Your pricing model needs a value model
Steven Forth is a Managing Partner at Ibbaka. See his Skill Profile on Ibbaka Talent.
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Most companies have moved away from simply setting a price to having a pricing model. A price is a number that you charge. A pricing model is a system with several interacting parts. Why do we need pricing models?
Most offers today package together a set of different functions and services together with data. Function + Service + Data. These are at the heart of today’s solutions. Pricing these solutions requires that all of the different pieces be taken into account and connected to each other. The pieces and how they are connected are the pricing model.
As simple example is the tiered pricing seen in many SaaS offerings. Let’s look at Quickbooks as an example. Here is there pricing page (accessed October 11, 2020).
Here we have four packages, each with different functionality, aimed at a different buyer persona. The buyer persona are signalled by the package name, you are a ‘small business’ or a ‘freelancer’ and if you are a small business you may have different needs. These packages and the prices are meant to be looked at together. There are a few subtle things happening here. Each price acts to frame the others. One would probably not change one price without changing the others, and each package has a role to play. The distribution of pricing is concave, which is often seen in companies that are targeting a large addressable market. In this sense it is a system.
Quickbooks has a fairly simple pricing model but a lot of thought has been put into it. Underneath this model one would expect to find further modelling on how many contacts convert into each tier, by volume and revenue, and the conversion model from tier-to-tier. With such a model, one can begin to optimize revenue and tune the packages and their pricing.
Is this enough to really succeed with pricing? No. There is nothing in this model about value to the customer (V2C). Value-based pricing has to begin with value. This is not willingness to pay (WTP). WTP is used as a proxy for value by people who have not bothered to do the hard work of understanding the economic, emotional and community value of their offers and used this value information to segment their market and target customers.
Before you build a pricing model you should have a value model. What is a value model? It is a lot more than a list of value propositions. The idea has its roots in the work of Tom Nagle, the father of strategic pricing and the main author of The Strategy and Tactics of Pricing, now in its Sixth Edition. The approach taken by Tom Nagle and his collaborators is Economic Value Estimation(TM) or EVE(TM) (the trademarks on these terms is held by Deloitte). An EVE model is focussed on the economic value. It takes the price of the next best competitive alternative as a baseline, adds the positive value drivers and subtracts the negative value driver (the unique costs of using your solution and your solutions’ shortcomings relative to the alternative).
Some organizations use Return on Investment as a proxy for economic value. This tends to be less powerful than EVE as it does not put factor in the alternatives.
Today, a value model will also consider non-financial value, emotional and community value. These value drivers can also be quantified and they set the context for how people will perceive price.
It is not enough to have a value model and a pricing model. You need to be able to connect them. This is not a vague ‘hand waving’ kind of connection. The same value drivers that you use to quantify your value model should be part of your pricing model. If you already have a pricing model (if you have a price you have some sort of implicit pricing model), do this simple test.
List your pricing metrics
List your fences (the ways in which you limit access to tiers or guide people into the tier that best meets their needs)
See if you can build a value model based on your existing pricing model
Can the pricing metrics be used as value metrics? (Can you use your price to estimate value?)
Are there pricing metrics that do not help you to understand value?
What additional metrics do you need to add in order to get a credible value model?
If you are like most companies, you will struggle to build a value model from your pricing model. There will be some pricing metrics that you cannot connect to value. There will be some value metrics that you are not using as pricing metrics.
The first is bad. Pricing metrics that do not connect to value should be scrapped. The second may be fine. There are generally at least five-to-seven different value metrics and there is no need to use them all in your pricing. You don’t want your pricing to get too complicated. In general you want to have no more than one-to-three pricing metrics.
Keeping your value model and pricing model separate but connected helps you manage value and price across the customer journey. This is why we advocate layering value into your customer journey map. A connected value and pricing model also helps the different business functions align around pricing.
Solution development (whether you call this product development, service design, or something else) develops the initial value model and connects it to use cases. This is passed to marketing and used to organize the market and construct marketing messages and campaigns. This value model is used to develop the pricing model used by sales. In a pure online sales model, marketing will likely be responsible for the pricing model. In a high touch sales model, the sales team will want to control pricing. There is often a chasm between sales, implementation and customer success. Value promises made by sales are not communicated to implementation. One of the most important jobs of customer success is to make sure that the customer is delivering the value promised and that value to customer (V2C) is greater than the price paid.
Feedback from customer success is critical to the ongoing evolution of the value and pricing models. Pricing is not once and done. The same is true of value. It is dynamic and changes with market needs. Customer success has some of the best data for evolving your value and pricing model.
Ibbaka can help you to develop a value model and connect it to your pricing model. An Ibbaka value calculator will help you to formalize your value and pricing model, give you a way to collect and analyze data, and then align all business functions around delivering value to the customer.
You can download the Strategic Choice Cascade for Pricing template here
Ibbaka is providing these downloadable tools under a Creative Commons license.
Attribution-NonCommercial 4.0 International (CC BY-NC 4.0)
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