Trust is the key to value-based pricing
Steven Forth is a Managing Partner at Ibbaka. See his Skill Profile on Ibbaka Talent.
Over the past few weeks, the Ibbaka Talent side of our business (the part that helps you to understand the skills you need to deliver on your value propositions) has been writing a lot about trust. Trust has emerged as one of the critical concerns as organizations emerge from the first phase of the pandemic and into the new normal. Does trust have a role in pricing? What is that role and how does a lack of trust impede pricing strategy?
My experience is that without trust it is almost impossible to execute on value-based pricing. Trust means that other people can believe that the claims we are making are based on evidence and that promises made will be kept. It goes both ways. Trust is most authentic when people trust the people who trust them. One should not expect trust if one is not willing to give it.
There is a set of nested trust propositions in value-based pricing. Before we explore these, let’s make sure we are talking about the same thing.
What is value-based pricing?
Value-based pricing is the setting of prices based on the differentiated value of an offer. To execute on value-based pricing, one has to create differentiated value, communicate this value to the market, deliver the value to customers, measure the outcomes so that value can be demonstrated and then capture a fair share of the value in price. Those familiar with the Value Cycle will notice a change in the order - we used to have ‘capture’ before ‘measure’ but to prepare for performance-based or outcomes=based pricing we are now putting ‘measure’ before ‘capture.’ Capture refers to the capture of your fair share of value being created in price.
This is a lot more to value-based pricing than customer willingness to pay (WTP). There are a number of consultants and software vendors out there who confuse willingness-to-pay with value-based-pricing. They are not the same thing. Willingness-to-pay is a situational variable, it changes all the time and can be influenced in many ways. It is dependent not only on value but on the ability to pay (I may want the fancy carbon fiber bicycle and understand its value, but I still cannot afford it). Willingness-to-pay is of no value as an analytical framework and claims to measure it should be treated with skepticism. What matters with value-based pricing is understanding the full value cycle and using this to align pricing and value with the customer experience. Doing this requires trust.
What is trust and what role does it play in business?
The basic meaning of trust is that we believe the claims other people make and are willing to act on them. If you say that your process will reduce errors I am willing to take you at your word and try the process (though my stance will likely be one of trust and verify). At a deeper level, we trust others to take actions and make decisions on our behalf, trusting that they will act in our interests. In some business, financial, legal and healthcare, there is a legal obligation to do this, a fiduciary responsibility or duty of care.
In business, trust is a competitive advantage. Trusted parties can make decisions more quickly. This leads to speed and agility. Teams with high trust tend to outperform (this has been confirmed in Google’s work on high-performance teams). The same is true of products, services, and solutions. Trusted products and providers are easier to buy and approve. One is willing to delegate decision making to providers and systems we trust. This is going to be increasingly important as AI makes more and more decisions for us. Whose AI will you trust to make good decisions and to act in your interest?
Trust in pricing
Trust plays three roles in pricing.
For customers, trust makes it easier to make buying decisions and to delegate certain actions to vendors.
For the salesforce, trust in claims made by the product marketing function can give sales the upper hand in negotiations and help them resist discounting pressure
For regulators, trust makes it possible to allow industry self-regulation (when this is violated as with the Boeing 737 Max, there can be huge long-term consequences)
Trust allows you to capture more of your differentiated value and leads to more pricing power. So how does one build trust? Here are five simple rules to follow.
Understand your customer’s business and how they create value for their own customers. Demonstrate this understanding in how you design pricing. Your pricing should track how you provide value and help your customers provide value to their own customers. This is the Understanding Value work that underpins the Value Cycle.
Stand behind your value propositions, provide evidence, do what is necessary to make sure the value is delivered. This is the Value Delivery part of the Value Cycle.
Keep lines of communication open, to build the two-way conversations that support trust. Remember that communication is two way. It is not just about you delivering messages to your customers and the market.
Design your pricing to reflect the value you deliver. Connect the value metric (the unit of consumption by which the customer gets value) to the pricing metric (the unit of consumption for which the customer pays). Avoid fancy behavioral pricing tricks that attempt to manipulate behavior. Pricing design is part of the Capture part of the Value Cycle.
Work with your customers to create value. Customers can play a key role in designing your solution, your pricing, your customer success practice.
Over the next decade, Ibbaka believes there will be a trend to performance-based or outcomes-based pricing. These are pricing models where the price paid is dependent on the outcomes delivered. In most cases, this will lead to higher prices, as today’s prices have an implied risk discount (buyers know there is a risk that the solution will not deliver the value promised and so discount value claims to reduce that risk). Executing on outcomes-based pricing will require trust on both sides. Buyers will have to trust vendors value promises and act on them. If they fail to act, they will fail to get value and the vendor will have to fire the customer. Vendors will have to trust that buyers will actually execute on the solution. Both parties will need to trust each other enough to share the data needed for effective execution.
Many people and companies will resist this. They will not trust their counterparties to honestly to act in their interests and will see great risk in doing so. The buyers and sellers that are able to build trusted relationships, and to change how prices are negotiated and paid, will have a huge competitive advantage. They will be able to make decisions faster, change course based on shared (trusted) data, and the value cycle will spin faster.
Ibbaka continues to research the most important pricing choices and how to make them.
What are we missing here? What pricing challenges are you facing and how are you addressing them?
Contact us at info@ibbaka.com
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How to hire a pricing consultant
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