How to Develop Pricing
Pricing can be the most challenging, and yet the most rewarding, aspect of planning.
Once your offerings have been well refined into clear solutions, the question must be asked, “What value does this provide to your customer?” This can be a difficult question to answer, but Tenato provides a clear methodology to determine it. Using market research, competitive intelligence, and our clients’ industry-specific knowledge, we can zero in on the pricing that will be most likely to succeed.
At Tenato, we have developed pricing structures for numerous types of businesses, and we approach the pricing strategy three stages. First, we design the structure of the pricing. Second, we set the level of the pricing. Finally, we determine how discounts and financing terms should be applied.
Tenato’s 3-Step Pricing Methodology
Step 1: Pricing Structure
The structure of the price is determined by your organization’s delivery method. For example, do you deliver the same offering each month, day, or year? Are you offering something that has a clear start and end point? Is your customer likely to hire you as once-in-a lifetime event, or might he or she be returning for repeated service? Good pricing structure will encapsulate the offering in a simple, intuitive manner, where the customers’ increased usage does not erode your profit margin. In addition, good pricing structure encourages more use from the client.
Typical structures are cost-plus, turn-key project, hourly/daily rates, contingency (results-based) pricing, flat-rated (retainers for availability) or a combination of these, but it is the ways in which these are applied that can make or break profit margins. It is also crucial to consider whether you will use a channel of distributors who will be entitled to their “slices” of the end-user price, and how you can protect their interests as well as your own. Detailed pricing analysis will also help to determine whether or not outside distributors should be used as a strategy to expand your business.
A final aspect of refining your pricing structure is to root out any untapped areas that are hindering your profit margin. Specifically, we examine valuable aspects of your offering that are currently being offered as “freebies” and find ways these might be addressed within the pricing structure.
Step 2: Pricing Level
Would you rather be asked the question: “Why are you so expensive?” or the question “Why are you so cheap?” The first question positions you to talk about the superior quality of your offering. The second question positions you to identify ways you’ve cut corners. It is surprising then that so many businesses are more comfortable undercutting their competitors.
When examining the level that your pricing should be at, we are really asking, “What is your offering worth?” That is, how much time or money does it save your customers, or how does it affect their risk or brand perception? The level of the price is determined by both the value your organization provides to its customers, and the pricing that your competitors are charging. The weight of these two factors depends on the extent that your offering can be differentiated, i.e. if your offering is highly differentiated then your ought to price more by value. If less differentiated, you may be forced to stay closer to competitor pricing.
Tenato uses a careful methodology to ascertain the value of your offerings, identifying both tangible (financial or time aspects) and intangible (trust, prestige, etc.) aspects. Once assessed, you may be surprised to learn how much money you are putting in your customers’ pockets, and how little of it you keep for yourself. This is the crucial element to thinking differently about your price.
That said, many clients still worry about competitor pricing, and where their level should fall versus competitors. At Tenato, we believe that a higher value offering should be priced above that of competitors, and that only a lower value one should be priced below its competitors. Even if you are launching an entirely new offering, this does not mean it could not be priced at a premium, assuming it is better than the offerings of competitors. While there are exceptions, under-pricing an offering of high value is usually leaving money on the table, and lowering future opportunities to expand.
Step 3: Price Discounting, Financing and Payment Terms
Many organizations make arbitrary decisions as to when and how discounts and financing terms are applied. Some good reasons for discounting include breaking into a new market (and needing the first client to be your “market spokesperson”), high-volume purchasing, non-peak season discounts, or great customer loyalty (and good referral sources). Less justifiable discounting can occur because of poor negotiation, a difficult client relationship, or simply grandfathering of a discount level that no longer has a supportable reason for being sustained.
Financing and Payment Terms are also important aspects of this process; for example, an especially expensive offering can be spread out through financing (and perhaps outsourced to a third-party financier), or sold as a rental-type service. In addition, early-payment discounts could be specified on invoices so that customers take notice to pay on time, helping to maintain margins. For example, you might raise a slow-paying customer’s price by 2%, and offer a 2% discount if payments are received before a specified date.
How do we determine the levels of discounts that should be applied? It is a matter of tagging a discount value to specific scenarios. For example, a new client “first trial” discount might be 5%, and an upfront cash payment discount might offer a 3% rebate. The “art” of this is to understand your margin in the overall process of developing the structure, and to ensure the discount values you choose are really worth what you intend to give. Many clients choose not to give discounts at all.
Regardless, at Tenato, we can help to build a more consistent discount policy (even if your policy becomes “NO DISCOUNTING”) to be applied by your sales or customer service teams.
Once pricing strategy has been determined, we move on to selecting your target markets.