Pricing is the only element in the marketing mix that produces revenue; the other elements produce costs.
– Philip Kotler, Professor of International Marketing at Northwestern University
Correctly pricing your products is fundamental to any business. But how do you know if your price correctly reflects its value and demand? Price too low and you leave money on the table; price too high and you lose sales. The optimal price will always depend on the product, the customer, and the market. Successful B2B companies tailor their pricing strategies to maximize profit per customer and product.
Key Price Variables
The optimal price for a product is influenced by many variables. Competition, the general economic environment, perceived value, and emotional factors are just a few to consider. In addition, the product, the customer, and the market all have unique price sensitivities to consider. Constructing an algorithm to accurately factor all variables is difficult, but by considering the heuristics for product, customer, and market price sensitivities, you can improve pricing performance for each transaction.
Product. Different products have different price sensitivities. Within your own product line, you may have premium products, commodity-type products, and custom-type products. Margins on your commodity-type products are typically lower and they tend to be very price-sensitive. They should be priced differently than your premium or custom products, which are less price sensitive and have higher margins. Your pricing strategy should reflect these heuristics. Begin pricing by correctly identifying the product category based on price sensitivity.
Customer. Every customer is unique and has their own price sensitivity. Large volume customers tend to be more price sensitive than smaller volume customers. Customers who purchase frequently are also more price sensitive than less frequent buyers. In addition, different customers have an individual perception of the value of support and brand relationship. Customers who place a high value on relationship and product support are less price sensitive than those who perceive these elements to be less significant. You should also know where your customers are in their own business cycle.
Market. Each market has its own level of sensitivity. If your products serve multiple markets, you must consider the sensitivity of the market as well as the product. The pricing environment of your industry is a variable as well. In some markets, movement by an industry price leader can impact prices for all market players.
Align Economic and Emotional Value
Willingness-to-pay isn’t just a factor in the B2C marketplace. B2B companies need to consider it as well. It’s the sweet spot where economic and emotional value intersect to create perceived value. If you are targeting customers that are innovators and early adopters, they are less price conscious. This segment is driven by the high emotional value of gaining a competitive edge and supports a high economic value.
On the opposite end of the spectrum are buyers that place no emotional value on your product. The purchase has low to no emotional value and willingness-to-pay is low as well. You must carefully match their perceived economic value to your price.
But the vast majority of your market lays in the middle, meaning that buyers are rational overall, but can sometimes be subject to emotional surges. For these you must price according to the economic drivers specific to their niche. Your pricing must support their own pricing metrics and value models.
Too often, cost plus pricing is the standard strategy. It’s easy because it doesn’t require market research or understanding the psychology of customers or competitors. It is also inefficient and does not maximize profits. Cost plus pricing assigns the same margin to every customer; but we know customers have different price sensitivities and emotional values. Cost plus pricing can be effectively used to set price and margin floors. These floors can be used as the starting point for developing a value-based pricing strategy.
Competitive pricing is essentially price plagiarism. You look at what the competition is doing and price your products accordingly. Using this strategy places no more value on your products or brand than that of your competitors.
Value based pricing takes time and data but it maximizes profit per customer. By pricing per customer, per product, and per market, you focus on the customer to set your price. For example, large customers with tremendous buying power are priced differently than small customers who make infrequent purchases. Unlike static cost plus or competitive pricing strategies, value based pricing is more dynamic and because it is more customer-based, it can improve marketing efforts as well. After all, once you understand your high value customers, you can grow by targeting leads that resemble these customers.
A Word About Contested Markets
Sometimes B2B companies face intense competition. In highly contested markets where industry-changing innovations and cost advantages aren’t possible, the secret to profits is smart pricing. When faced with almost debilitating market conditions, you must remember to manage for profits, not for market share. Managing for market share often times results in price wars, depressed prices, and poached customers. No one wins.
A recent A.T. Kearney study of oligopolies found pricing leaders focus less on maximizing their market share and more on maximizing their profits. These leaders don’t blindly attack by slashing prices. Instead they strategically anticipate how their own customers would react to an attack by a competitor and then invest in strengthening customer relationships. The resulting customer relationships last 3 times longer and see 6% price hikes.
The takeaway is that when faced with a highly-contested market, resist slashing prices. Instead, understand rival company positions and wargame how they will attack. Focus on protecting margins and territories by strengthening customer relationships. Understand your customer from all angles. Attack competitors less often and thoroughly understand all consequences of any attack. Retaliate only when necessary to protect your turf.
New Support for B2B Pricing
Employing an effective B2B pricing is an on-going process and it isn’t easy. That’s why OroCommerce is developing a new Price Selection Strategy feature. This feature will empower system administrators to set minimum price floors to maximize profits. Stay tuned for more details.
“If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business. And if you have to have a prayer session before raising the price by 10 percent, then you’ve got a terrible business.”
– Warren Buffett