Towards value-based pricing in the industrial sector
Blog: Essi Huttu, Mika Järvensivu & Ville Tiainen
Despite many benefits, companies are struggling with the transformation towards value-based pricing. From our experience of working on pricing topics in the industry sector, we have identified five levers for supporting the implementation of value-based pricing.
Value-based pricing brings benefits to companies … but implementation challenges companies also
Value-based pricing is rapidly becoming the preferred sales approach for the innovative products and services that many radical changes in industry structures, business relationships, and information availability make possible. In value-based pricing, the price of a product or service is based on the added value delivered to the customer. Value-based pricing focuses on an outward look compared with a cost-plus strategy that looks inside an organization or a competitive pricing strategy that looks laterally towards competitors.
Companies using conventional pricing approaches often win pitches by undercutting competitors’ prices but thereby risking margin erosion and price wars. Companies following a clear value-based strategy have a competitive advantage and win deals due to strong business relationships, good knowledge of customer needs, and excellent product performance. By focusing on the advantages and the value of a solution instead of its price, companies following a value-based pricing approach have succeeded in shifting the focus away from a discussion revolving solely around price. Additionally, value-based pricing is expected to make pricing more transparent, benefit suppliers that create value, and reduce customer risk.
Five Principles for Building Value-based Pricing
1. Build solid customer understanding and focus on customer value
The consistent focus on customer value is perhaps the most common characteristic of high performing firms. In order to price based on value, you need to have a profound understanding of customer needs and their willingness to pay, buying behavior, information needs, and service preferences. At the moment a significant amount of analysis is conducted in the area of price data analysis. Less attention is given to customer research and the use of customer-based information
2. Quantify and demonstrate the value of benefits
After you have identified and understood value-adding features, you need to quantify them. This is the greatest challenge for value-based pricing. The main thing is to specify the link between the offered features, the customer benefits of the features, and the quantified worth of those benefits to the customer. Based on our understanding, most companies identify features and link them to benefits but fail to quantify the value of those benefits. The trick is to continue to ask “So what?” until one can make a link to the customer cost or revenue driver and demonstrate the economic value. Many industrial companies lack the initiative or capability to develop supporting business cases to demonstrate and explain the economic value of the solutions and technologies that are offered.
3. Remember that one size does not fit all
Value-based pricing is not a one-size-fits-all concept. Thus, prices should be based on an offering’s economic benefit, defined at segment or customer level. Truly applying a value-based pricing strategy is the result of understanding how you as an organization are positioned in regard to customer expectations and competitive offerings: How do customers define value and what are their corresponding expectations and needs? What are competitors offering in order to meet customers’ needs and expectations? What are you offering today? The fact that different customers and customer segments can have different value drivers adds to the complexity of value-based pricing.
4. Harmonize the pricing and sales approaches
Moving towards value-based pricing will finally promote a shift from transactional interactions to long-term relationships that value the long-term benefit more than short-term success. This shift requires companies to review their selling capabilities. The potential of pricing can only be unlocked if a strong linkage to sales is guaranteed. This is especially true in the case of value-based pricing. Active communication by sales executives to customers must be done to illustrate the advantages of a product or service.
5. Drive change towards value-based procurement
An important aspect is also the customers’ procurement process. As suppling organizations are moving towards value-based pricing, buyers will also have to adjust their current way of working towards value-based procurement. Two key components distinguish value-based procurement from other sourcing strategies. Firstly, the buying organization should focus on impact in the definition of the specification and evaluation methodology. Secondly, financial analysis should go further than just analyzing the costs of purchased goods, services, or solutions.