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The price is right

Written by Josh Russell on Thursday, 03 January 2013. Posted in Financial management, Finance

Once upon a time, pricing products and services was comparatively easy. But now, making sure you’re giving the right price involves a lot more thought

The price is right

Pricing your products or services isn’t as simple as pulling out a pricing gun and covering things in sticky labels. Knowing what to charge and how to approach pricing is becoming increasingly complex, with competing companies often charging wildly different figures for their products and solutions, meaning that developing an appropriate pricing model for your enterprise can be a bit of a struggle. Which is why it can help to have a little expert advice to cut through the treacle.

While it’s a complicated area, there are a few simple guidelines that will always apply. “You can never see pricing as disconnected from your product, your technology and what you’re doing,” says Christian Lanng, CEO and co-founder of invoicing platform Tradeshift. It may be an incredibly appealing option to pull a Facebook, making your service free to the end user and generating all of your revenue through advertising, but is this really appropriate at a stage when you have limited traffic and need rapid liquidity? Often what is needed is an awareness of the how pricing models build in sophistication and complexity.

The European Pricing Platform (EPP) is an international knowledge-sharing platform, aimed at sparking conversations around pricing and profit-optimisation management. President Pol Vanearde believes the key focus must be around what they term the ‘pricing maturity level’. “We have explored different kinds of industries and companies and we’ve seen four different levels,” he explains. The first level is cost plus – looking at how much the product or service costs them, the organisation simply adds a margin, largely based on comparing prices with the competition. Level two is about improving the profit this makes and beginning to make use of available transactional data. “The company tries to optimise its portfolio in order to sell the right products to the right customers at the right price,” says Vanearde. “They also try to find margin improvement and start margin improvement projects.

“The next step is trying to get full value capturing,” he continues. “You start to move on from cost plus.” This third level is when an organisation truly prices its products based on their value to the consumer, rather than on their cost. At this point, price improvement requires more of a dedicated journey than simple improvement measures. “It’s a real change process to develop the pricing maturity in the organisation.” Lastly, the fourth level involves not just considering your revenue streams as a mere result of your pricing, but actually considering the structure of the whole revenue model in relation to the ways you can price your product. “An example is Michelin, which no longer sells tyres outright and, instead, is being paid per tonne carried, per landing or per kilometre,” says Vanearde. “These are the kind of new revenue models that are linked to new pricing models.”

Easy enough to say but all of this requires a huge amount of knowledge about your current revenue streams. Patrick Schneidau, vice president of product marketing at big data analytics firm PROS, puts the enormity of this task into context. “The average-sized company may have 5,000 customers, they may sell 200 products, they may sell through two or three distribution channels including their website,” he says. “That’s three million different combinations of pricing and selling decisions that need to be made.”

This is obviously an overwhelming amount of data to work through and when using more traditional, rule-based pricing models, companies often found that it was almost impossible to keep track of such a detailed picture. “Companies started to build up all these business rules around pricing and it just got too complex for any one person to understand how all those rules affected profitability,” Schneidau explains. “You have to take a step back and say: ‘There’s got to be a way to handle this complexity.’” Which is where EPP’s journey to develop pricing maturity comes in, allowing companies to begin to approach their pricing in more sophisticated, granular ways. Schneidau remarks: “It’s important to use the data to understand the market from a customer point of view, using value-based pricing and giving specific price points to specific customers.”

But where do newer models fit into this? Technological innovation is reciprocally driving revenue innovation forward and providing new systems, such as the recent trend in software to work on a ‘freemium’ model. “Freemium became really big two years ago,” says Tradeshift’s Laang. “The idea is that most users can start out for free and later they can pay if they want more services.” But while, like many an innovation, it has caught organisations’ imaginations, it is a mistake to let its novelty blind you as to whether it really is the most appropriate model for your solution. As with all models, the freemium model has both positives and negatives and these need to be taken into account. Laang points to one of the model’s major flaws. “You’re locking away those features that you think will make your user pay behind a paywall,” he explains. “Suddenly you’re taking the best part of your applications, that should make users love and use your product regularly and locking them away.”

Ultimately, one of the aims of getting your pricing model right is going to be making your organisation competitive. However, this isn’t really just a case of undercutting your competitor’s, prices – instead you need to consider how much value your customers are going to place in your individual provision. “You really have to think truthfully how your pricing model and the way you’re disrupting the market align with the value of your business,” says Laang. This is something Scheidnau concurs with. “A lot of companies underestimate the value of the relationship, of the service they give, of their differentiated product capabilities,” he remarks.“While you want to take in some of the competitor price information, it shouldn’t be the sole decision criteria out there.”

 

The models

Simple & scaleable

Joanna Swash, sales & marketing director at Moneypenny

What we do is answer the telephone for lots and lots of businesses, ranging from small one-man-bands right up to big multinational corporations. Where we’re different is we give companies their own dedicated Moneypenny receptionist. For me, the issue of pricing is key because you’re trying to keep everyone happy along that scale.

There are an awful lot of people in the marketplace who win business on price but we just don’t want to be seen as playing in that field. What that leads to then is a very clear cost price model, so that the customers are very clear, right from the outset, what their pricing will be. There are no hidden extras. There’s no surprise when they get their invoice. It’s all scaleable and very much based on the call volume.

 

Two-sides to every market

Christian Laang, CEO and co-founder at Tradeshift

In our space, which is the electronic invoicing space, the dominant price model for the last 20 years was that the supplier would pay for it and the buyer would pay very little. But that doesn’t work for anyone. You’re buying a solution because you want suppliers to switch from paper to electronic invoicing, but the business model was built in the way that you’re in essence fining the people whose behaviour you want to change. What we went in and did is, we said: ‘We make it free for suppliers and make buyers pay.’

It’s a two-sided market model, where you get one party to subsidise the cost for the other party because it’s in their interest. What Google has done with search is a very clear example of a two-sided market model because it has advertisers who will pay for Google running a service to another group of people. We’ve found it’s in the interest of the large buyers and large organisations to subsidise billing and invoicing software for small companies for free because that means they can get electronic invoices rather than paper ones. It’s a model that really works. 

About the Author

Josh Russell

Josh Russell

As editor, Russell is the man in charge of properly apostrophising our publication and ensuring Oxford commas are mercilessly excised. Our digital doyen, he’s also a Photoshop Pro, a dab hand with InDesign and the man to go to if you need a four-hour soliloquy about the UK's best silicon startups.

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