The Outcome-Based Proposal & Risk Reduction

The big problem for outcome-based projects (or “fixed bid”, as they are more commonly called) is that while the fee is fixed, the scope may not be. How can you CYA, and also set the project up for success?

Timelines & Deadlines

First, when you deliver a outcome-based proposal, in addition to an outcome and a price, you need a timeline. This provides a boundary on how much you commit to do. In part this is because you have an end point, and also because the customer can only absorb so much so fast. The timeline provides a firm end date for the project, describes the final deliverable, and provides checkpoints along the way. (Weekly is best, IMHO, but use what works for you and your customers.)

If the project is “too big” or doesn’t have clearly defined deliverables, break it up into smaller chunks. A common first phase for me is “figure out what we should be doing with our pricing and give us your recommendations.” Even this is ambiguous, so I have to be careful to spell out the scope of what we can investigate when, and what the customer’s responsibilities are. In other words, don’t set out to do a big, uncertain project with a fixed bid. Do a small, somewhat uncertain project (the assessment). Then lay out the next phase. This will have the same impact on the customer’s budget and schedule as hourly billing, but it will be less paperwork for them to manage.

When you set the deadline, by realistic. Many entrepreneurs are driven and want to do things faster than most, sometimes faster than possible. This is great, but often companies don’t care. If you’ve just killed yourself to deliver what should be a two month project in one month, and then you see the customer sit on it for a month because they can’t actually do anything until the end of the quarter, you get pretty frustrated (so I’m told). Give yourself a bit of extra time. Things happen. Kids get sick. Customers don’t deliver data. Something doesn’t go as planned. The idea that you can truly and consistently devote 8-10-12 hours per day of productive time to the project is unrealistic. Better to have a little bit of room in the schedule. Sometimes even have time to go back and do something a little better, so you can be really proud of your work. You’ve built in enough money and time that you don’t resent the extra effort, you’re excited about it. And sometimes, particularly if you are waiting on input from the customer, you can actually work on something else in parallel, which is essential to escaping the feast and famine cycle of many service providers.

Remember that the customer often doesn’t know exactly what they are trying to buy, so you, as the domain expert can help them. This may mean doing several phases. If you go the doctor with a heart problem, you may need the doctor to figure out exactly what the problem is before trying to solve the problem. You can do the same thing with your clients.

Describing Deliverables

The biggest problem for fixed bid projects is defining deliverables. You might promise to deliver “a web-based CRM system with the following features…” The customer’s Japanese sales office might simply assume that the system will be localized with Japanese currency, language and more. When they see everything in USD and English, they can’t use the system and don’t sign off. Part of the assessment has to be figuring out what success really means for the customer– which often means multiple constituencies that may have different needs. You must define deliverables on your customer’s terms, not yours.

For example, instead of delivering a piece of software (“a web-based CRM system”), you may deliver software that “lets sales reps do X, Y, and Z, while integrated to systems P and Q.” Instead of delivering a “pricing training class, focused on value-based pricing”, the customer wants “to arm each sales rep with a system to present quotes leading with value instead of price, and to handle price objections.”

It’s just taking the deliverable up a level or two. What the customer is buying is not the exact service you’re selling. They are buying the reason they need that service. (See the previous parts.) No one wants to buy a training class. They are buying a training class because they want to make their sales efforts more effective. Your deliverable should provide a clear answer to the need.

It’s also helpful to explicitly define what you’re not delivering. Even if it seems obvious to both you and your client counterpart, there may be other people who assume that the CRM system will include Japanese. If you know that it won’t, say so. Anything you can explicitly exclude is good not only for you, but for the customer, as well. They will appreciate the clarity, and having a clear answer for their boss, when someone asks why Japanese isn’t available (“future phase”).

Of course, you can’t solve all needs at once. Your assessment only addresses an intermediate need. A prototype might demonstrate the feasibility of a concept, or allow executives to select a course of action. Stepping stones are good, not bad.

Brining It All Together

If you manage your timelines, deadlines, and deliverables carefully, you can avoid most of the risk of fixed-bid, or “outcome-based” projects. Will you occasionally have to take on more than you wanted? Yes, probably. In my experience, the average estimate is pretty good, but sometimes it’s over and sometimes it’s under. Overall, the results have been positive not just for me, but for customers. Everyone knows exactly what the goals are and I get to spend my time and effort working towards them, with minimal administrative overhead. Situations where we have gone back and done another iteration or added a feature, or otherwise done more work were more often driven by my desire to do things right than the customer asking. In some cases the customer may not have even noticed or cared, but I like to feel good about what I’m doing.

Remember, customers don’t buy hours (I’ll post a counterexample in a follow-up). They buy outcomes. If a group of trained monkeys could deliver the same results and get paid in bananas, you’d be out of a job. But if you can sell (and deliver) outcomes, you can do more satisfying work and make more money. So now when you put together your proposals, you can sell outcomes. Instead of 40 hours of earth moving, you sell beautiful new landscaping. Instead of 200 hours of software coding, you sell an integration to salesforce.com. If you can take it up a notch, you can sell 20% more selling time, not just an integration. What you sell should be as close as possible to what the customer is trying to buy– the real outcome that they care about– which increases your chances of winning, the meaning you create while delivering, and the value you can capture as a reward.

Outcome-based Selling

If the customer is willing to pay $100,000 for a certain outcome or deliverable, you can then decide if you can or want to deliver it for that price. In many cases, the customer will compare the price with quotes from more traditional firms who are billing based on time and materials. If you’re competing with someone overseas who is charging $30/hour, you don’t want to have to justify why you are $300/hour, even though you will take 10x fewer hours to complete the project. You don’t want to have to justify $90/hour, even if it will take you a third as many hours. You want to keep the focus on the benefits and the overall price. Is this a good investment for your customer? You don’t want to be in the business of convincing them to make bad investments, right?

The closer you can get to the real outcome, the more easily you can use value-based pricing. You may not be able to get a 40% revenue share like a trial lawyer, but even doctors, who can’t guarantee outcomes, get paid different amounts for different activities. (Medical pricing is pretty screwed up, but I don’t hear anyone saying they think doctors should get paid by the hour, regardless of what they are doing.)

So if customers really care about outcomes, not hours, and if hourly pricing lowers the profit and increases the drudgery of providing services, why do so many service proposals have hourly billing? When everyone is doing it, it becomes standard practice. People start asking, “what are your rates?”, not “how much will it cost?” And when companies start comparing bids, hourly rates are easy to compare. Furthermore, if you can’t differentiate your offering from a competitor’s hourly option, the solution becomes commoditized and the market drives rates towards marginal cost. This means that you can’t simply charge a portion of the benefit, even if you could quantify it, because other competitors could then deliver better returns at lower prices. You can only price up to your perceived differential value.

Sounds bad, but if you’re trying to get out of hourly billing, you can actually use this to your advantage. You know approximately what other providers will bill, based on the estimate of work and hourly rates. You can differentiate in terms of value delivered (might be hard) or time spent. If you can truly do the same work in less time, you can bill similar total amounts, leading to a higher effective rate. For example, when I did a lot of high end pricing analytics, we built custom tools to allow us to crunch through certain “what-if?” scenarios much more efficiently than you could in Excel. We could do in a week what a typical consultant might do in a month, and we could do in 3 man months what another firm might do in 6 or 12. Of course the effective rates were higher. The company from Part 1 that refused to pay $175/hour later gladly paid twice that effective rate because we recast the project as a deliverable with a due date.

For this to work, you have to be able to do something better, cheaper, and/or faster than your competition. Note that “better” means better in the customer’s eyes. If they don’t perceive the value, it’s not real. If they do, even if you don’t think it’s important, it is. Cheaper and faster are amenable to technological improvements (like our custom software tools), or other templates and prebuilt intellectual property that you can use repeatedly.

One great thing about this method is that you have a lot of flexibility to serve the customer. For example, in one case, we realized that it would be better and cheaper to buy an off-the-shelf software package rather than doing the work by hand or implementing certain software features ourselves. If we had been on a typical hourly contract, we never could have won approval to do this in time. It would have broken the model and required another legal review. Since we were responsible for the results, we made the decision in an afternoon and were able to accelerate the project and deliver better results. Using the project approach, you want to think about ways to deliver value faster, more easily, and in a more automated fashion. If you’re just billing by the hour, there is a strong disincentive to improving delivery efficiency. Even if you’re not simply billing lots of hours, your mind will be thinking in a different way– one that is ultimately not as good for you, your team, or your customers.

In addition, customers aren’t exactly dying to handle extra paperwork. Some projects I’ve worked involved consultants, subcontractors (too specialized for me to hire full time, but essential for certain pieces of certain projects), and other 3rd party services. Simply getting approvals for all these pieces, let alone managing them, invoicing, and processing payments, would have taken significant time for the customer and for me. Instead, we wrapped it up nicely, saving time for the customer and ourselves, so we had more time to focus on actually delivering the solution.

Many service providers would love to get out of the hourly pricing cycle. They would love to deliver “outcome-based proposals”, but they are scared of the risk. So in the next part, we’ll talk about how to mitigate risk and set your project up for success.

The Customer’s Perspective

The interesting question in sales (and in pricing), is not “what am I selling?” It’s “what are you buying?” As the saying goes, no one buys drill bits, they buy holes. And they need holes to do something else. Customers buy services for the same reason they buy drill bits. Perhaps they even want to buy the holes, letting you drill them.

Human nature makes us want to focus on ourselves. We want to talk about what we sell and why it’s so great. We want to look at our costs and our goals and set an inward-looking price to make our profits. Customers want to solve their problems. We can be much more successful if we focus on our customers’ problems, figure out the value in solving them, figure out how much we can charge to help solve them, then how we should deliver the offering so we can be profitable.

An extreme example is contingency-based fees charged by lawyers, rain makers, and other high level partners. They get a (big) cut of any benefits, but don’t get paid unless they generate value. These situations require 2 attributes:

• A clearly defined value that the parties can divide.
• A clearly perceived differential value that prevents someone else undercutting the price. In the case of the lawyers, most people would rather get a better lawyer and try to win, rather than “save money” on a cheaper lawyer who is less likely to win and may win a smaller settlement. In addition, trial law still requires geographic proximity– you can’t just outsource your lawyer to a cheaper country.

Most services businesses operate without either of these advantages. Even the customer may not know, or even be able to know, how much value you deliver. And in most cases, there is a cheaper alternative available.

So you need some way of knowing what the customer is buying, what outcome they actually care about, and approximately how much it should be worth to them. Thanks to human nature, people like to talk about themselves and their problems. So if you are genuinely interested in helping them solve their problems, they are usually happy to provide you with lots of information about them. You may even have to ask some questions they haven’t considered. I always like to ask “how will you measure success?”. (See this post on creating a proposal for more details on figuring out what the customer really wants.)

Note that if you overestimate the value, the customer can always tell you that you are too expensive. If you underestimate, they usually don’t tell you that you are too cheap.

In the next part, we’ll look at how to sell outcomes.

I get this question a lot, both from consulting clients who want to figure out how to optimize their pricing, and from Mimiran application users who want to automate not just proposals but quoting, and suddenly realize they don’t know what to enter under “Products”, let alone pricing.

In this post, let’s look at how most services businesses answer this question, and why I don’t like that answer. In the follow-up, we’ll look at a more profitable, enjoyable, satisfying answer.

The default answer is “hours.” 500 hours of a senior software engineer. 120 hours of a solutions architect. 20 hours of earth removal. The advantage of this approach is that it’s simple for everyone to understand. I will work for you for a certain number of hours, and you’ll pay me a fee for each hour worked. Kind of like you’re a parking meter. (You can probably guess where I’m going with this–subtlety isn’t my strength.)

Now let’s look at the disadvantages:

• Your rates are tied to people. You can’t take a Senior Solution Architect who was $250/hour on the last project and sell her as a Junior Integration Consultant to the same customer for $125/hour, even if she’s not busy, and it would be the right solution for you and the customer. Even doctors have figured this out. They don’t bill an hourly rate for a checkup and the same rate for open heart surgery. The bill based on what they are doing (or rather, what the government and insurance companies think they are doing– but that’s a whole different discussion.)
• You invite commoditization. Whenever you quote a rate of $X/hour, you invite comparisons with a competitor who charges X – 20%, or X/2, or even X/10. Even if the buyer understands that you will take half the hours, and do better work, they only concrete thing they have to compare is the hourly rate. Especially in the age of outsourcing, this puts you at a big disadvantage. Back when I charged people like this, I had one prospect tell me that they knew I would be a great deal for them, but they couldn’t get approval to pay $175/hour. (I later learned how to bill them $300-500/hour, which provided tremendous value for them in a politically acceptable way, but we’ll discuss this more in part 2.) It didn’t matter what skills I brought, or how much faster I could complete the task, or how much value they would get out of the project. They simply weren’t authorized to pay that kind of hourly rate.
• You limit your compensation regardless of the value you deliver. There’s a story about a real estate developer trying to get a 9-figure project moving. His lawyer cleared away the obstacles with a few phone calls and presented a bill for a few thousand dollars. The developer said that the bill was absurd, tore up the invoice, and wrote a check for a million dollars. Most of our clients are happy to get good value, but unlikely to pay more than their invoices require. If you combine this issue with the previous one, you end up chained to your job, trying to hit utilization targets instead of value targets. You work yourself out of your own passion, the very thing that drove you to start the business in the first place.
• You have to watch the clock. Not only do you have to track your hours, you have to account for what you did with all of them. When I’ve done hourly billing, I found this could add an overhead of 10% to a project. Cost of time to me and money to the client that was not spent on solving their problem, but just on bookkeeping. If the client is paying by the hour, they have a right to know what happened in those hours, but this approach drives me crazy. I don’t have a mind that shuts off when I leave the meeting. I have had important insights and solved critical client problems while driving away from their offices, while jogging, in the shower, and yes, I’ll admit it, even on the toilet. Sometimes I’ll decide that it’s time for bed, especially if I’ve been stumped on something, close my computer, head for bed (very quietly if my wife is already asleep), settle under the covers, lay my head on my pillow, close my eyes, and then realize that I just solved the problem. I’ll suggest to myself just going to sleep, and that surely I’ll remember in the morning, but it’s too late, the wheels are turning, and get out of bed, back to my computer and take care of the issue. How do you bill for this in an hourly manner? Lawyers have the answer, of course, just bill for all the time, but I don’t want to think about billing, I want to think about the customer’s problem.

Most of you who read this are going to go back to billing hourly. That’s OK. Just set up your rate structure so you can make money, delight your customers, and retain your passion. Often, this just means raising your rates to the point that some of your customers say no, and you can say no to some of your customers.

I’ll discuss another approach in part 2…

I created this simple pricing calculator to show how small changes in price, volume, and costs, can have a huge impact on your bottom line. Use this to help figure out how to set list prices and adjust pricing once you start negotiating your proposal.

The spreadsheet has 2 sets of inputs for price, volume, variable cost, and fixed costs. I suggest putting your current data in the first scenario, then using the second scenario to explore possibilities. (If you don’t have exact numbers for some of the inputs, guesstimates are a good start.)

Note how price changes have more impact on profit than similar changes in volume, fixed cost, or variable cost. To see this, make the second scenario an exact duplicate of the first scenario, then change one input at a time. Which one has the most impact on profit?

You can also see your breakeven volume– the amount you would need to sell to make the same profit in the first scenario, but using the second scenarios price and cost parameters.

What are the implications for your business?
Download the Pricing Calculator (xls file).

When you create a new proposal, you can start from scratch, use one of your existing templates (if you have one), or select a public public proposal template. It’s easy– see below.

Also, if you sign up, you get a couple of sample proposals to start, so you can send a proposal in under 5 minutes to try it out.

Now it’s even easier to send proposals online. If you send proposals with Word and email today, this will change your world. Take a 30 day free trial and check it out.

What if you need to transport more than 2 people?

What if you have kids?

What if your neighborhood has enormous potholes?

What if your knees aren’t good enough to get in and out of the Ferrari?

What if your driveway is really steep?

What if you need to go grocery shopping?

Many small business owners think that they have something “less” than the big companies they may run into in the market. They think the big company is the Ferrari. It’s different, it may be more expensive, and it will certainly be better for some people. There are lots of reasons, even beyond price, to prefer the Odyssey. Don’t try to sell the Ferrari people an Odyssey. Find Odyssey people. The fact that you have an anti-Ferrari may actually be helpful. (If you do have a Ferrari, don’t try to sell it to Odyssey people at Odyssey prices. Find Ferrari people.)

When someone says they want to buy, but they don’t like the price, you need to know why they are objecting.

If they were never really in the market for your services, this is a positioning failure. Take steps to avoid wasting time on discussions that cannot be fruitful. Even if you need to have a conversation with a prospect to generate a quote or proposal, put a “starting from” on your website. A web design firm put a form on their website to allow visitors to request a proposal, but they put a big “starting from $50,000” above the form. How much time do you think they wasted talking to people with $10,000 budgets? So if you’re dealing with someone who is simply not in the right place, politely suggest some better alternatives and take steps to position better.

Next, you want to know if price is the real issue. When people don’t feel comfortable with a purchase decision, they often say that price is the problem, even though, consciously or not, there are other issues holding up the sale. So ask what their price expectations are. If they say that they are ready to sign, they just don’t like the price, you know you can deal with a pricing problem. If they say they don’t like the price, and one of their colleagues has raised some issues and someone on their team thinks they should do it themselves, etc, etc, don’t talk about price! You will end up discounting without solving the real problem(s). Go solve the real problems, then discuss price.

Also, keep in mind that many buyers reflexively ask for discounts, because they know that many sellers will immediately cave on price. Wouldn’t you ask for a discount? (How are you training your customers to handle this part of the sales cycle?)

Now that we’re talking about price, there are 2 basic kinds of price objections:

1. We don’t think your offering is worth what you claim (even though we probably have the money).

This often starts with “alternative X does most of what you do, but it costs half as much.” This is a great chance to discuss your value. For example:

• True, X is much cheaper to purchase, but over the lifetime of the product, you have much higher maintenance costs and the cost of the production downtime ends up being much more expensive than the purchase price. Our product is designed to keep you running for years.
• True, X is much cheaper, and it’s in the same category as us, but that’s like saying a Kia and a Porsche are both cars. Here’s what we do that’s different that will end up having a huge impact on your bottom line. If they don’t value some of the differentiators, offer to remove them (if you can). This really helps clarify what the customer really cares about. If you can remove parts of your solution, and lower your cost, you can make money will saving the customer money. In many cases, the customer decides they really do want the value-added features they said they didn’t want to pay for.

Often, the discussion is really about risk. “If you can do what you say, this is great, but how can I be sure you can deliver? I’m in big trouble with my boss if we spend all this money and I can’t show results.”

• Remember you can’t reduce risk by reducing price. In fact, you increase risk.
• Offer as much guarantee or pay-for-performance as you can. In some cases, you won’t have enough control to offer very much.
• Acknowledge the risk, and discuss how you have handled it in the past, including what works well, and what you want to make sure you avoid. Be clear about your expectations of the customer’s contributions and commitments.

2. We agree with your value and your price, but we just don’t have the money.

Work something out. Just don’t discount and provide the value for less money without gaining something in exchange. For example:

• If you are dealing with a project, break it into phases.
• If you are selling a software application, offer a limited pilot for some users.
• Offer to reduce the price a bit if they pay entirely up front. (This works better if their budget almost covers the cost.)
• Offer a discount for a testimonial, press release, or other marketing help. (Happy customers are may be willing to do these things for free, but don’t discount without exchanging value.)

I’m lucky to have a good angle on these conversations. I can often short circuit the whole conversation with “do you really want to hire someone to help you reduce your negotiated discounts if they cave on price?”

What are your favorite stories of price objections and how to handle them (as a seller or a buyer)?

From knowyourmeme.com

I don’t know you. How can I know you’re pricing all wrong? Obviously, I don’t, and there’s a chance you’re actually doing it right, but experience with hundreds of business owners lets me play the odds. So in this post, we’ll look at the most common ways small business owners hold back their own businesses by pricing badly.

Before we go into that, a quick primer on why this is so important.

Let’s take a simple example first. Many businesses start out as sole proprietorships where the owner trades his or her time for money. (If your business is different, bear with me for a moment.) If you can bill 70% of the time (we’ll assume 2,000 hours is full time– 50 weeks at 40 hours per week) at $75/hour, you make 2,000 x 0.7 x 75 = $105,000. Now suppose you can bill at $100/hr. If you keep the same 70% utilization rate, you make $140,000. Of course, you might lose some business (many small business owners are pleasantly surprised that their volume increases as they raise their prices, but that’s another story), but you could go all the way down to 53% utilization and still make the same money you made before. Plus, you now have an extra 350 hours of time in your year, to grow your business in other ways, spend time with your family, enjoy your hobbies, etc.

Let’s say you grow your business (you priced at $100/hr and used the extra time and money to do a lot of business development), and you now have 5 subcontractors. You still bill clients for their time, but you also have to pay them. To keep the math simple, let’s say that each person costs you $60 per hour, plus you have $20,000 in fixed expenses for office space and other overhead. You keep them busy and billing 80% of the time and as junior people, they bill at $75. Now each employee brings in $120,000 in revenue and $20,000 in profit ($24,000 – $4,000 for their share of overhead). Now let’s say you increase their billing rate to $100/per hour. If you can keep their utilization at 80%, they now bring in $160,000 in revenue and $60,000 in profit. In other words, when you increased the rate by 33%, you increased your profit by 200%! Let’s say their utilization falls to 60%, they still bring in $120,000 in revenue, but your profit has gone up to $44,000! In fact, your utilization would have to fall all the way to 30% (600 hours per year) for you to make the same $20,000 profit per person. This is powerful stuff.

(When I did consulting full time and had a team, I never wanted to be above 50% utilization. I wanted to charge a good rate, work for people who valued what we did, and not do the weekly grind that chews through the lives and souls of so many people in this line of work.)

Now imagine that you want to increase utilization, and you offer a price discount to $70/hr. How much more work do you have to get to make the same profit? You need to get to 120% utilization, which is a recipe for burnt out people.

The exact amount that price and volume changes impact your profit depends on your fixed and variable costs. High fixed costs *and* low variable costs generally push prices down, to cover fixed costs and drive volume. High variable costs must push high prices. But even within those guidelines, there’s a lot of flexibility.

Now let’s look at how you’re (probably) doing it wrong.

You’re pricing based on costs

The “easiest” way to set a price when you have no idea where to start is to look at your costs and mark up. There are 2 problems with this.

1. It can be really hard to accurately allocate your costs, include all variable costs, etc. You can go nuts just trying to think about it. Why do that when:
2. Customers don’t care about your costs. They only care about the value they get. If you achieve some supply chain efficiencies and reduce costs by 10%, do your prices go down 10%? Perhaps, but they shouldn’t automatically. You should lower your prices if that will drive a volume change that will increase your profits.

You should have a basic idea of your fixed and variable costs. You can then sanity check your pricing to make sure you will actually make money. But don’t start with your costs. If you price based on your costs, you make the minimum you can viably make and stay in business. This would be like Apple charging $299 instead of $499 for an iPad.

Many software startups try to calculate server and support costs and derive a price from there. They are developing something innovative and valuable, but pricing it like a commodity. This will lead to problems down the road.

You have no idea what your value is

It’s hard to price based on value, if you have no idea what your value is. This is where a lot of people go wrong. They come up with something that they want to sell, or something that they can make, or something that they can build, and then try to figure out how to price it. This is when they usually revert to cost-plus. The interesting question is not what can you sell it for, but what do customers buy it for? Customers need or want to do something. Depending on the customer, the way that gets expressed is very different. For example, if you need a car for transportation, your best bet, economically, is to buy a reliable used car. Yet many people buy new cars. And new cars run anywhere from a little over $10,000 to well over $100,000. Different buyers place different value on the different things.

To get an idea of your value, think about what your customers would do if they didn’t buy from you. Would they “do nothing” (keep doing what they do today)? Buy from a direct competitor? Buy from a larger company? Buy from an indirect competitor (competition for the local sports bar includes not just other sports bars, but people’s own homes, and even the internet). In some cases, the alternatives are dire. If you just developed a cancer drug that cures otherwise incurable cancer, your offering’s value is very high. If you sell something that’s directly substitutable, you have no pricing power– you are at the mercy of the market.

“Value” is really perceived differential value. This means that value is in the mind of the buyer. You can influence this perception, but ultimately the buyer decides. It’s also differential– compared to one or more alternatives. One problem many well run small firms have is competing against “cheaper” alternatives that aren’t cheaper. For example, a boutique firm charges $200/hr and can complete a project for $50,000. A larger firm with less qualified staff charges $100/hr, but it will take more people, more time, and the total bill will be at least $60,000. Without help in perceiving the value, many buyers choose the “cheaper” $100/hr option.

Notice further that your value is probably not related to the exact number of hours you work. So don’t price by the hour. All you do is invite complaints that you’re overpriced and join in a race to the bottom.

If you have a virtual good, try to scale the price the same way the value scales, at least in general terms. For salesforce.com, they assume that value scales by the size of the enterprise and the needs for different features, and the number of users. The type of features required dictates the edition, which then determines the per user cost. It’s not a perfect match for value, but it’s reasonable.

You are trying to be cheaper, not better or different

Many small business owners don’t know how to compete against larger, more established players, so they think they have to be cheaper to attract business. Unfortunately, most of the value buyers don’t want “cheap” they want “value”, and the lower price actually undercuts the value message. One enterprise software company could not get traction in the market until they increased their price 50X. Buyers just didn’t think they were credible because their prices were too low.

There can be only one (cue Highlander) low cost provider in any market. In most cases, unless you have some defensible, sustainable cost advantage (think Southwest airlines), this will not be you. So don’t get in a price war with bigger competitors. All you do is transfer money to your customers’ pockets, and greatly reduce your income (see the introduction for some examples). You have the advantage that you don’t need a huge slice of the market, so you can focus on a niche that perceives a lot of value in what you do. For example, Wal-mart can’t provide great service, but it can provide cheap bikes. If local bike shops tried to compete with Wal-mart on price, they would lose. So they sell more sophisticated bikes, with great service, catering to a different part of the bike market. Almost any market can be segmented so you can deliver great value to a small niche, at higher prices and higher margins than the broader market. A corollary is that you can also segment the market to provide “enough” value at low prices to be very profitable if you have the right cost structure. This is how Microsoft came to dominate desktop computing.

When you pursue your market segment, you will find prospects in nearby segments who don’t value what you do the same way you do. That’s OK. The sooner you can identify that they are not really in your market segment, the more time you can save. As a small business owner, every minute that you waste is a minute not spent growing your business, enjoying your family (did anyone start a small business hoping to spend less quality time with their family?), or sleeping.

When I did a lot of corporate consulting, the message was that we could do detailed, quantitative analysis (including measurable results) beyond what your time could do, at a fraction of the time and monetary investment of someone like McKinsey. This made it easy for prospects to understand if we were a good fit. If someone had $10M to hire McKinsey, they were going to hire McKinsey. If someone thought they could handle it in-house, they wouldn’t talk to us. But if they needed some analysis, ideas, and implementation for between $25,000 and $250,000, it would make sense to have a conversation. The value we would deliver would typically be several million dollars of profit improvement, discounted for the perception of risk. We used proprietary tools to let us do things you couldn’t do in Excel, and we didn’t bill by the hour. We wanted to align with customer value as closely as possible.

Now that I do proposal software, the message is “killer proposals made easy.” This automatically excludes the majority of the small business market that doesn’t have any need for proposals. And for people who already think proposals are easy, well, they obviously don’t need us. Only businesses that spend too much time putting together proposals and trying to close them are going to care. Is it “cheaper” to use Word and email? Sure, at least in the short term, but for some part of the market, the investment is worthwhile.

Another example is Draft by 37signals. This is a simple iPad sketching app. It costs $9.99, which is considerably more than other apps which have a lot more features. Why does 37signals charge $9.99? It’s for people who want only simple sketching, and want to share their sketches via email, or another 37signals app, called Campfire. If this is all you want to do, this app will do it better than an app with all kinds of extra complexity and features. Furthermore, 37signals doesn’t want everyone looking for a sketching app to buy this. They know there are cheaper alternatives. They are targeting the portion of the market that wants to work within Campfire. This way they make good money on the customers who value their product, and deliberately keep out those who don’t care, thus keeping down time and expense supporting customers outside of their core market.

You don’t believe in your own value

After I have a conversation with a small business owner about value, they often say, “OK, but I can’t charge that, that’s twice what I charge now.” Why not? Because fundamentally, they don’t think they are worth it. They are embarrassed about their current prices, let alone the potential future prices. If you don’t believe in your value, you can’t expect your customers to believe in it, either. Don’t kid yourself and inflate your value, but if you have the numbers to back it up, be proud of it. When you talk about pricing, never sound apologetic. Make price part of the value. If you walk into a Ferrari dealer, they will tell you all about the car, including the price. They don’t go into an embarrassed whisper. (So I’m told.)

You fear price objections

A related problem is fearing price objections. When someone tells you that you are too expensive, it’s a great chance to explain why you are different, better, and an overall better value. It’s also the only way you can know if you’re charging enough. If you never get price objections, you have a big problem. When you explain your pricing, without apology or reference to your costs, your customer can either agree and buy (great outcome) or push back. They may not perceive some aspects of the value you profess. They may not even be in your target market. Or, they may simply not have the budget. We’ll discuss this scenario more in “you have no plan for negotiation”.

You surprise your prospects with your price

Prospects should not be shocked when they see the price. (“Sure, the Ferrari sounds great– can you send me a proposal? … “What, this is way out of my budget, I only had $20,000.”) Even if you don’t know the exact price when you start discussions with a client, you can give a range, or a “starting from…” For example, I recently had someone inquire about a pricing workshop. I gave a brief outline of some options in an email, and noted that prices depend on the solution, but start at $5,000. That was more than he wanted to spend, so we all saved a lot of time. If instead, we had been embarrassed to talk about price, I might have wasted my time and his finding out more, creating a proposal, etc, only to find that it was never a fit. Even if there is a potential match, don’t surprise your prospects. If you can’t quote a price on your website or in your initial discussion, start discussing prices as soon as you have collaboratively developed a potential solution. Some people say this puts you in a bad negotiating position. I say it saves everyone time and helps you become a real partner to the customer. You can start upfront with some ranges (“in past projects like this, we have charged between about $40,000 and $100,000. I know that’s too big a range to be useful, but we can adjust who does what and how much we get done in this phase to suit your needs”). After more detailed discussions, you can offer a preliminary proposal with a menu of options. This way the customer pays for what is valuable to them, and you don’t waste your time on things that aren’t valuable. Whatever you do, the price should not be a shock on the proposal.

You have no plan for negotiation

Now even if everything has gone relatively smoothly, you will often get drawn into negotiations. This is often a symptom that you didn’t understand what the buyer(s) really needed and how they make their decision. In some cases, you need to help buyers understand their own problem, because they may not have the expertise to diagnose it properly and formulate the right solution on their own. In any case, customers will push back on pricing, even after hearing your value message. The important thing here is to have a plan and execute it. Many people forget to prepare for this step, and then, in the heat of the moment, end up discounting the heck out of their business. (“I just closed a deal that I really didn’t want” is a lament I have heard far too often.) This is such an important topic that I devoted 2 posts to it, one devoted specifically to services. The short version is: be prepared to trade value– don’t just give away value. For example, a customer might get a discount in exchange for paying early, pushing the delivery date back, doing a case study for your web site, committing to a certain volume, accepting a reduced service level, or some other mutually beneficial exchange. Be willing and able to take something away if the customer doesn’t value it. The plan should never be “just discount up to X%.”

You think you need one price

Following on from the previous point, if you have different discounts for different scenarios, you have, in effect, different prices, even if you only sell one offering at one price. No matter what “optimal” price point you pick for your offering, you will leave money on the table with some customers, and price others out of the market. You can use good/better/best offerings to subsegment your market. This is what car makers do with different trim lines, what Apple does with different iPad models, and, more subtly, what restaurants do with early bird specials and movies do with matinee and senior pricing. Software is particular amenable to this kind of thinking, as it’s easy to create different editions with different value to slightly different audiences. Salesforce.com is a great example. Their core offering ranges from $2/user/month all the way to $250/user/month.

You’re too busy

“I can’t keep enough inventory. Everything sells out as soon as it’s available.”

“I’m so stressed out about all the projects we need to deliver. I’m not sure how we’re going to get them done.”

These are the good problems to have– far better than the reverse. Yet they can still make life miserable for the small business owner, her employees, and family.

I like to say “you don’t have a supply problem, you have a pricing problem.” Many of the folks making these complaints haven’t raised prices in years. They are not even keeping up with inflation, let alone increases in the perceived differential value of their offering. Being “too busy” is a symptom that you are not managing demand well. Going back to the introduction, what would you rather do: work half the year on the best projects, or delivering to the best customers, who really care about what you do, or working all year, getting really stressed out, losing out on family time, and making the same money. The market sets the maximum price you can charge (as limited by your perceived differential value), but it’s up to you to charge it. Going back to planning for negotiation and needing more than one price, you can use pricing to help move demand to off-peak times. My accountant charges the same rate whether it’s April 14th or the middle of July. (Don’t tell him I said that.) I’ve seen print shop owners who don’t want to charge rush fees because they don’t want to penalize great customers. Then they complain that they are always doing rush jobs.

Thinking that you have to get it all right the first time

No matter how strategically and cleverly you think about pricing, no matter how well you think you know your market, things change and you will need to revise your pricing from time to time. This can be simple tweaks, like a small price increase in January (good to do small, regular price increases so customers are used to them and you never end up having to do a huge price increase to stay in business), to changing discount programs, to completely changing the way you price.

Communicate as openly and honestly as you can with your customers (goes back to not shocking them). If you provide something valuable, your customers will understand that you need to change the way you price it sometimes. Chargify had to do this twice. First, they caught a lot of flack because customers felt let blindsided (they also did away with their Free plan– no one gets as upset as those paying nothing suddenly learning that they have to pay for what they used to enjoy for free). The second time they announced a price increase, they outlined their reasons 2 months in advance, asked for customer input, and got a much more supportive response. I don’t think they were trying to “trick” anyone with a low price that they would have to raise, they just had to make a course correction. Many companies, including software companies, change the price they charge new customers, while keeping old customers on their familiar payment plans. This keeps your customers from getting upset and is helpful if it’s viable technically and economically.

You’re doing it right

If you’ve made it this far and you’re thinking, “none of this applies to me,” then you are doing a great job and I might want to hire you. All these things are much easier said than done. Even as a “pricing expert”, I have been guilty of all of these things at one (or more) time or another.

Take a look back through this list and see where you can apply some tips to improve your pricing, your business, and your life. Small improvement can mean amazing changes. As one of my customers said to me a few months after a price increase, “thank you for my new patio.”

You walk into the doctor’s office with a cut on your hand. You think you need some stitches and perhaps some antibiotics, but you’re not sure. The doctor says, “great to see you. Looks like you could use a heart transplant.” You’re puzzled.

“But, doc, I just have a cut on my hand. I think I need some stitches.”

“Sure you do, but have you also considered the benefits or a heart transplant? I’ll throw the stitches in for free.”

I bet you haven’t had this experience, at least not in the doctor’s office. Yet, we’ve all had this experience as a buyer in some other context, and many of us (myself included) have been guilty of it as a seller. We all like to be proud of what we do and what we sell. Sometimes we get so proud we forget that whole purpose of what we sell is to help someone else, and that their problem, not our solution is actually the important part.

Rather than selling your solution, take some time to really understand the problem. Then you can determine if you have a good solution. (This is for B2B folks or complex B2C sales– I know there are lots of cases where you don’t need to get into this much detail.) If you do have a good solution, you and the buyer can have confidence in it. If you don’t, you can devise one together, or refer them to someone who does.

Let them describe their problem. Ask questions to get details about what the real problem is– it may be hidden under several layers. “We need a new sales system” may be the layer before “because we just bought another company with an incompatible system and we want one system for everyone”, which may be the layer before “the CEO tasked me with solving this before the end of the fiscal year.” If you don’t understand all the layers, your solution may miss the mark. I can’t count how many sales cycles I’ve seen end because people didn’t understand the real problem, or even how many sales cycles ended “successfully” but led to failed projects, for the same reason.

This is why doctors start by asking about your symptoms, taking your blood pressure, and doing other tests, so they understand what’s really going on before they recommend a course of action. You might think “the human body is complicated and the consequences of bad decisions are really high, but my business is much simpler.” Plus, you don’t have time to do lots of consultations, especially since customers often don’t want to pay to truly understand their own problems.

However, people’s businesses are important. Maybe not as important as their hearts, but still something you want to get right. To avoid unnecessary conversations, your sales and marketing efforts should not only try to attract the right prospects, but exclude the wrong prospects. If you have a solution that starts at $100,000, tell people that. Then you won’t spend half your time fielding calls from people with $50,000 budgets. As much as this advice is important for large companies, it’s critical for small businesses.

The less you “sell”, the more you work on really solving their problem, the easier it is to sell, and the more likely your project is to succeed. Treat every prospect like they were just referred by a friend (who will certainly hear how you treated them). You don’t have to give them a huge discount, just treat them well and treat them fairly. But make sure you are really solving their problem or referring them to someone who can. This sounds obvious, but it was an important revelation for me– I suck at selling, but fortunately get most of my business through referrals. Once I stopped “selling”, I really started selling.

If you have the right conversation with the right customer, you can generate a killer proposal and close the business. This may seem like a lot of work, but if you have the right tools (shameless plug, check out a Mimiran sample proposal), you spend very little time on grunt work, and can focus on the client specific pieces. I use the same proposal template about 80% of the time, and it’s mostly a matter of filling in some key information from the discussions. Note that the proposal is not where you present a novel solution (“turns out I think you need a heart transplant!”), but rather a synthesis of your discussions, which, once you have uncovered the problem, lead to designing a solution together.

I’m off to do a phone call. Turns out someone sold a deal without understanding the customer’s real problem. The customer didn’t explain it in detail and the sales rep never questioned them because everyone wanted to get the deal done. This is different than wanting to get the problem solved. Now I have to see if I can solve the real problem, or refer them to someone who can.