This blog post kills three birds with one stone.
First, I have been serving on an internal team at Sage regarding pricing and the ideas found in this book will help this team. Second, Ron as me in January to write about the most impactful book I read in 2008. While I would not have written about this book then, but upon reflection it has been the book that has influenced me the most thus far in 2009. Third, I have an email from Amazon.com dated March 14, 2008, asking me to write a review. Talk about procrastination!
Executive summary (and Amazon.com review)
Reed Holden and Mark Burton’s Pricing with Confidence makes the complex topic of pricing strategy understandable and usable to businesses of all industries and sizes. Many of the examples are easily transferrable from one industry to the next. Their approach is logical and rational and can be adapted to a sole proprietor with an entrepreneurial idea to the largest of companies. The only thing, I severely disliked about the book was the poker analogy which runs throughout the book. Business, unlike poker, is not a zero-sum game. I understand the analogy they are trying to make, but, in my opinion, it detracts from the overall value of the ideas presented.
Important ideas in the book
Develop and offer options. Having at least three options with different value propositions positions the organization to make fewer concessions during negotiation. When a prospect balks at price you can always direct them to a lower cost, but lower value (to them) option. Companies should establish a “walk-away” price for your lowest priced option. This assists in making sure you do not take on a bad customer.
Create a good “fence” between options. A fence is the way to protect one option from the other by providing a clear trade-off of price and value between the options. Well developed fences will make sense for both the customer and provider. The most utilized fence strategy is bundling. When you bundle, if a customer asks for a break down, you should explain that while you could provide that for them, the overall price will be higher.
Setting price is one of the most difficult decisions leaders and managers can make. The strange thing is they often delegate it to others including allowing competitors to be a large influence on price. Price competition (price war) can only work during the high growth phase of a business’ life cycle. At any other time, price competition is never a sustainable business model. Lowering price is the least sustainable competitive advantage.
If you discount to meet the numbers, you will inevitably kill your long-term profitability. It should not come as a surprise that few businesses (if any) have ever created a long-term profit strategy around discounts. Discounting demolishes the self-esteem of the sales force to the point that they themselves begin to question the value of the very products and services that they are selling. This is poison to an organization.
Business must focus on creating greater value for customers. Companies that focus on value, in dollars, delivered to customers are more profitable. Talking about anything other than real financial value is just noise.
Great new term: discount creep – the propensity of a company to begin discounting for good reasons and having it then become systemic. If you must discount by all means measure it. Holden and Burton suggest creating a “discount bucket” that is only allowed to be emptied over a certain predetermined time period.
Pervasive discounting is usually a function of poor customer selection. The authors cite a study which says that 79 percent of business-to-business companies respond in some way to all prospective customers. Going further they posit that there is not just an 80/20 rule for customers but a “20-225 rule.” 20 percent of customers account for 225 percent of the profit. Yes, kids, this means that 80 percent of customers account for a 125 percent loss.
There are only three, count ’em, three, pricing strategies: skim, neutral and penetration. Skim only applies when you are clearly differentiated from your competition. Chances are, unless you are Apple, you are not clearly differentiated. Neutral pricing is used when you want to compete on something other than price. Penetration pricing is used when you want to establish a dominant position in a new market place.
There are four, count ’em, four, buyer types: price, value, relationship and unknown (OK, they call these guys poker players, but I dismiss the analogy). Aside from the poor term, the book is worth reading just for this deeply developed idea.
Most companies think they sell to price buyers, they are sadly mistaken. The following sentence clearly excludes all professional knowledge firms from thinking they deal with price buyers – “Price buyers are very careful not to let themselves get committed to any particular supplier by making sure they have no switching costs.” Emphasis added. This is clearly not the case for professional knowledge firms. If all of your customers look like they are price buyers, it is because your sales force is not establishing trust during the sales process.
You need to be paid for your high value knowledge as soon as you begin providing it. The trouble is usually some demonstration of knowledge is needed to get you in the door. Their suggestion is to set a minimum price for knowledge.
A great strategic question for a company to mull is “What can will do (other than discount) that would force our competition to react?” Answering this question is not easy, but it does get to the very heart of innovation.
I thoroughly enjoyed this book and looking back on it has made me realize what an impact it made on me. Many of the ideas listed above have come to the forefront in my coaching conversations with Sage partners. It is clear that this book will continue to influence my thinking for years to come.