Mimiran

If you’re reading this blog, you probably know the dramatic profit impact of small price improvements.  (For a company running at 10% net margin, a 1% price improvement increases profit by 10%.)  Yet even when companies want to improve pricing performance, they often feel like they are at the mercy of the market.

If you’re truly in a commodity market, you are in fact at the mercy of the market.  Either focus on your cost, or differentiate to decommoditize.

Few businesses are in true commodity markets.  And for a lot of these businesses, especially at the SMB level, the first barrier to improved pricing is the one the business owner can control most directly: themselves.  Many business owners look at their costs, tack on a “fair” profit, and call it a day.  Or they look at the competition and price a bit below them.  Even when costs go up, they often have trouble raising prices.

Your pricing is ultimately limited by the perceived differential value of your offering.  I’ll go into more detail on the value side in a later post, but for now let’s think about the amount of value you can capture.  You work really hard to create value for your customers.  You work proactively to make them successful.  Don’t sit back passively when it comes to capturing your share of that value.  Pricing is the monetization of value, and you should be just as proactive about that as value creation.

So don’t be the limiting factor on your pricing.  If you think you should be achieving higher prices but you haven’t asked because it makes you uncomfortable, you need to fix that.  If you are used to giving big discounts when you get nervous in sales cycles even though the value is there for the customer, you need to fix that.

Here are some exercises to help you think about this:

• The Series of Increasingly Outlandish Prices.  From Steve Blank, author of 4 Steps to the Epiphany.  When the customer asks for the price, keep getting more and more outlandish until the customers pushes back.  For example:  “It’s $1M dollars.  Per month.  Plus $2M for setup.  Plus 20% maintenance.”  The point is to help discover the price for a new offering, but it’s also useful to force you to think beyond “I think it should be about $99.”
• Double Your Price.  Someone bursts into your office and holds a gun to your head.  They tell you that you have to double your prices in a month.  (Maybe it’s your accountant.)  What would you have to change about the way you sell, your products, your services, your customers, to achieve this?  While you may not be able to actually double your prices, you can make dramatic improvements.  We used this method to double consulting prices, although it took us 2 years, not a month, to actually do it.
• Visit a Porsche Dealer.  Test drive the fastest convertible on the lot.  When it comes to negotiating the price, keep insisting that you are deciding between this car and a Hyundai Sonata that seats 5.  Keep asking the sales manager to come back with a better price.  After they get done laughing and throwing you out, compare the reaction of the car salesreps to your reaction when customers try to chisel you down on price.
• Say It to the Mirror.  It may sound silly, but if you have trouble asking for the price you think you should get, practice saying it to the mirror.  Not just the price, but why this is a great deal for the customer.  Make sure there is no hint of apology in your voice or your body language.

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.

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.

Twas the night before Christmas, when all the through the house
Not a hard drive was stirring, not even a mouse.

The pipeline reports were tallied with care
In hopes that the revenue soon would be there.

The sales teams were in hotel rooms, snug in their beds
While visions of commissions danced in their heads

The CFO had his latte, and I had my cap[puccino],
because after working all night we really wanted a nap.

When in the conference room arose such a clatter,
That meant we wouldn’t make numbers– that was the matter.

To my dashboards I flew like a flash,
I knew I had found a great source of cash.

Sales Compass showed our profit on each deal in flow
Which ones were met target, and which were below.

And then what to my wondering eyes should appear
But deal approval alerts and analytics so clear.

That I didn’t need Excel, I could be nimble and quick
And I knew which deals needed which kind of trick.

More rapid than eagles the deals they came
And I whistled and shouted and called them by name.

“Now Upsell! Now Cross-sell! Now Big Deal and such!
On this one and that one there’s no need to discount so much!

If we drop the price here our profit will fall!
And we’ll give away all our hard work after all!”

As dry leaves that before the wild hurricane fly,
When they meet with an obstacle, mount to the sky,

So up to the Target Price the deals they flew,
With price optimization and simple comparisons, too.

And then, in a twinkling, I heard on the phone
The happy laughter of successful sales reps back home.

As I drew in my hand, and was turning around,
Across the wi-fi St. Benioff came with a bound.

He was dressed in a Hawaiian shirt, true to form
Because the North Pole is cold but The Cloud is quite warm.

A bundle of toys he had on the AppExchange,
Some expensive, some cheap, some just a bit of change.

Under his breath he was singing about “The Cloud”
And I’m not sure he knew he was singing out loud.

The stump of a cigar he held tight in his teeth
And the smoke it encircled his head like a wreath.

He was long haired and bearded, a bit tall for an elf,
And I laughed when I saw him, in spite of myself;

With the click of a mouse and a twist of his head,
He gave me great insight to move some deals out of the red.

He spoke many words, and went straight to work
And filled my page layouts with Apex and Visual Force,

And swiping a finger across his iPhone,
He approved several deals, including one of my own;

He sprang to his sleigh, to his team gave a whistle,
While data sync’d in the cloud, gently as the down of a thistle.

But I heard him exclaim, ere he drove out of sight,
Happy Christmas to all, and to all a good night.

Are you leaving 10% of your profit on the table?

Do you know where?

This free report provides analysis on your business to help you maximize sales and profit for 2009, including:

• Where you’re leaving money on the table in negotiations. (Every 1% of extra discounting could be costing you 10% of your profit.)
• What types of customers find your offerings most valuable.
• What products your customers find most valuable.

Salesforce.com customers can get their free report with just a couple minutes of setup of Sales Compass Free Edition– which is automatically upgraded to personal edition through 12/31/2009. (See the setup instructions.)

Following the nice mention on Inc.com last week (see Free Pricing Analytics for SMBs), salesforce.com highlighted Sales Compass Free Edition in the “Latest Listings” section of it’s November AppExchange newsletter. If you use salesforce.com (Unlimited, Enterprise, or Professional Edition with Products) get the Free Edition now on the AppExchange. If you’re not a salesforce.com administrator, you can sign up for a free account on the Mimiran website.