4 Rules for Pricing Proposals

One of the most important (and stressful) parts of the proposal, for both the buyer and the seller, is the price. As the seller, you get to decide on the price you offer, although you can’t always dictate the final price.

How you price the proposal, and how you present that price are big factors in whether you win the deal, and, if so, how much money you make. How important is the price?

Let’s look at an illustrative example— a software development company plans to bid on a project that they estimate will take 10 person-months of work. To keep the math simple, let’s imagine that the fully burdened cost to the company for those people for that time is $100K. If you lose the deal, and you don’t replace it with another project, you’re out $100K. If you win the business at $120K, you’ve made $20K. If you win the business at $125K, a 4% price increase, you make $25K, a 25% improvement in profit. The particulars will depend on your business and the details of the proposal, but hopefully you get the idea. Small changes in price can have big impact on profit. (You can use this handy spreadsheet to help you run through different scenarios.)

With the impact of pricing in mind, here are 3 important rules for pricing a proposal:

1. Don’t price based on your cost.
We just talked about how your cost ties into your profitability, and now you’re telling me to ignore cost? Pretty much. We need to check our price against our costs to make sure we’re making money, but we don’t want to price based on cost. Cost is an inwards-looking metric that has nothing to do with the value the prospect receives. Should the prospect pay more because you are terribly inefficient? Or, for that matter, should they pay less if you are very efficient, and can do the work in half the time of your closest competitors?

Unfortunately, “cost-plus” pricing is very common because it seems simple. You have some approximate view of your costs, you add a markup, and arrive at your price. This means that you will leave a lot of money on the table. (OK, there are true commodity businesses that have to price this way, but hopefully you are doing all you can to avoid being a commodity business.)

2. Your price is limited by your perceived differential value— so price based on that.
“Value-based pricing” is a hot topic in sales and pricing circles, because if you’re following rule #1, you don’t want to price based on cost. The next idea is to price based on value, which is the right idea, but be careful. Value is not something defined by your features. It is based on how you change the equation for customer. More specifically, it’s about how the customer perceives you change their situation, relative to the next best alternative. Your price is limited by your perceived differential value.

Let’s illustrate this with 2 examples.
In the first scenario, you have a customer with order errors that cost $1M per year (let’s assume for simplicity that this is the only business result the customer cares about— a gross oversimplification, but it helps keep the math easy). You can fix the problem for $250K, netting the customer $750K the first year, and $1M every year after that. However, you have a competitor who can also fix the problem, and offers to do it for $200K, making your perceived differential value compared to the status quo $750K, but compared to the competitor, $-50K.

Now, let’s say you have a similar situation, except the problem is worse, costing the customer $10M per year. You bid $3M. Your competitor bids $1M, but can only solve $8M of the problem. You are even after the first year, but every year after that, you make the customer an incremental $2M.

In the real world, the situation will be more complicated, but also less concrete, with a lot of hand-waving estimates instead of hard numbers. Moreover, many of our decisions are made with our gut, and then justified with our brains (was Stephen Colbert right all along?), so often the main issue to make sure the decision maker’s gut wants to select you, then make sure the math will work out in a way to make sure that passes rational muster.

How do you figure out how much value is at stake? How do you know the value of your competition? You have to start by asking a lot of questions. “Why are you doing this now? What’s the impact? What’s the impact of that?” Etc, etc. In addition, the most common and most wily competitor is usually the status quo, and you can uncover how you compare to the status quo with those questions.

Understanding the value, and having a shared framework with the customer is critical. If you have an ROI spreadsheet that promises 800% ROI in the first 2 weeks based on some optimistic assumptions and no cost inputs other than your fees (excluding training, change management, etc), no one will believe your numbers. Help the customer create the value framework. You can advise and assist. Remember, it’s perceived differential value, not asserted differential value.

Once you have your value framework, you can lay out the value case in your proposal. Then, present your price in terms of the value case. Often, this means ignoring hours worked, records migrated, and other cost-plus type metrics. If you can save the customer $1M in a year, you want to position your $250K fee against that $1M, not highlight that your top people bill at $350/hr. Earning a 400% ROI seems like a bargain. Hiring $350/hr consultants seems expensive.

3. Don’t lower your price to try to lower risk

Many SMBs competing against big companies think that lower prices will help. This is true if the buyer thinks the big companies are inefficient and you can get the job done more cost-effectively. This is not true if the buyer is concerned about your ability to deliver. In this case, a lower price does nothing to help your perceived risk, and that’s if your lucky. In many cases, the lower price serves as a proxy for value and increases the perceived risk. Discounting from your initial offer certainly does not diminish the perceived risk.

You want to be better, not cheaper. Keep in mind, you might charge $100K for a project that a larger firm would charge $200K for. That’s OK if you’re actually billing at twice their rates, but can do the job more efficiently. (However, in this case, shouldn’t you be worth more than $200K?)

4. Give the buyer options

In many cases, especially when selling services and solutions, the buyer doesn’t know exactly what they want until they see a proposal, and you can’t give the buyer what they need until you learn a bit more about them. You have to do a little dance. If you send a proposal with one solution and one price, you have 4 possible outcomes.

  1. You could hit it just right. You actually arrived at just the right solution and the right price. Congratulations. It happens, and it feels great, but be careful (more on that below).
  2. You are close enough that the buyer wants to work with you and you can discuss your way to a mutually satisfactory project.
  3. You overprice enough to get priced out of the deal entirely.
  4. You underprice and underserve the customer, leaving lots of money on the table. (Keep in mind that you may think you’re in bucket #1, but you’re actually here. I did this all the time— winning business and feeling great, only to realize later that the customer would have been happy to spend twice as much, or even more, for a more comprehensive solution.)

One way to avoid this problem is to give the buyer options.

Aim “up the middle”, based on what you know about the problem and the budget. Then do a “bare-bones” option, that strips away all but what you perceive to be the absolute essentials. Then do a “best solution” option that includes extra work and benefits. There’s no guarantee that any of these will be right, but:

  1. You’ll avoid getting priced out of the deal. If they don’t want to do the bare-bones option, they probably aren’t a good fit.
  2. You’ll get more discussions like “we really like option 2, but we don’t need the second line item, can we swap in the first line item from option 3? We understand it may cost a little more.”
  3. 1 and 2 mean you’ll win more deals.
  4. You’ll not only make more money from winning more deals, you’ll make more money per deal, by better matching up with what the customer really values. You avoid leaving money on the table.

Follow these 4 rules of proposal pricing and you’ll not only win more business and make more money, you’ll have happier customer and employees, because they’ll be working on what really matters (and you’ll be able to pay them better).

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