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Value vs. Power

April 2015 Pricing

I met a person who hated value based pricing last week. He was in procurement.

Now, we met at a networking event so we both wanted the conversation to be professional and friendly.  Unfortunately, I couldn’t just move on for we were boxed into a conversation by being seated next to each other over lunch time.  We mutually desired to find a meeting of minds for networking events only work if people find those rare points of intersection.

But where can a value-based pricing advocate find agreement with an anti-value based procurement officer?

Did he even know what he was disagreeing with?

He understood the principals of value-based pricing well.  He even gave me an example of a salesperson who showed him how a product delivered $10 in benefits and therefore he deserved to get $8 in price, leaving procurement with $2 in value.

He understood how salespeople can practice value-based selling as well.  He told me stories of salespeople asking how they would use the product, what that would mean to them, and how much that might be worth to them.

Yes, he knew what it was, but he didn’t like it.

What was better in his mind?

To him, the vendor’s cost basis was the important issue in determining the price he would pay.  He thought all negotiations with all vendors should start with their costs.

When I first went into professional B2B selling, I remember falling for this trap.  The customer wanted information.  I thought of myself as a conduit for conversation between my employer and their customers.  So I asked for cost information.  That was a big no-no.  I never did that again as a salesperson.

But for this procurement agent that was the relevant metric, at least in his mind.

Why?  Why should a company’s frugality or profligacy impact what they are worth?  Why?  I asked myself pleadingly.

But outwardly, I sat silent waiting for him to speak more.  (Another trick I learned in sales – people can’t stand silence and will offer up more information if you only wait for it.)

Then, the truth came out.

Power Games

He worked at a large corporation with multiple billions in annual revenue, and his vendors tended to be smaller.  Thus, in his mind, he held buyer power and wanted to use it.

ARGH you Porter’s Five Forces.  It hits entrepreneurs below the belt every time.  But that too is fair in business.  So don’t be an entrepreneur unless you can stand up for what you’re worth.

ImmovableObject

And how do entrepreneurs face this challenge?  How can salespeople address a power negotiation like that?  By changing the rules of the game.  Greed trump’s size in capitalist power plays.

Until a customer pays, the entrepreneur or salesperson’s company owns the product, not the customer.  If the customer wants the benefits of what the company created, the customer has to pay for it.  And why would customers pay for it?  Because it delivers value and customers are greedy when it comes to value.

That stuff big customers broadcast about being “anchor accounts” only holds to a limited, a very limited, degree. An entrepreneur only needs ONE anchor to be grounded.  If that anchor didn’t really pay the company what it was worth, that anchor isn’t very good.  Better to go hunting for another “anchor account” than to give your pearls to swine.

So, here’s the appeal to greedy customers:  I am giving $10 to anyone who gives me $8. Who doesn’t want $2 in free money?

Aha!  Nexus.

Many wouldn’t.  I know that.  Why?  Because they don’t trust the offer.

Ok, trust is a loaded word.  Let’s talk about risks instead, as risks lie at the nexus between me and my new procurement friend.

Suppose an exchange value model shows that an offering will deliver $10.00 in benefits, can the vendor get $9.99 in price?  Should they settle for something much lower, like $1.50 instead?

The key determinant to driving this answer is the issue of risks.  How sure is that $10 in benefits?  When does it arrive?  What might make it less?  Will the offering slip into the existing infrastructure or will they have to make changes in process, organization, and technology?  What are the implementation risks?  How sure is it that the vendor will be around in a few years to service the offering?  Will the offering need servicing?  What happens if things go wrong?

Risks largely determine how much value a vendor can capture in price in comparison to the benefits they deliver.  By reducing the perception of risks in benefit achievement, the vendor can capture a higher price.  If those risks can’t be mitigated, they may have to accept a much lower price.

If a vendor can show that their offering directly replaces an alternative with clear calculable costs to that alternative approach and few risks, then that vendor tends to be able to capture most of the value they create.

But if that vendor can only point to a promise of future cost savings, cost savings that may be lost due to changes in infrastructure, market needs, competitive actions, business process, technology, etc., or may be related to saving a moment of a person’s time here and there but never leading to an actual headcount reduction, or related to a future revenue growth which may never materialize, then that vendor may find they have to give most of the benefits away and accept a lower price.

Not all value can be captured through price.  Identifying risks as the mediator between the benefits delivered and the price to pay allowed me and my new procurement friend to meet in a happy zone.

Note:

My new procurement friend’s risk discounting factor was at fifteen cents on the dollar.  Meaning: any new technology vendor would, at most, be paid $0.15 for every $1.00 in benefits they deliver.  That’s a pretty hefty risk aversion discount for new technology.  Still, it is a data point.  Not the full piece of information, but a data point nonetheless.



About the author

Tim J. Smith, PhD is the Managing Principal of Wiglaf Pricing, and an Adjunct Professor at DePaul University of Marketing and Economics. His most recent book is Pricing Strategy: Setting Price Levels, Managing Price Discounts, & Establishing Price Structures.

Tim J. Smith, PhD
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