In response to the entry on the services pricing pentagon, a frustrated salesman in a product company contacted me. His question was simple:
“What do you do when the competitor drops their pants on price?”
I like it. A simple, direct question on pricing strategy. If only service pricing discussions resulted in simple, direct answers.
When a salesman starts discussing how competitors are poisoning deals with low ball pricing, I think the first question to ask them is what is the viable pricing range for the deal?
A viable pricing range for any service engagement is bounded by two extremes:
1. The most a customer would be willing to pay for a service
2. The least compensation you would be willing to accept for the service
The top and the bottom of a viable pricing range are determined by two of the five variables found in the pricing pentagon: cost and value. The top of the range is determined by how much value the service actually brings to a customer. Not many customers will pay you more they perceive the benefits to be worth. The bottom of the range is determined by how much it costs you to deliver the service. The image below shows the viable pricing range for a service offering that delivers $50,000 in benefits to the customer and costs $25,000 to deliver.
The image makes it obvious to me why pricing services at a product company is so difficult. Product sales reps and customers alike prefer fixed pricing. Yet, how many service organizations have a clear sense of what it costs to deliver some of their more complex services and solutions? Complex projects start with project estimations and the final cost is driven by the actual effort required to deliver the final solution. Next, how many service organizations can define and defend the true business value of their service? Without these two lines firmly in place, the service organization can be very handicapped when trying to determine pricing in general. Now, add an aggressive competitor and the situation becomes more complex.
When a competitor brings a lower price to the customer, the service organization must decide what extreme of the pricing range they will attack. Either the response will be focused on differentiating the value of purchasing the service from you or the response will focus on reducing the cost structure to make the bid more competitive. The worst possible response to competitor low balling: reducing the customer price without reducing the cost structure to deliver. The quickest path to a crappy project margin!
So, back to our very direct sales rep. I asked him what path made sense in his case. Could he define the additional value his company delivered and hence justify a higher price to the customer? Or, would he focus on restructuring costs to make the bid more competitive? His response:
Well, we are delivering the same thing as the other guy. The problem is, our delivery costs are almost twice as much. I can’t lower the price without losing money on the deal. What do you recommend in this type of scenario?
You know, there is no magic pricing pixie dust I am aware of that wins deals when you offer the same exact value at a higher price. As Peter Drucker pointed out, it is not your customer’s responsibility to make sure you achieve your target margins. Needless to say, my direct sales rep friend was not happy with my direct reply.