If you haven’t already, check out Gerhard Gschwandtner interviewing Ron Hubsher from the Sales Optimization Group on the sales negotiation process.  Ron looks at the sales process with the same philosophy I do– namely, selling value instead of price, and using that profit increase to build a much more valuable company.  However, he approaches the problem from a sales training perspective, a nice complement to the analytical approach we use.

Check it out:

I’m a big fan of analytics.  And sports (although I no longer have time to keep up with them).  So I’ve always been puzzled that with so much money and pride on the line, teams have done so little analyze data to help them win.  Sounds a bit like pricing, right?

There’s no shortage of stats in sports, just as there’s no shortage of KPIs in business.  While these numbers are interesting and sometimes even useful, they often provide little insight into true performance, and may even distort performance in a way that reduces overall effectiveness.  For example, some baseball statisticians think On Base Percentage is more important than batting average, but everyone focuses on batting average.  In business, there is a huge focus on revenue at the expense of profit.

The reason for this mismatch is not that teams hate winning or business don’t want to be profitable– it’s just that it’s easier to measure some things than others.  It’s easy to measure revenue or points scored.  It’s harder to measure profit, because cost is such a tricky subject.  And no one records whether those points came off a double screen or were set up by a teammate’s cut that drew away defenders.  (Still, we have it easy.  A friend in Africa fighting AIDS described how one of the big challenges was even measuring the scope of the crisis so they would know how to allocate resources and whether those resources were effective.)

Now some researchers at Queen Mary University in London have done some graph-theory analysis of World Cup matches, developing a way to visualize the balance of a team’s attack, and the “centrality” of each player.  Check out the graph for Holland v Spain.  I’d love to see them go a step further, and put a goal at the end of the pitch, and weight each edge of the graph by the chance of successful completion.  For example, a number of short passes may have a 90% completion rate, while a long ball might have a 50% chance of success, but may be more likely to lead to a goal.

Similarly, in the corporate world, a lot of effort gets expended on deals that make $0 profit (or even negative profit).  If you know where your profit comes from and know how to price those deals appropriately, you can have a huge return not just on investment, but on effort.

As a heavy iPhone user, I was less than thrilled about AT&T’s plan to end “unlimited” data plans. Apparently, I consume over 3GB/month, despite doing most of my heavy lifting through WiFi. This means I will either need to reduce my network consumption, or pay more to AT&T. (I never hit the 5GB limit of the “Unlimited” Plan.)

Despite this inconvenience, it’s about time AT&T realized that a supply problem can be converted into a pricing problem. Also, pricing is much more flexible and flexible than most supply chains, especially those involving massive amounts of cellular infrastructure. So until network capacity is truly an unlimited commodity, too cheap to meter, it makes sense to charge heavy users more. (Note that AT&T also reduced prices on those who consumer relatively little data.) I wasn’t part of the conversation, but I can only assume that after AT&T ran scenarios for data usage, customer churn, and revenue, that the new plans came out ahead of the old plan.

This situation applies to other businesses, as well. Even if you’re not at 100% capacity across the board, bottlenecks in your business indicate areas you can expand, and/or increase prices. Is it hard to get an appointment with your service techs? Maybe they need to charge more. Do you bundle in rush delivery for your customers?  (I’ve seen companies that always express shipped very heavy goods, just because they never made their customers pay a premium for it. In that case, why wouldn’t ask for express delivery?)  Maybe it’s time to unbundle it.

p.s.  Verizon– can you please get the iPhone?

Thanks to the good folks at Inc magazine for a nice mention of Sales Compass as one of “4 New Killer Sales Apps.”  Congrats to Proposable, salesforce.com, and Sybase, as well.

Btw, pricing for Sales Compass is actually lower than mentioned in the article for large teams.  Check out our Pricing page for details.

In a previous post (Be Better, Not Cheaper) I talked about the importance of differentiated value.  I have conversations about value almost as often as I have conversations about pricing, because a lot of pricing confusion is really value confusion.  If you don’t know what your value is, it’s hard to put a price on it.

Part of the challenge is going from “inside-out” thinking that focuses on your company, to “outside-in” thinking that focuses on what customers care about.  From a customer’s perspective, the price of your offering may only be a small part of a much larger value equation.  It’s easy to get hung up on the price (and offer deep discounts) without addressing the real issues that can hold up a sale.

Now Sales Compass includes the ability to map out the value you provide.  If you don’t have a Value Framework for what you sell, go in and create one (or more).  Show it to your colleagues and discuss.  I bet it clarifies a lot of pricing issues.

Value Framework

Who doesn’t love a bargain?  We all do, and we know our customers do, too.  But that doesn’t mean price is the only thing that’s important.  It becomes the only thing that’s important if everything else is the same.

Many companies feel they don’t have good differentiation, so they have to compete on price.  When Fortune 500 companies do this, the only implication is losing a few points of margin and billions of dollars of market cap.  When small businesses do this, they go out of business.  They either cannot sustain themselves financially, or they can’t sustain themselves psychologically.

That second problem may not seem intuitive, so let me explain.  Take a business that does 10% margins.  If the owner can raise prices 5%, she can increase profit 50%.  Or, she can make the same profit with a lot less work.  Less hours.  Less employees.  Less support calls.  Fewer customers.  Less stress.  If she feels she has to drop prices 5% to match a competitor, now she has to double sales just to get the same profit.  Even if this is possible, now she has double the orders to handle.  Double the chances of something going wrong.  She needs more people, more trucks, more inventory, more support staff.  More stress.  Even is she can keep the business afloat, at some point she’ll decide that it’s not worth trying to stay on a treadmill that keeps going faster and faster and doesn’t go anywhere.

What’s the alternative?  Be different.  Don’t let price be the only factor.  For many small businesses that sell the same commodities as larger businesses, the difference is service.  Note that a lot of the potential addressable market won’t care about your service.  They might even see it as a negative.  Don’t compete for those customers.  Go after the ones who value your differentiators(s).  The big companies have to appeal to broad markets.  That means there are niches where smaller companies can add value.  When a customer in your niche challenges your price compared to the big players, it’s a great opportunity to remind them of the value you deliver.

Remember, 10 years ago salesforce.com and Google were “niche” players in established markets.  Only hippies drank pomegranate juice or organic milk.  Blockbuster was the 800 pound gorilla of the movie rental market.

I get this question a lot.  Sometimes from people who want to think it’s some kind of magic that doesn’t require rigorous analytical thinking, usually from people who want to prove that it’s a science.  Often their desire for proof is more than philosophical.  If we are suggesting major price moves that will have real consequences on the business, they want to have as much comfort as they can in their decisions.

We want to think about pricing as scientifically as possible.  This makes executives more comfortable (and us, for that matter).  It also leads to better decisions.  Most of the price moves we recommend fall into the “low hanging fruit” category.  They are not rocket science.  This means things like “stop selling deals at negative contribution margins.”  Or “stop offering free express shipping for goods that weigh several hundred pounds.”  Even with seemingly incontrovertible suggestions like this, people want data.  Like, “how do we know that we are actually losing money on these deals?  Could we just have funny accounting?”  Or, “if we take away these deals, and we lose the customers, what happens to our overall margins?”  (Reasonable question, but typically these situations are not deliberate “loss leader” tactics– they’re just a matter of things sliding out of bounds.) In these cases, you don’t need a lot of art or science, just good analytics.  (Yes, that’s what we sell.)

More complex scenarios involve assumptions about what might happen given a certain price move, perhaps in conjunction with competitive or market changes.  Here, the ability to look at what happens on a fine-grained basis is extremely powerful.  Rather than dealing with averages in a spreadsheet, you can apply the model at the level individual accounts and transactions and roll up the results.  This often gives very different, and much more reliable forecasts than working with the averages.  Still, there is a certain amount of art involved in deciding the parameters of the model, since the selection and exclusion of data points has a big impact on the results.

Here, the political setting has as much importance as the mathematics.  If people perceive that a pricing adjustment is about assigning blame for past behavior, their natural response will be to divert or diffuse blame, often by attempting to explain why certain pricing actions were good, rather than asking whether they were good.  On the other hand, if the environment rewards people and teams working together to find opportunities going forward, without assigning blame for what has already happened, people are more willing to look at whether better actions would lead to better results.  The math, economics, and analytics can be identical in the two situations, but an opportunity-focused organization will get much better results than a blame-focused organization.

Even assuming that you are in an opportunity-focused organization where everyone is trying to be objective, you can still run into issues of selection bias.  Ironically, some of this bias is enabled by the capabilities of the very software that’s supposed to provide fact-based analysis.  Powerful, flexible software that lets you easily exclude certain data points and run scenarios or flag deals much more effectively than Excel is handy, but you can always find another set of scenarios to run or ways to look at the data.  We’ve found some organizations get so excited about having better visibility into pricing performance that they get sucked into analysis paralysis, at least temporarily.

In these situations, there’s a lot of pressure up and down the chain of command to come up with solid, statistically valid decisions.  Which makes perfect sense.  But you can now crunch numbers in so many ways that you can, if you want, create almost any scenario.

Indeed, the same situation has happened in medical trials.  Computing power lets companies essentially run lots of experiments in parallel, and cherry-pick the results they want to see.  (Check out this great article on Ars Technica, We’re so good at medical studies that most of them are wrong.)  I often tell people “we’re running a business, not an FDA study.  We need to make a decision by Friday, so we have to go with the best information we have.” Then if we’re doing consulting work, we usually have to run the numbers one more time, with another set of assumptions, until the executive in charge makes the decision to go forward.   Turns out, even the FDA studies have similar problems.

What does this mean?  That we should abandon hope of having a solid mathematical foundation for pricing decisions?  Certainly not.  Just that we can’t ever get to certainty.  But with some decent analytics we can do a lot better.  And that’s all we need.  We don’t need perfection, or even “optimization.”  We just need 1% better.

So is pricing an art?  A science?

Yes.

Join us for a webinar on B2B sales optimization. We’ll look at how manual negotiation processes cost time, sales, stress, and 10% or more of profit.

Why does this happen? What have companies tried to do about it? And what kind of results have those efforts yielded.  Do you have to choose between selling faster and more being more profitable?

February 24, 2010, 11AM CST. Register Now.

Chris Anderson of Wired said that Free is the price of the future. Some of us beg to differ. Among those with other opinions are Lincoln Murphy of 16 Ventures who published a paper called The Reality of Freemium in SaaS, and Dave McClure, who wrote Subscriptions are the new Black on his always entertaining and provocative blog Master of 500 Hats.

Lincoln notes that “free” is a marketing tactic, not a pricing strategy.  (As a pricing strategy, free can work well as a defensive move to discourage other entrants from building free or cheap products that could threaten your core business.  It’s a hard way to build a core business.)

McClure writes (rants?)

ASSERTION #2: The default startup business model for 2010 & beyond will be subscriptions and transactions (e-commerce, digital goods).

Newsflash folks: The Internet does NOT want to be FREE… It wants to GET PAID on F&*&ing Friday, just like everybody else on the damn planet.

What does this mean?  It means you have to think about the value your customers receive from using your offering, and how that value compares to their alternatives, including the option of doing what they are doing today.  Value includes both positive and negative elements.  For example, saving time might be a positive value, whose worth depends on how much time and whose time you’re saving.  Signup time or data migration time would be a negative value.  If you can’t generate a strong value proposition and get your prospects to believe it, you’re going to be in trouble.

This can be especially hard for tech companies that create cool technology and focus on the features.  Features don’t have value.  Features can create value by providing benefits, but it’s the benefits that create value.

This summer, Steve Silberman over at Wired wrote a great article called “Placebos Are Getting More Effective. Drugmakers Are Desperate to Know Why.” While the implications for pricing in the pharmaceutical industry are obvious, there are also important analogies to pricing activities in a much broader range of companies.

The article discusses how big pharma saw controlling the central nervous system as a path to a whole new class of profitable drugs. What they found was that the mind had a huge impact over the body, but not necessarily because of the active ingredients in drugs. Patients who thought they were taking drugs often showed improvement even without taking actual drugs (placebo). This has been documented for some time. More interestingly, patients who received placebos from doctors who actively engaged with them and suggested the patient would get better had better results than patients whose doctors were strictly clinical and aloof. (They did as well as patients on the leading drugs– not that I want to veer into a discussion of health care reform.)

Placebo effects (or “responses”, as some experts prefer to call them) can also work the other way. Patients told of a drug’s potential negative side effects are more likely to report those side effects.

In short, our minds form expectations that end up shaping how we interact with the world and become self-fulfilling, or at least self-reinforcing prophecies.

So when you focus your conversations with customers on price, cost, discounts and other aspects of the pricing calculation, pricing takes the fore and you find out that customers “only care about price.” If you express your relationship with the customer in terms of the customer’s benefits, what other similar customers have achieved, and other aspects on the value side of the ledger, you generally find lower price sensitivity.

Don Hammalian, Senior Vice President at Alexander Proudfoot, a business process improvement consulting firm with a large sales process practice notes:

Salespeople tend to credit their competition with strengths and abilities that go far beyond reality, especially around competitive pricing. I’ve been with client salespeople who, on their way to close a sale, succeeded in convincing themselves in the car that they had to reduce pricing, even though the customer had not made it an issue. In some cases, they cut prices by 10-15% based on their own self induced fears. Rather than selling the value proposition, service and dependability of their organizations they focused on assumptive prices they could not match and missed their positions of strength. In nearly all cases, these concessions are made without a complete understanding of the impact on margin and market positioning. This is a formula for failure … they failed.

Selling on value is covered in Sales 101 and Pricing 101. The particulars of any given sales situation make it much more complex to implement, of course. Some organizations and individuals will try it, and most will see some kind of success. But it’s often anecdotal (despite the views of professor Jenny McCarthy, this does not make it valid). A couple of setbacks, and companies stop trying.

The goal is not remove price sensitivity, or win every deal at full price. This would be absurd. The idea is that overall, you can create a small but meaningful shift in pricing results, simply by positioning price appropriately. And if your margins are 10%, a 1% improvement just added 10% to your bottom line.

How can you use this effect to your advantage with your customers and sales team?

Part of it is a mindset shift.

We saw one company whose new executive team knew that it had to increase margins. They explicitly focused on value and improving price yield rather than just whether the deal is signed. They moved price exception approval from an administrative function to an executive function. They used our software to get details of open opportunities and how they compared to similar opportunities with the same customer or related customers. They even rejected a few deals that might previously have been considered acceptable. Within a month, the sales team had adjusted to the new regime and stopped asking for massive discounts. Sales and close rates did not change.

This effect is also why companies spend a lot of money on the customer experience outside the core “product.” Fancy restaurants have fancy decor and nice plates, setting your expectations for the food (and the bill). A Lexus showroom is very different from a used car lot. An Apple retail store looks different from Fry’s. Businesses communicate expectations about price and value, deliberately or not. Better to be deliberate, and aligned with your value proposition.

So if you feel you have a premium offering, act like it. This will help set customers’ expectations for price. If you want to communicate that you’re a low-price offering, don’t try to be as fancy as the more expensive competitor. Just don’t fall into the trap of saying you’re the premium offering and acting like you’re the discounter– you’ll incur the expenses of developing the premium product, but fail to achieve premium margins.