness to sell.
Where a specific component falls on the value stick determines how a sale’s value is split between a firm, its customers, and suppliers.
Willingness to Pay (WTP) – represents the highest price a customer is willing to pay for your product or service. Customers are more likely to make a purchase when a company charges any amount up to that threshold. The difference between a customer’s willingness to pay and the final price of the purchase is known as customer surplus
Price – The price an organisation charges is the final price a company charges when it sells a product or service. Price is a point on the value stick that an organisation has the most control over hence the importance of pricing strategy, execution, and evaluation. Price can be set at any point between a firms cost of production and its customer’s willingness to pay. Pricing is how your organisation is able to monetise its value creation and delivery efforts. As mentioned previously customers receive the difference between their willingness to pay and the actual price, while your organisation gets the difference between the price you can charge and the costs associated with creating the product. This is referred to as firm margin. The end goal for an organisation is to ideally maximise profits from the collection of sales without damaging the overall customer experience and brand promise. Too much profit maximization in the long-run is not a good way to build a brand
Cost – Costs are incurred due to the inputs required to product a product or service. Costs can include physical costs such as the resources needed plus other resources like energy and factory and office space. The lower a firms cost base the higher the value that can be shared with customers and potentially extracted.
Willingness to Sell (WTS) – This is the lowest price your suppliers are willing accept in exchange for their inputs that are needed to create your products. Think of partners and resources on your business model canvas. The difference between a suppliers’ willingness to sell and the cost (what they charge your firm) is known as supplier surplus.
Four generic tactics to improve firm margin:
Raise prices - depends on price elasticity aka responsiveness that a price change has on quantity of product or service demanded
Increase your customers’s willingness to pay - positioning a brand in way that increases your customers’ willingness to pay
Reduce input costs – use cost leadership as a means to carve out strong unit economics position for your product
Lower your supplier’s willingness to sell - find ways to help your suppliers to lower their willingness to sell level aka their internal cost structure
The Connection of Pricing Management and Product Packaging
“…your pricing is the exchange rate on the value you’re creating in the world” – pricing intelligently
Masters of pricing focus on understanding how their company’s offering creates value and how they can maximize value capture without compromising customer/consumer surplus.
Your offering would generally be summarized in your value proposition or marketecture (depending on the size and scope of your offering) or brand architecture and final product packaging.
Pricing is what customers use to evaluate a product or service, they weigh its perceived value against the asking price.
Pricing management involves a few elements like pricing strategy, execution, models and the consideration of alternatives.
Pricing strategy is really a function of considering:
Positioning (Brand Architecture)
Packaging (Product Taxonomy, Product Marketecture, and Whole Product Thinking)
The choice of appropriate economic models (Pricing Models)
A pricing strategy is one of the most commonly overlooked and undervalued revenue levers in business. Carefully selecting the right pricing strategy whether you're starting a business or growing an existing one, takes a deep understanding of your product value proposition, market niche, and your customers’ needs or jobs to be done.
When it comes to pricing approaches there are generally three common pricing approaches.
Value based pricing - Price based on your products perceived worth
Competitor based pricing - Price based on your competitors pricing
Cost plus pricing - Price based on cost of goods or services plus a markup
The three above approaches are the workhorses of pricing that will get you 90% to a useful pricing approach.
There are additional pricing approaches that can be employed to differentiate your organisation from the competition like penetration pricing, price skimming, psychological pricing, bundle pricing, economy pricing, premium pricing, etc…
Execution in pricing is about making sure you implement a pricing model that will generate enough surplus for you as a business.
“Pricing is simply the exchange rate you put on all the tangible and intangible aspects of your business. Perceived value for cash.”
How can you practically implement price management?
Businesses trying to make superior pricing a source of distinctive performance need to execute at three levels specifically having a deep understanding of pricing models and approaches employed in your industry, the product and market strategy level and finally the transaction or moment of truth level.
Industry price level - The broadest view of pricing comes at the industry price level, where managers must understand how supply, demand, costs, regulations, and other high-level factors interact and affect overall prices. Companies that excel at this level avoid unnecessary downward pressure on prices and often emerge as industry price leaders. I can’t overstate the importance of being in an industry where you can be a price-maker.
I have been in situations where mobile network operators who supplied a previous employer organisation with digital products like airtime and data could unilaterally change the price we could on charge to our clients and we had no legal recourse. In a situation like this it is clear there is strategic question concerning industry structure and your place in the value chain.
It got to the point I built into a forecast tool sensitivity analysis that could show the impact of a unilateral supplier input pricing change, a year ahead and how we had to grow volumes to offset the price reduction from our vendors.
Product/market strategy level - The primary issue at this second level is pricing a product or service relative to the competition. To do so, companies must understand how customers perceive all offerings on the market and, most particularly, which attributes—product as well as service and intangible attributes—drive purchase decisions. With this knowledge, companies can set visible list prices that accurately reflect the competitive strengths (or weaknesses) of their offerings. This can involve understanding alternatives available to customers as well as incorporating external market pricing information and approaches.
A survey of understanding the alternatives available to your customers can illuminate a range of strategic options and choices you have to make. Doing this sort of analysis with actionable insights can place you probably in the Top 5 - 10 percent in your industry. If you are developing a 0 to 1 product more often than not the alternative for your customer is doing nothing especially if you are trying to create a new behaviour.
Transaction or Micro-value event level - The focus of transaction pricing is to decide the exact price for each transaction—starting with the list price and determining which discounts, allowances, payment terms, bonuses, and other incentives should be applied. For the majority of companies, the management of transaction pricing is the most detailed, time-consuming, systems-intensive, and energy-intensive task involved in gaining a price advantage.
This is the sort of work that differentiates the Top 1 percent from the rest. A considered pricing model that ties into to your core value proposition and associated features is a key leverage point for creating economic value.
Practical steps you can take to pricing
“Pricing is the reflection of everything you do as a business, from your product development all the way down to a link on your website, because we live in a world driven by value. Nothing else defines a business and a product more.” - price intelligently
A few practical steps can be taken to figure out pricing for your products.
Step 1 - Validate your buying persona(s)
Some sample questions to get the creative juices going.
What is the price each buyer is willing to pay?
What is the estimated Lifetime Value (LTV) of that customer?
What is the estimated Customer Acquisition Cost (CAC) of that customer?
What are the top three marketing channels you’re finding this buyer in currently?
Who does this buyer report to? Who reports to them?
Which three features do they care about most? The least?
Which value proposition do they care about most? The least?
Who else needs to approve a purchase (if anyone)?
Build out your buyer personas to make sure you're attacking the right customer(s) in the right markets. Everything in your pricing strategy and wider company strategies will stem from these personas. If you have taken a jobs to be done approach getting this information from the product team should be trivial.
Step 2 – Identify the right features for your buying persona(s)
Your buyer personas are your pricing strategy's foundation; now we need to build the structure on top of them.
If you have done the work of identifying valuable problems for customers and creating compelling value propositions the remaining work is to make sure features are aligned to our buying personas. Our ultimate goal is to have a plan or entry point for each buyer persona, and then a place for them to grow via cross-selling or up-selling.
The main challenge will be to make sure you align features to outcomes your buying personas care about. This will require you to make some tough choices and to force your prospects to make trade-offs. There are a variety of statistical techniques to get to the answers you need.
Sure, you'll have some tough choices to make when your prospects tell you a particular feature you developed lovingly isn't as valuable to them - it happens all the time. Yet, the process requires you collecting data via surveys from your target customers.
Your surveys will need to force respondents to make trade-off decisions when asking about features. You'll be able to align those features to personas, which will force your pricing tiers to emerge. Remember that it's ok to adjust your buyer persona assumptions after these types of exercises.
Caveat: Developing high quality surveys is both an art and science. Get skilled professionals to assist here if you don’t have the skills in-house.
Step 3 – Anchor on a value metric
Once you've aligned your features (or found that you don't have any differentiable features) to a buying persona, then you need to start thinking about a proper value metric.
A value metric is essentially what you charge for (per user, per visit, etc.), and it's literally one of the most, if not the most important aspect of your pricing strategy.
The key is selecting a metric that grows as the buying customer usage grows.
You can use feature analysis to see which feature is valued most highly over all personas at all growth stages. This might be a hidden gem worth holding back to match pace with company growth. You must be careful to make sure you're not throttling an aspect of a product that's crucial for retention.
Step 4 – Price your product packages
At this point you need to collect some data, similar to the type of data you collected in the feature value analysis. Price sensitivity data is actually much easier to collect though, because we simply take advantage of how people think about value.
Human beings don't think about value as a single point as evidenced from studies conducted by Bain & Co. Value can be viewed as a spectrum where it's difficult for you to give someone a point blank answer when asked, "how much is this worth to you?"
Using pricing techniques like Van Westendorp Pricing models can be enlightening.
You can harness insights on value by simply changing the way you ask about pricing to the following four questions:
At what point is [your product] so high-priced that you'd never consider purchasing it?At what point is [your product] getting expensive, but you'd still consider purchasing it?
At what point is [your product] a really great deal?
At what point is [your product] so low-price that you'd question the quality of it?
Step 5 – Create a pricing structure and process for managing price changes
Depending on the size of your organisation you may need to create a structure and process to manage pricing.
In enterprises this could take the form of a pricing committee where representatives from key parts of the business are present like the CEO, CFO, CRO, CPO, CMO, CTO and a senior leader from the pricing function.
This committee will have a few responsibilities like managing pricing models, setting guardrails for which Sales can negotiate rebates, discounts etc., managing price exceptions and approving investments into the pricing function and its associated enabling infrastructure.
At my last role, I created the strategy document recommending a pricing committee that would own and manage pricing models and making sure we were meeting targeted Product Line PnL and margin targets.
I recently met with some old colleagues, I was pleasantly surprised to hear the committee was up and running and running according to the defined principles in the strategy document.
Closing Remarks
Pricing from the outside can appear to be a black box. The pricing black box can only be illuminated through a process.
Take the above knowledge, apply what’s useful, scrap what’s not, but just systematize your pricing approach to the point that you're capturing more of the consumer surplus that you generate.
If you don’t, then you’re giving away an enormous amount of money, and that hurts no one else but you.
In closing, a business that pays no attention to pricing or has no control over pricing is not in a strong strategic position, has no real long-term moat or defensible positions and has question marks about its’s long-term survival.
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Pricing Strategy and Execution