What is the value of value-based pricing?
Steven Forth is a Managing Partner at Ibbaka. See his Skill Profile on Ibbaka Talent.
Value-based pricing emerged from the need to price differentiated products and services in the B2B context. Price optimization models based on simplistic economic theories proved inadequate for complex solutions with multiple stakeholders in the decision making unit.
The top 5 value drivers for value-based pricing are …
Align price to value - stop leaving money on the table
Negotiate on value - reduce discounting
Build features that drive differentiated value-efficient investment
Segment the market on value - target your best customers
Track customer lifetime value and value to the customer
Pricing is about a lot more than putting a number on a price tag. The key insight of Tom Nagle and the other people who created the discipline in the 1980s and 1990s was that there are two components to a price. There is a set of commoditized functionality where there are substitutes available and the price is set by market forces. And then there is a differentiated component, where each solution creates value for a customer (or set of customers) in a unique way. Market pricing will misprice this part of the value. The best explanation of this is in ‘Pricing the Differential’ by Gerard Smith and Tom Nagle in Marketing Management (May/June 2005) which I summarized in a post for LeveragePoint back in 2009 Are Value Maps Leading You Astray.
A good introduction to value-based pricing is Jessie Tai’s post What is value-based pricing?
The Value Cascade
Value-based pricing is used to design (rather than set) prices. It does this by first researching the differentiation value (this is done through primary research directly with customers). In the traditional approach, this is done by identifying and quantifying (putting a dollar value on) the economic value drivers. At Ibbaka, we have extended this to include emotional and community value drivers.
Once one understands the value drivers, which can differ by market segment, the goal is to find a set of pricing metrics that track value metrics. The pricing metric is the unit of consumption that a buyer is charged for; the value metric is the unit of consumption by which the buyer or user gets value. In value based pricing we connect the value metric to the pricinging metric and use this to build a pricing model. The pricing model comes before price setting. It is part of a complex adaptive system that is meant to evolve.
Value-based pricing began as a pricing framework, but over the past two decades applications have expanded, first to sales and marketing, then to product management and marketing and most recently to customer success.
We can use behavior driven development (BDD) to get a feel for the different ways that an understanding of value is being used by different business functions. BDD emerged from test driven development as a way to an agile software development process that encourages collaboration among developers, quality assurance testers, and customer representatives. By design it connects people across business functions, which makes it a good way to think about how value-based pricing and its related concepts connect different business functions.
One of the most powerful things that value-based pricing offers is a common language that people from different parts of the business can use to discuss value. Value is sometimes thought to be a mushy idea, but it is not. Value-based pricing gives us a way to have concrete, data driven, conversations on value. There is a standard taxonomy for value drivers, a way to define the economic value drivers as equations, which means that data can be gathered and ordered to quantify value in different situations.
Innovation leaders can use the value model to explore new ways to create differentiated value. Are we trying to improve existing value drivers (sustaining innovation) or to create new value drivers or deliver value drivers to new market segments (disruptive innovation)?
Product managers are responsible for creating differentiated value. Developing a value model as part of the product strategy is an emerging best practice. This also helps frame prices early on and build the data collection needed for the pricing model into the product or service.
Marketing leaders need to define market segments, select targets and then communicate value in order to generate leads. Value-based approaches give a formal way to connect all the pieces of modern omni-channel marketing together.
Sales leaders are responsible for selecting from the MQLs (marketing qualified leads) to create SQLs (sales qualified leads) and closing deals at reasonable prices (without an over reliance on discounting). Conversations about value are more productive than arguments about price and are more likely to lead to a close.
Implementation managers are accountable for delivering on the value promises made by marketing and sales. They are sometimes expected to do this without even knowing what those promises are! Documenting value promises so that implementation can deliver is a critical part of customer value management.
Customer Success managers are also responsible for value delivery. They are also responsible for cross sales, up sales and renewals in many organizations. To do this effectively, customer success needs to document value delivered as it searches for new ways to deliver additional value.
CFOs - value is the new mandate for the CFO. This began with the recognition that customer lifetime value (LTV) was becoming an important way to measure the health and value of a business. But LTV is just one side of the coin. LTV is dependent on the value delivered to customers (value to customer or V2C) and V2C needs to be larger than LTV. Progressive CFOs are leading the drive to formalize value analysis.
CEOs and board members are accountable for strategic direction and growing company value. Value models and the data collected and organized through these models provide the insights needed to provide direction and sense emerging business issues early.
Procurement managers. The procurement manager! You may be surprised to see procurement here. But leading procurement managers care about how the goods and services they contract to drive competitive advantage for their companies. They can use value-based approaches to choose vendors and make sure the supply chain is supporting differentiation strategies.
Value-based pricing and customer success are coming together to create the new discipline of customer value management. Ibbaka Valio is intended to support this transition, and make customer value management a reality.
Implement Customer Value Management with the Ibbaka Value Pricing Dashboard
What is the value of value based pricing? (this post)