How does your IT firm calculate its product or service price?
Often salespeople feel that pricing is a key impediment keeping them from hitting their quota.
This is a misnomer for many who believe that lower pricing means always-greater sales. In fact, this hypothesis is not supported by business studies.
Pricing, as a selection criteria, falls below technical competence, service and support, vendor’s understanding of a company’s need, and past experience with vendor based on research by Getronics, IDG Research, and CIO Magazine.
Let’s take a look at how some firms determine their pricing structure.
11 ways firms calculate their product or service pricing:
- Use a competitor’s price as a benchmark to set their price
- Use price points (drop the price) to increase market share penetration
- Use price as a marketing tool to break into a new account to “create a relationship” that will generate additional revenue after the first sale
- Use cost of labor as a benchmark and then mark up gross margin based on some mathematical projected profit model that includes corporate G&A costs
- Write off all of the development or cost of labor costs, calculate all revenue as gross margin, and set price with no costs of goods
- Price the product on an inventory spin model to generate more gross revenue by “turning” your inventory faster (i.e., selling more product faster)
- Use a bundling model by tying multiple product options with service options to hide actual segmented pricing
- Create value pricing where price is based on the business value and how it affects the buyer’s ability to increase income or decrease expenses when the product or service is deployed
- Create price based on Return On Investment (ROI) calculation for the buyer
- Use a profit-driven price model where each deal is individually reviewed to determine its overall profitable contribution
- Last, but certainly not least… just guess (I don’t recommend this but it seems to be pretty popular.)
Let’s look at three of these methods:
- Pricing based on competitor’s price benchmark;
- Dropping price to get market share; and
- Dropping price to “start” a relationship and generate more revenue on the back-end of the first sale with a prospect.
When we look at these three methods, we observe they are short-term action steps that never truly help a firm become more profitable.
Pricing based on your competitor’s sales price never works because it ignores your firm’s operational costs and assumes that your business costs are the same as your competitor’s costs.
Market share pricing only helps firms who already have a monopoly and restricts company profitability.
Discount pricing to launch a key account relationship is a common practice but recent studies conflict with this pricing approach. Of particular note with regard to this method, past studies by Walker Information show that 1 out of every 2 buyers do not plan to buy from the same vendor again and are unhappy with their business relationship.
So, all of the prospect negotiation techniques of cutting your price to start a relationship are just that… negotiation tactics.
What is the right pricing method for profitability?
For most firms, it is going to be a combination of the first 10 methods.
The key to the correct pricing model is focusing on how you bring value to your prospects’ purchase while balancing your firm’s cost of business. The incorrect pricing model is, of course, number 11.
“You win customers by quality rather than price.” —Jean Ridley