Why are companies struggling to adopt Value Based Pricing?
Karen Chiang is Managing Partner of Ibbaka. See her skill profile on Ibbaka Talent.
I will be leading a conversation on this theme at TSIA Interact with Laura Fay, who is TSIA’s Vice President for XaaS. It is going to be an interesting exchange that will get to the roots of why and how companies struggle to adopt value-based pricing. If this is an issue for your organization, you will want to attend.
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I admit that we are biased at Ibbaka. We put value at the core of each of our interactions. When it comes to pricing, we almost always recommend value-based pricing. Value and monitoring its delivery to customers and stakeholders over time is critical to driving engagement and building trust. Given our point of view, Ibbaka frameworks, methodologies and tools will put value at the center. We begin with understanding value, specifically differentiated value (value relative to the alternatives), and use this to inform market segmentation, customer targeting and of course pricing design.
Let’s first recap the different approaches to pricing as summarized in the table above:
Cost Plus pricing is typically used when your client controls the deliverables. We often see cost-plus used in professional services. I think back to my days where we were delivering custom software projects and we would look at the cost of our team and target a range for profitability. This was not an easy business model to scale and it was often difficult to truly understand all the input costs. I also found that this approach undermined the value and differentiation that our team could bring to the table. The buyer would solely look at the dollar value rather than the outcomes that they would get as a result of working with us. The customer would discount value that could be measured in terms of economic value (efficiency gains, speed to implementation, risk reduction); emotional value (peace of mind, making an impact as a result of innovating faster); or community (elevating and raising the bar of their community domain). The benefit is that profit is better ensured and cost plus is seemingly well understood.
Market or Market Following is a good approach in that, by nature, you are responding to the market. But you are doing so as a follower. Again you are prone to leave value (money on the table). It is passive in nature. Just like other non-value based approaches, you are at risk of devaluing your offer. And if one is not careful, taking a market following approach can lead to the initiation of a price war. Price wars serve no one and can erode the value of entire markets and industries. We see the use of market pricing mostly being applied to the commodities space.
Input based pricing also is a response to the market and for it to work you need to be able to demonstrate understanding of your market and customers. Input based pricing operates in a world of unpredictability. Unpredictability for both you and your customer. Also, we find the market here is highly sensitive to external factors. Utilities and energy are examples of inputs. Within the technology space, opportunities to create value have opened up with the advent of innovations and inputs such as processing power, storage or data transfer have disrupted business models and pricing levels.Outcomes based pricing is what many organizations need to strive for. Outcomes based pricing or performance based pricing is where the pricing world will eventually evolve to, but this will take many more years. The holy grail that outcomes based pricing promises is the ability to truly track value delivered and consumed and to have evidence on which to price based on measurable performance goals. Value-based pricing is a precursor to outcomes based pricing. You will not get to outcomes based pricing without the discipline, data and understanding created by value based pricing. Also, you need to be able to collect and monitor the appropriate data to measure the efficacy of value delivered and captured.
Value-based pricing as its name implies is rooted in value. It is the most flexible in achieving your pricing objectives. For a useful guide to build alignment in your pricing objectives, consider using our Strategic Choice Cascade for Pricing Tool. Value-based pricing works especially well in cases where your offerings are differentiated. For it to be effective, you need to understand how you are delivering value from the perspective of your customers. You will need to really understand your customers’ business and make investments to stay informed.
Our research shows that despite the benefits of value-based pricing, companies are still lagging on implementation and execution. Corporations are failing in value-based pricing and are therefore not maximizing their opportunities to transact. This is a topic that Laura Fay, VP & Managing Director, Offers Research and Advisory, and I will be exploring during TSIA Interact. On October 21st, we will be discussing why it is difficult for customers to identify and connect value metrics to pricing.
In working with our customers, Ibbaka has discovered four main barriers that have prevented organizations from implementing value-based pricing.
Accepting Frozen Accidents. Companies have chosen to default to their traditional models of pricing. We often hear, “This is the way our organization has always priced and we haven’t had the need to question it.” Most of the time, there is an underlying assumption that staying with the status quo will be fine. Unfortunately, businesses can be caught off guard and may find themselves having to react to pricing pressure rather than shaping their pricing dialogue.
Dependent on the maturity of your pricing execution. TSIA has done a lot of research in the area of the lifecycle of pricing model applications. As your pricing confidence increases and you look to drive pricing potential you are better positioned to adopt value-based and outcomes based pricing. Your firm may not have the maturity to get to value based pricing.
It needs to start from value-based segmentation. Unfortunately, many businesses still solely rely on firmographics to define segmentation rather than defining their segments on value. Without this clear connection of value to determine your value metric (the unit of consumption of your offering that tracks value created), it makes it very difficult to link this to a solid pricing metric (the unit of consumption of your offer that is used to price). Not having this clear mapping makes it difficult to not only position your pricing but to also defend your pricing.
But let’s face the true barrier to implementing and executing on value-based pricing. Many businesses do not have the capability and skills to do this. See our report on Skills for Pricing Experts to learn more. On top of that, we see instances where pricing is established on gut reaction because organizations or those responsible for pricing have no formal framework or approach. Specifically, for value-based pricing, many businesses do not know how to quantify or think about value.
I am personally very interested in understanding why organizations are challenged to adopt value-based approaches throughout their customer journey, from marketing to sales through customer success. What have been the objections and barriers you have faced or struggles you have had in implementing value-based pricing? Conversely, if you have implemented value-based methodologies, what are some lessons you can share with others looking to do so?
