From willingness to pay to ability to pay (managing pricing in a time of uncertainty)
Steven Forth is a Managing Partner at Ibbaka. See his Skill Profile on Ibbaka Talent.
For the past few weeks we have been having many conversations on how one should respond to the Covid 19 crisis and adjust one’s pricing to shape, rather than react to the market. We have been doing this through conversations in person (well, on video), project work with our customers and through two surveys. Some initial results have been shared in this post on OpenView Venture Partners. The two surveys are still open.
What pricing actions are you taking in response to the Covid 19 crisis?
This survey will stay open until the end of April .
For those who need to go deeper, and pause to reflect on how the future will impact their pricing choices, explore this survey.
What scenarios are you planning for? Building a pricing action portfolio.
One of the most popular concepts in pricing is Willingness to Pay or (WTP). Many software packages or consultants will tell you that they can calculate your customer’s willingness to pay and use that to set prices. At Ibbaka, we are a bit sceptical of this, as WTP is the outcome of many other things rather than something one should attempt to measure or manipulate directly. See What shapes willingness to pay and What is the distribution of your Willingness to Pay curve?
What happens when willingness to pay collides with ability to pay? Or when there is compelling community need that transcends either. This is happening to many of Ibbaka’s partners today. Willingness to Pay is not really an issue. A customer in the emergency management space has seen demand and willingness to pay soar. But at the same time, hospital systems are severely constrained in their ability to pay, at least for the moment. US hospitals especially are seeing their ability to pay decline rapidly as resources are sucked up by the need to respond immediately to the Covid 19 crisis. To get some insights into this, read Healthcare Industry Briefing: Long-Term Predictions and Impacts of COVID-19. What should a supplier do in this situation? There is one bad response (destructive of long term value) and two good options.
Cut prices to reflect current ability to pay
Offer deferred payment terms until the worst financial impacts of Covid 19 have passed
Provide a free option until the worst financial impacts of Covid 19 have passed
Cut prices to reflect current ability to pay
There are industries where this makes sense, such as fast moving consumer packaged goods or food products. For most B2B categories though, this is a very bad idea. The price cut is very likely to get frozen into the market and frame prices for years to come.
If you have to do this, do it with a stripped down, bare bones offer that you are willing to remove from the market once the crisis has passed.
Offer deferred payment terms
This is the best response for most B2B companies whose customers have seen customer ability to pay collapse. This is why it is important to distinguish willingness to pay from ability to pay, especially when the change in ability to pay is temporary, as we all hope it is with Covid 19. Failing to distinguish willingness to pay from ability to pay can lead to bad decisions that will haunt you for a long time.
Provide a free option
There are many reasons to provide a free option, especially in the Software as a Service (SaaS) and subscription economy. There is a new one in the current circumstances.
Typically one provides a free option for one of three reasons
To drive awareness and consideration (in this case the free offer is generally fenced by time or functionality
To feed a viral business model (more on that here)
As part of a two sided market
There is now an additional reason. To accomodate ability to pay.
This is especially important at present. Our research is showing that buyers are placing more weight on community value drivers. Value drivers come in three categories, economic, emotional and community - the relative weight of these changes when a market is under stress. Some initial research on that here.
One option that some companies are taking is to provide some core functionality for free, at least for a period. An example of this is Github, “Github is now free for teams” although in this case Github is saying they will keep this functionality free.
One option for our customer in the emergency management space is to provide its mission critical platform free for six months or a year. In this case, the investment after the free period is passed should be negotiated up front. Set clear expectations about price and value.
In today’s market, we need to seperate willingness to pay from ability to pay and address both. Build future willingness to pay through investments in your community that recognize their current ability to pay.. But don’t compromise long term willingness to pay with with shortsighted discounting or price cutting.
