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Value-Based Pricing: Is It Right For You?

Liston Witherill
Liston Witherill
11 min read

Value-Based Pricing: Is It Right For You?:

Full Transcript

In 2012, the wall street journal published an article claiming that Mac users were willing to pay 20 to $30. More per night for a hotel than Windows users. The insight came from a huge reliable data set, published and shared by the travel site orbits. This should surprise exactly no one. I’ve paid close to $3,000 for multiple Mac machines. And I can tell you that one, it’s clearly worth it, send your hate mail to me. And number two, I’m also the kind of person who tends to buy the most expensive thing when given the choice. Yet, I’m cheap in many areas of my life, I exclusively buy unsexy used and extremely safe cars, then proceed to drive them until the wheels fall off. That literally happened once thankfully, I was in a parking lot driving three miles an hour. The same study showed something that economists have been saying for over 100 years, and everyone seems to know to be true. Different people are willing to pay different amounts, because different people like different things. Leave it to academia to show up a century late and say what everyone already knows. There’s a prevailing story out there that you should adopt a similar pricing strategy, usually called value based pricing. But I’m here to tell you that value based pricing is oversold, despite a credible cadre of zealots promoting its game changing benefits for your profit margin. I’m also here to tell you that they’re right. And then it’s a complicated story. I recently saw a private survey of firms that showed value pricing accounted for less than 1% of all revenues. It reinforced my opinion of the concept, value pricing, super useful to know, but not an option for most firms. In this episode of the podcast, we’re going to look at what value pricing is how it works in the core challenges that make it magnetically attractive, but incredibly elusive to most. Welcome to the serve, don’t sell podcast, a show about revenue strategies for creative firms, consultants and independent experts. I’m your host, Liston Witherill. And I’m on a mission to make 100 million people, world class ethical communicators, because the world needs more good people. Yes, even in business. If you like what you hear, sign up for my email newsletter at serve, don’t sell calm, and you’ll immediately get my top 10 podcast episodes and articles right when you sign up. Now to the show. What is a value based pricing strategy? Well, value based pricing is a strategy that relies on the differing preferences of groups and individuals. Simply put, you charge more to the people who value things more and are willing to pay more for it. And the implications of the simple idea run deep in your revenue strategy. The obvious place to start is that larger companies and wealthier people will on average, tend to pay more for the same thing. If you’re selling brand strategy, the $1 billion company will surely be willing to pay you more than the $1 million company, or at least they will on average, it’s just worth more even if the deliverables are identical. As a result, you charge different amounts for different clients based on their preferences.

So here’s how value based pricing works. Unlike other pricing methods, value based pricing requires the customer to explicitly or implicitly reveal their preferences. Implicit preferences are those you can infer based on other observable characteristics. That’s what Orbitz did. And that’s what they figured out about Mac users. Similarly, you might assume a larger client is willing to pay more because of their scale. Explicit preferences are revealed directly by your prospect, they tell you what they value. The challenge is that not all prospects will be able to quantify their preferences, or the perceived value of achieving their goals, and therefore the value of your services. Still, value based pricing relies on three primary inputs, the change and results that your client wants to experience, the amount of the change and the results, they’ll get the value per unit of that change. Once you have these answers, you’re in a clear position to anchor your pricing to your clients desired outcomes. That’s not to say that the value of your service is equivalent to your clients desired outcomes. Of course, it’s not they have bills to pay and they need to make a profit. friend of the show Blair ends summarize the components of value based pricing as the answers to four simple questions. Number one, what do you want? Number two, what will we measure? Number three, what’s this worth to you? And number four, what would you pay for this? The point here is to anchor your client on the maximum value you can provide before talking about fees. Contrast that to the typical sales Advice which urges you to artlessly ask your client what their budget is, trade offs exists on both ends of the spectrum. Let’s now turn to a value based pricing example. Using the inputs outlined above, we can take the example of a company looking for a better brands strategy on the road to IPO. Their goal would certainly be to stand out from the competition and offer more differentiated choice to their customers, leading to increase market share and pricing power, you know, the things every business wants. If we collect the three inputs needed for value pricing, we may hear answers like these, for the goal in amount, increase market share by 10%, and increase the average sale price by 5%. value of each unit, every 1% of market share, let’s say is worth $20 million in every 1% of price increases worth 500 k, then we multiply it all out. And the total value of achieving these goals is $200 million per year. Trust me, I’ve done the math for you. In this example, the explicit value of a project that achieves the client’s goals is $200 million in annual revenue. And that doesn’t even consider the increased shareholder value created before the IPO, which would be considerable. Now the big question how to apply this information to your pricing. Let’s start with first principles. none of this matters unless your client agrees to it. Remember that value pricing is based on individual and group preferences. Whatever you think has little to no bearing on what your client will pay. Sure, you can try to persuade them, but it’s a poor approach as compared to your client reaching their own conclusions. The concrete bottom line number here will function as a price anchor more than anything else. Once your client agrees that their goal is to capture another $200 million in annual value, you have an upward anchor to use in your pricing discussions. To my mind, that’s the most obvious utility of the value based pricing exercise. But it’s also true that for most people in most companies, value based pricing flatly will not work. So now let’s turn to who this will not work for.

And it’s time to address trust and leverage. value based pricing has exactly zero chance of working. If your client doesn’t believe you can deliver the results they want. It’s unlikely that you’d reach advanced talks with them if they didn’t trust you. But it’s a little more complicated than that. Trust isn’t a binary it spans a spectrum. The more your client trusts you and your firm, the more likely they are to believe that you’ll deliver the promised results. And therefore you’re way above market price proposal will be worth it and fully justified. Have you ever done this before and did it work? That’s what every client you’ve ever spoken to has asked themselves. They don’t want to take a risk on you, or at least they want to minimize their risk. Once you enter the realm of value pricing, this question will become more pressing, which leads to the next point of leverage. David C. Baker outlines seven points of leverage. But I’d like to emphasize two here, positioning and pipeline. Your positioning has to do with who you serve, what you do for them, and how you’re different from other options on the market. Ideally, your positioning strategy is so strong that you’re seen as a category of one, though, it’s quite difficult to achieve, let alone sustain. The stronger your positioning, the more leverage you possess. Because of your ability to credibly create dramatic improvements for your clients. You’re also going to need a large pipeline to have that value pricing swagger. If you have more opportunities than you can handle. You’re more confident throughout your sales process. Because each deal and each client you encounter have less importance, you’re free of desperation and confident that there’s always more opportunity. This confidence translates directly to the prices you charge. Here’s the last challenge for value pricing, your sales process, it’s going to be a lot slower, and you’re going to need top notch marketing. This is no small point. value based pricing will require you to implement value based selling and for you and your team to learn and adopt new skills. You’ll also need exceptional marketing to reinforce those last two things positioning and a healthy pipeline. If you’re not committed to these activities, value pricing is not for you. Now I want to make a note about fairness. capuchin monkeys love grapes, Billy cucumbers too, but they prefer grapes if given the choice. In a 2003 study, capuchin monkeys were given tokens that they could trade for food, think about it kinda like money. You get a coin, you can trade it for some food. They found that a monkey in isolation is happy to trade a token for either grapes or cucumbers but If a monkey trades a token and receives a cucumber after witnessing another monkey receiving a grape, it gets hella mad like mad enough to throw the cucumber it just received. And isn’t that irrational? Now think back to the Mac versus windows story and the willingness of different users to pay. One detail I left out is that orbits didn’t charge for the same room, they simply observed the Mac users would choose more expensive rooms on average. This makes sense, since most Mac users also have higher incomes. But imagine for a second that you found out you are paying more for the same thing. Because of your revealed preferences. How would it feel it’s totally irrational, because you would have been happy with your purchase before knowing that someone else paid less. In the case of the monkeys, they’re happy with grapes or cucumbers in isolation. It’s only when they know they’re at a disadvantage that they get pissed. value based pricing has this cosmic innate question of fairness baked right into it for both you and your clients. I’ve spoken to dozens of people over the years who are unwilling to entertain value based pricing because of how they would feel if they found out they’re paying a variable rate. Of course, this tends only to apply if you’re the one overpaying. But the point stands, your own sense of fairness is an obstacle on your path to value based pricing. Likewise, your clients won’t like it very much. If they find out, they’re paying a lot more than other clients. This speaks once again to the importance of having a strong position. If you or your firm are seen as a commodity with perfect market substitutes, who in their right mind would pay any kind of premium.

So there are a few obvious key challenges to value-based pricing. And by now you’re starting to get a sense of why I believe value-based pricing is a useful idea, but an unwieldy tool for most. It’s useful, and then it forces you to think about how your clients perceive and experience value, you’ll begin to understand and pinpoint the sources of value that your clients experience. You’ll also need a deep understanding of how your clients perceive you relative to competitors and other alternatives. That’s a good mindset to have. But value-based pricing is unwieldy or even ineffectual insofar as most providers will never meet the prerequisites to succeed at it. I’ve written about revenue strategies and delivered training for many years. And I’m still surprised by how inadequately firms prioritize sales and marketing competence. And while value-based pricing has the sex appeal of a spec, and 2021. It’s a black belt tactic promoted to relative novices. It goes way beyond sales fundamentals in into very advanced territory. It’s possible that you or your firm can apply it, but you’ll have to overcome the key challenges I’ve laid out throughout this podcast episode. Namely, value-based pricing requires that you meet five key factors before you can even attempt it. Number one, have a strong market position and differentiation strategy. Number two, maintain a strong reputation that generates trust and credibility. Number three, practice to ensure you can guide a value conversation with a client. Number four, sustain a healthy, abundant pipeline of opportunity, no small task. And number five, work large enough deals to justify a totally custom sales process and pricing strategy. Now we’ve come to the point in this episode, where I have to talk about alternative pricing models. In case I’ve talked you out of value-based pricing, which by the way, is my goal for most of you, I want to present the primary pricing alternatives, you’re likely already doing one or more of these. Here they are in order of how commonly they’re used. Cost based pricing or cost plus pricing. You figure out how much it costs you to deliver your service, then you add a profit margin on top and call it a day competition or market based pricing. You look around for cues in the market, see what people are charging, and then typically add or subtract about 20% performance pricing or revenue sharing or commission pricing determined in part or entirely on the results of your engagement. This is how affiliate compensation works. You’re familiar with the model. And then there’s demand based pricing or surge pricing, variable pricing based on changes in demand. You’ve experienced this if you’ve ever called an Uber at different times of the day, or almost certainly on your electric bill in the summer when you’re running the air conditioning. Last is the issue of how your fee is assessed. This is another area where I have a strong opinion but a much clearer one bill using fixed fees in most cases. There are clear advantages to hourly billing. In some business models, but if your value proposition is based on your expertise, used fixed fee billing, instead of hourly billing and your life will be a whole lot easier. So just to wrap up here, wherever you land on the question of value-based pricing, I recommend you maintain a healthy degree of skepticism. You’ll also need some self awareness about your skill level and reputation with prospects. Point blank. This isn’t easy, and prospects need to think really highly of you. I also recommend that you absolutely internalize the fact that different people and organizations have different preferences. Understanding this will help you recognize patterns amongst different types of clients, while leaving room for new information that can help you deliver more individualized value. There’s a final point to make here. The prerequisites to value based pricing are good for your business, whether or not you ever attempt value based pricing. And no matter what, keep going. People need your help. That’s our episode today. Thanks again, so much for listening to the surf don’t sell podcast. Once again, my name is Liston Witherill. And I am on a mission to make 100 million people, world class ethical communicators because the world needs more good people just like you. If you like what you heard today, sign up for my email newsletter at serve. Don’t just how it sounds. And I’ll send you my top 10 podcast episodes and articles right when you sign up. And if you liked what you heard, please tell someone about the show.

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