Finance & Operations

10 Steps to a Better Pricing Model

June 20, 2011

Doing pricing well means developing a price model that balances your financial and strategic needs with those of your customers within the markets you serve. Pricing is about more than just a “number.”
Getting the pricing model right is all about the price structure and details.

The problem is that too many companies work on their pricing models at the last minute. Many times the person responsible for pricing is a product manager who has little time to focus on the task and may even be the least experienced person on the marketing team.

The result is predictable: the price structure doesn’t scale with the value created and the price levels are not in line with the value a customer gets. Most of the time price levels start off too low, which means lower sales and the need to raise more capital.

Pricing mistakes can be fatal for early stage ventures and executives. Developing a good pricing model requires experience, insight and wisdom, and implementing one takes all that and courage.

So what can you do?

Here are 10 tips to help improve your chances of establishing a successful pricing model:

  • 1. Learn your customers’ business — Make sure your product and service offerings create value for your customers. This involves learning what drives your customers’ economics. Once you understand how customers make or save money with your offering, you can develop a pricing model based on value.
  • 2. Set price structure before setting price levels — Pricing is a complicated problem that needs to be attacked systematically. You should get a consensus on price structure (what you charge for, license types, packaging, standard discounts, etc.) before working out the details of price levels and deal pricing.
  • 3. Charge appropriately for value delivered.It’s important to document the financial impact of what your customers consider valuable. Make sure your marketing and sales people can make the case for this value in every customer encounter so that you are able to justify (and get) the highest appropriate price for your products.
  • 4. Develop standard discount policies. Standard discount policies can guide salespeople when they have to discount. Don’t give away your discount dollars willy-nilly, and avoid across-the-board, deep discounts unless you are sure volume will increase to offset the lost revenue or margin. Cutting prices usually attracts price-sensitive and service-intensive customers.
  • 5. Run the numbers carefully. Before launching your prices, make sure you have run a detailed “what if” model to assess the revenue impact of proposed prices. Break customers into groups, estimate the revenue impact of price structure changes, and model each group’s sensitivity to price changes and assumptions about usage.
  • 6. Make pricing easy to understand. There needs to be logic to your pricing that is easily explained to your customers by your sales force. Make the logic simple and compelling so customers can quickly understand the value they will get. Customers won’t buy it (what you’re offering) if they don’t get it (your logic).
  • 7. Make pricing easy-to-use.Organize prices and volume/standard discounts into a short price book that sales can use (or that customers can use if you publish pricing). You should organize prices according to customer usage and tie usage scenarios to product configurations so it’s easy for customers to understand what they need (and then order it).
  • 8. Change prices as a last resort. If sales aren’t ramping as fast as you expected, look for other ways to acquire customers before changing prices. Make sure price is really the issue and not something else like inertia, perceived risk, packaging or what you are charging for. Ask why people didn’t buy. Don’t settle on “your prices were too high” – go deeper.
  • 9. Make customers earn discounts. Give customers additional discounts when volume targets are achieved. Do not give significant volume discounts in advance since customers may not meet their commitments.
  • 10. Don’t negotiate price only. Include more than just price in the negotiating process. Consider payment terms, timing of deliverables, service charges, no-charge items and services. Remember, deal structure can be just as important as the amount of a deal, and not all deals are worth doing.