What’s your strategy for determining the optimal price for your B2B offering? If you check Wikipedia, the obvious source of all that’s true in the known universe, you’ll find 26 different pricing models or strategies. In this first of a new blog series focused on value pricing, let’s take a closer look and see how you can set prices that benefit both you and your customers.
The majority of those Wikipedia pricing strategies can be combined into three broad strategies: cost-based, market-based, and psychological-based pricing models. This post discusses how these three strategies do and don’t work in a B2B environment.
This strategy is based entirely on the cost to produce and deliver your offering. Some examples of cost-based pricing are absorption pricing, contribution margin pricing, marginal cost pricing, and cost-plus pricing.
Cost-based pricing is the laziest and least effective way to establish a price because it doesn’t take into account what a customer would be willing to pay for your offering. In all likelihood, this strategy will reduce your profits because your offering is underpriced and under-valued. So if you’re doing cost-based pricing, take our advice: STOP NOW!
No customer is ever going to tell you that your price is too low, because customers want more for less every day. They will, however, tell you that you are overpriced through direct feedback and by not buying from you. Does this mean you’re really overpriced? Maybe, but probably not. The true test is whether they pay the price that you offer. If they do, then your offering is not overpriced.
Cost-based pricing strategies masquerade in many forms. We once had a workshop participant come up after we talked about pricing and say, “Wow, great stuff! I’m happy to say that we don’t do cost-based pricing. We do target-margin pricing.” So we asked how they calculate their target margin. They hesitated and finally said, “Oh, it’s a target margin over our cost.”
Proceed carefully when using any pricing strategy that uses cost as an input instead of customer value. We used to say that cost-plus pricing was the worst possible form of pricing. Then we came across multiple instances where costs weren’t well understood and they ended up with cost-minus pricing. Cost-minus pricing is definitely worse but both should be avoided, dare we say, at all cost.
Market-based pricing is when you base your pricing on competing products in your marketplace. This is easy to do when you know what your competitors charge, they know what you charge, and so do potential customers.
The assumption is that customers will base their buying decision on relative price. This is mostly the case in a true commodity market. If your offering is exactly the same as the competition, including everything in it that creates value, then your price must match or be very close to others in the same market. But that’s rarely the case in a B2B environment.
Market-based pricing strategies include skimming, penetration, predatory, premium, and price leadership. Although any of these may work, you must be careful not to leave money on the table.
Say you choose a price-skimming strategy and price your offering at a 10% premium. How do you know if 10% is the right premium? Could it have been 20%, 50%, or even 500%? Or should you have gone with 5%?
Likewise with a penetration strategy. Pricing your product at 20% below the current market price may help you gain market share, but how do you know if 20% is the right amount? Will your discounted price trigger a price war if competitors slash their prices? Most importantly, if your offering delivers more value, should you have used a premium pricing strategy instead?
Basing your price on a percentage premium or discount off a competitor’s price is a common but less informed approach. While it’s important to consider competitor pricing when setting your own, it’s only one factor among many. To avoid selling yourself short, we strongly recommend using a market-based pricing strategy that also considers the business value of your offering.
Psychological-based pricing is more prevalent in B2C markets, but it is slowly finding its way into B2B markets as well. The goal of these pricing schemes is to either trick buyers into acquiring something they don’t need, or hook them with a low price and then raise the price over time. Some of these methods can work quite effectively, even in B2B markets.
The Freemium model is an effective psychological-based strategy. This is where you give away a free or limited version of your product (often software) and hold back many of the features that make the product really valuable. If you give the user enough functionality to get hooked and want more, they may be willing to pay for the full or premium version of the offering.
The downside is that you don’t gain any insight into how much the customer would have paid outright for the fully functional offering. In our experience, the Freemium model is a promotional and marketing strategy, not a pricing strategy. A legitimate pricing strategy establishes how much you charge paying customers, not how to hook them on your product.
Time-sensitive pricing is another example of psychological-based pricing. Although telling someone to “act now” to get a discount might work with consumers, business customers are more sophisticated than that. They know that if price discounting is available, they can expect to receive it whenever they move forward with the purchase.
B2B customers have well-defined buying processes, and use procurement agents that avoid responding to psychological-based pricing schemes. Consumers may think $199.99 is a better price than $200.00, but professional agents know that, for all intents and purposes, they are exactly the same.
Psychological pricing schemes are rarely effective over time in B2B markets. If you use one of these pricing mechanisms, you should first understand what customers are willing to pay so your pricing optimizes profitability. That can’t happen unless you understand the value advantage your product delivers.
You can’t build trust with B2B customers if your pricing is designed to trick, hook, or otherwise manipulate the sale. Likewise, lowball pricing that undercuts your own profitability might increase your customer base, but can work against you in the long run.
Our next post in this series will explore how value based pricing can improve your chances of closing the sale and optimizing earnings. In the meantime, proceed with caution using cost-based, market-based, and psychological-based pricing strategies.