What to consider when your pricing needs a pricing strategy?
Like many others, one of the energy technology company’s I worked with did not really have a clear-cut pricing strategy. It had their way on how to price their quotations, of course. But to a large extern pricing was dictated by their global customers.
Management realized that the margin challenges they were facing was partly due to pricing. Time has come to agree on a pricing strategy.
- Do you recognize yourself pricing your products mostly on pre-calculated margin expectations?
- Are you ready for a pricing strategy that support your sales growth and your margin growth?
Crossing the chasm, i.e. focusing sales growth on the majority of sceptic customers in contrast to like-minded early customers, has challenges. The need for a pricing strategy is certainly one of them.
“We target a 30% gross margin in sales and use this to calculate our quotations. For the last to year’s however, our company gross margins have been in the 25 – 27% range. That is too low for a healthy cash flow and we need to consider other pricing options.” (The founder of a European tech company with $70 million in annual sales)
In this guide I will shortly answer above two questions. I will give you guidance on how you can develop a somewhat more elaborated pricing strategy.
Read more what makes a good sales strategy.
Focus on early sales growth often leads to price discounts
Your early sales to your early adopters are relatively straight forward from a pricing point of view. Believe it or not.
Beyond sharing your ideas and showing interest in a solution, most early stage customer’s need to know that their purchase makes financial sense. That is usually a one-off ROI analysis.
In the early startup years focus is on sales growth. Meaning lead generation and quotations trying to land more sales.
After a while however, most entrepreneurs realize that their focus on sales and product development are not enough. As the business grow and gets more complicated, so is delivery. Hence also the ability to operate at a healthy margin prompting the need to focus on pricing, operational excellence etc.
Traditionally early stage entrepreneurs make a backward calculation of the needed price to get to their targeted price quotation. Sometimes with a small mark-up if the market so allows but more often closing their deals with a discount. The curse of a salesman is his and her eager to close the sales. In particular in your early entrepreneurial years. To give in on the price is not uncommon, and often a necessity in the course of negotiation a sale.
Soon however, you will realize that you will need a more elaborated pricing strategy. For two reaons:
- Your year-end margins will not be enough for a healthy sustainable growth cash flow.
- As you’re about to be crossing the chasm from early adopter customers to the vast majority of sceptic customers, pricing strategy becomes key to close new deals profitable.
Now, let’s dive into what to consider when your pricing needs a pricing strategy.
Why the vast majority of customers care more about pricing than your early adopters customers
What you experience with your early stage customers is different from what you will experience with the majority of customers. A majority of customers will be sceptic, pre-occupied and drag their feet in your negotiations. They are not as naturally curious as your early adopter customers.
You’re likely to be drawn into purchasing processes than you may not have experienced with your early stage, early adopters. The vast majority of customers are not driven by likeminded innovation ideas. They look for productivity, efficiency and maybe new features or end-of-life replacements.
Not being as eager to jump on new products these customers also tend to be more skilled in their negotiations. At least they tend to use their purchasing process and negotiation skills more deliberately than most curious early adopters.
It’s here where pricing comes in. Doing your entry sale, you will be challenged on your pricing. Most likely you feel the pressure for price reduction should you be able to close your deal.
As you will learn, your margins risk getting much thinner than before targetting the majority of customers in your market space.
In particular larger enterprise customers tend to be much tougher negotiators and more price sensitive than smaller early adopters. It may sound contradictory considering the higher values and benefits at stake at larger enterprises. It originate from internal budget processes, delegated decision power limitations and price focused purchasing teams.
To get a foot in the door of an enterprise sized customer is challenging. Very challenging. Beyond references, relevance, relationship journeys, quotations and negotiations, you will get squeezed on pricing. That’s the price you will pay to get your foot in the door.
This is where pricing strategy play’s a role. To get you the deal and to get you the margins you need.
Pricing strategy basics
A majority of customers are hard sales. The relationship journey takes time. Years in many cases. Once your inside thought, a new world opens. This is the core of most pricing strategies.
Most successful entrepreneurs and CEO’s testifies that ones on the inside of your customers, customers are much less likely to hard ball you on pricing, as long as you deliver value.
You should split your pricing strategy into entry sale pricing, getting the foot in the door, and your contribution pricing. The margin you lose in your entry sale needs to be recovered once inside your customers. You do this pricing and invoicing your change orders, revisions, consultations, training and up sales.
- Your entry sale will be heavily scrutinized and price pressure is real. Price to win the deal.
- Once on the inside with your customers, you shall aim for customer success and nurse additional sales that will get you your margins.
Once you’re on the inside and have delivered customer success, your customer becomes less price sensitive. His or her willingness to pay will be high as long as you deliver value and convenience. This is the core to a growth strategy and any successful pricing strategy.
You’re most likely aware that new customer sales are harder than nursing and upselling your existing customers. You have a platform for up sales and healthy sales margins as long as you deliver customer success and value.
The key take away I try to deliver in this guide is that successful pricing strategies often include a somewhat lower entry sales margin, with margin recovery coming from higher priced additional sales.
A common challenge amongst entrepreneurs is not only to price up sales differently, but to actually invoice all additional services. It’s important. This is where you shall make your profits.
The two core principles of a successful pricing strategy
Once you have made your entry sale, usually with prices that’s suppress your margins, you need to focus on customer success and deliver value. It’s now that you make a real impression on your customers. It’s time to prove that you’re worthy to become a trusted partner, beyond those early sales arguments.
The core of a successful pricing strategy is to find, invoice and earn your margin on a additional sales. Many entrepreneurs celebrate their new customers not realizing it’s only the start of earning your cash flow.
Here are the two core principles of a successful pricing strategy with a majority of customers, not least enterprise customers:
- Price to close your entry sale with new customers. In reality you will not get your target margin at your entry sale. You should instead focus on a truly value creatiing delivery and customer success to nurse a deeper relationship.
- Find additional delivery opportunities once on the inside and price those to earn your targeted margins. In plain text: Now it’s time to step up your pricing to recover and earn a higher margin.
As you probably realized from above pricing strategy, it’s also fundamentally important that you have targeted the right customers. The once that have up sale potentials.
These are the up sales potentials to improve your sales margins
Now, once on the inside delivering your service or product you will likely experience the following additional delivery potentials.
- Change orders, revisions or alternations is as common as the law of physics when delivering technical equipment and systems. Make sure to invoice these change orders. Make sure to use your targeted margin (that is likely higher than your margins in your entry sale).
- Consultations not discussed and formally agreed in your initial sales contract shall be invoiced in addition to your sales. This can be a bit tricky. Normal questions and clarifications is often deemed to be part of the initial sale but anything beyond that shall be defined as consultation. Make sure to describe this in your initial sales contract. And do use your targeted margin once you invoice these consultations.
- Training is an excellent up sale with the chance to recover and earn targeted margins. Offering training of additional customer staffs 6 -12 months after delivery is often well received.
- Additional users or systems can be a way to earn additional revenues. Higher margins and relatively less sales efforts compared to your entry sale are clear benefits adding users or systems.
Remember, above examples are not only additional deliveries. These are up sales.
Train you engineers, your delivery organization and your operations colleagues to recognize these additional tasks as important up sales
It’s very common that these kinds of additional services get delivered but not invoiced. Changing the way salespeople, delivery organizations and operations think or act is important if you like to grow profitable.
4 common pricing methodologies for your pricing strategy
Early sales and up sales pricing differentiation is core to pricing strategies. Once you get to that point, there are also a few pricing methodologies to develop as your business grow:
- Cost plus pricing adding a mark-up on your costs. The most common starting point for startups. You may however miss customers purchasing power and hence margin opportunities.
- Comparative pricing means matching your pricing with the competition. Common amongst of the shelf products and services, less common with complexed systems.
- Value base pricing based on how much value your customers believe your products or services is worth to them. A more sophisticated and more profitable pricing methodology. Product market fit is important as well as enough reference orders to understand the true value creation.
- Entry pricing is somewhat similar to what this guide is about. The difference is that entry pricing is often referred to when your low-ball your self into a market only to raise prices later. Your risk being unprofitable for years to come. Raising prices sustainable often requires you to have become the market leader.
Value based pricing is often the most profitable and attractive pricing method to strive for. However, you need enough references and a deep understanding of your customers situation to have a convincing price offer. The challenge is often to prove the value you add to the customer. In particular in your early sales journey.
Fact based pricing machine – you need to follow up your delivery orders
Another common challenge amongst early stage companies is lack of financial control. Focus is on sales, product development, operation and logistic. To most entrepreneurs, finance often equals payables, statuary accounting and periodic P&L and cash flow reports.
You need to find a balanced way to budget and follow up on customer projects. That way you will know if you lose quoted and budgeted margins on poor performance.
The delta between quoted margins and actual accounted margins can be found in delivery and operations. In how your colleagues think and act. You need to follow up and analyze to improve your operations and adjust your pricing strategy for higher actual margins.
In finance terms customer follow up is called segment reporting. Your mandatory segment is your legal statuary accounting, i.e. your company accounts. As your business advance, you should add segment reporting such as customer reporting and geographical reporting.
It does not have to include the full P&L, balance sheet and cash flow. The customer segment reports need to include revenue, gross margin and operating margin per customer segment or customer. If possible, you shall also report stock, accounts payable and accounts receivable per customer segment or customer to understand cashflow.
Pricing strategy becomes massively more effective if you start to follow up your delivery on customer level. At least you shall follow up on customer area level.
Knowing cost of product sold and hours spent on each customer gives you an understanding of your margins. And I tell you, in almost all cases I have seen, actual margins are lower than quoted margins and targeted margins. You don’t want to miss on up sale revenues and margins.
Constant following up on your deliveries makes your behavior and pricing strategy fact based. That’s how you start to improve your actual margins.
Dynamic pricing strategy will be your next level advanced pricing methodology
The ability to reset prices and price targets in real time is often referred to as dynamic pricing. A key price optimization feature if you sell catalogue type B2B equipment or services.
If your delivery is complexed technical systems dynamic pricing often means the way you optimize between entry sales margins and up sale pricing and margins. As we have discussed in this guide.
Other types of dynamic pricing strategies are price differentiations between regions, countries or customer types. As your business grow, you will need to spend more time on pricing strategy. It pays off and is often the difference between losing or winning deals, profitable.
Do you recognize yourself pricing your products mostly on pre-calculated margin expectations? Are you ready for a pricing strategy that support your sales growth and your margin growth?
I have addressed these two questions in this guide and hope if finds you well.
Pricing is difficult. No least since it involves how salespeople, delivery people, operations and customer support think and act. It’s easy to forget to invoice on services made and not explicitly agreed upon.
Pricing strategy can also be boring and pushed forward unless you start to realize it’s actually quite interesting. It’s much more than setting numbers. It’s about scope of delivery, up sale potentials and how the entire organization think and act.
Crossing the chasm for larger sales beyond those early adopters definitely introduces the need for a pricing strategy. It’s too easy to price as usual not understanding the pricing dynamics with the majority of customers.
The secret to better margins with a majority of customers is the change orders, consultations, training and other up-sale potentials. It is with up-sales that you make your margin with larger enterprise customers.
Pricing strategy becomes an extreemly valuable art once your targeting sales increases beyond your early adopters.
I hope you enjoyed this guide. Good luck.