Interesting Pricing Scenario

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A student wrote in to ask the following question.  It was fascinating enough I want to share it with you.  All identities and industries are modified to protect the privacy of the actual situation.  Here’s the question:

Hi Mark, I’m wondering if you can assist me with something I’m struggling with. I’m working on a deal right now and trying to price it based on value but the customer is pushing back very strongly saying that it’s not worth the fee we’re trying to charge.

We’re a private B2B company. With our magic, the use of our product will allow this particular client to increase revenue in an area of their business from about $90k to $260k, without having to charge their customers any more money or to fundamentally change the way they do business; they do what they’re doing, charge their customers the same amount of money, yet they almost triple their revenue. We have built a compelling economic model, which they worked with us on, and which they agree will have a significant impact on their bottom line.

Our product is a license based service that will help them realize $180k in new annual revenue.  Using what I learned in the pragmatic marketing pricing course, I applied the 10% principal so our license fee should be $18,000 / year = $1500/month. Despite showing them a strong economic model, which they have said they agree with, they have only offered to pay us $2500 annually for a license.

I’m not really sure what to do now. They love the product, and want it.  We know the value that we add to them, but they are simply refusing to move off that number. We don’t want to walk away from the deal, but we’re also conscious that the value that we’re delivering them is substantial and they should pay a reasonable amount for it. No way we’re going to accept a $2.5k license, so we’re not really sure what to do.

Any thoughts/ideas/suggestions?  Thanks, Jason

Hi Jason,

From what you describe it seems you are spot on. Here are a few thoughts on what may be happening.

First, make sure this is a Will I? type product, meaning you have no competition. Assume for a second that your buyer decides to not purchase from you. What will he do instead? If the answer is nothing, then your thinking is correct. If the answer is purchase a competitor’s product or build something similar himself, then you’re probably not going to be able to capture 10% of the economic value you deliver.

Second, we have to make sure the customer believes the economic value we promise. You said your customer agrees with your numbers so that’s probably not the issue. But we will only get 10% of the economic value our customers believe they will get.

Third, although our costs don’t drive our pricing, often our customers think they do, or at least should. Your customer may be looking at what they think this costs you and don’t feel your price is fair. Alternatively, they may be looking at prices of similar (not competitive) products that are priced much lower. In these cases the buyer has a price he expects to pay and you are asking a much higher price. This is often very difficult to overcome. It may take a little time for the buyer to get used to your price.

Fourth, maybe your buyer is simply a tough negotiator.

Here are my suggestions.

1. Change the structure of your offer. In conversations, offer to give him the product for free and share the upside 50-50. This looks fair and is essentially free money to your customer. However, your customer will never go for it. The purpose is to get the customer focusing on how much of the upside he wants instead of how much he’s paying. (By the way, these incremental profit sharing plans are extremely difficult to enforce. You really don’t want them to accept it so don’t push too hard.  Instead, you are using it as a tool to make the 10% number look inexpensive.)

2. Be patient and walk away. In negotiations, patience pays. If you show you are anxious to close quickly, the buyer will not budge. If you look like you’re willing to walk away the buyer will likely move his price up. It would be foolish of the buyer to walk away from the additional profit you can deliver to him just to spite you because he doesn’t like your price.  If it appears the buyer walks away (which looks like a couple of weeks of silence) then you can always go back and accept a price closer to his offer if you want.

Oh, and you probably don’t want to just hold your price.  Find a reason to give a little to show you’re not unreasonable, but don’t give much.  Maybe a 3% discount.  It looks like you’re trying, but you don’t have room to go.

3. Offer a free trial period. If the implementation isn’t too onerous, the customer may be willing to try it out and then find out if the additional profits do appear. Then, when you go to take it away the decision becomes much easier for him to make. However, if the implementation is challenging, then the company may not want to invest that much of their own resources for the test.

Good luck,
Mark

And to close the story, here was Jason’s reply:

Hi Mark,  Thanks for writing back so quickly…  I really enjoyed my 3 days with you, and I appreciate you taking the time to help me out; I owe you a steak and a beer the next time you’re in my town 🙂

This is definitely a “will I” product and not a “which one”. Currently, we are the only company in the market with the product/solution we have (we’re patent pending!). Truth be told, the prospect (this one and all of our other prospects) didn’t even know they had the revenue leakage problem until we brought it to their attention. We have asked the customer what other solutions they are considering and he assures us there are no other solutions and if they don’t go with our solution they’ll just continue doing things as they have been doing.
Now that I say that out-loud, you bring up a good point. Despite them agreeing with our numbers, and there being considerable upside, they may still feel that paying $18k/year in licensing fees isn’t good value. Despite the revenue increase our product offers them, the optics could be that the value isn’t there (possibly because we make it look too easy to make them that much money).  And of course, they may also just be playing hardball.
My business partners suggestion was your first suggestion.  The problem is that he’s confident that they’ll go for that option. Implementation is a bit onerous (on our part), so I’m keen to avoid the 50/50 agreement and the free trial period.  It’s true that we would make a lot more money with the revenue share model but I don’t want to be on that sort of model; it gets messy fast, and in my experience customers have a habit of thinking that they’re quasi-partners in your product then, too, which makes life difficult.
I’m going to talk with my partner…  I think being patient and “walking away” might be the answer; people never want something until they can’t have it, and when they can’t have it, it’s all they want.  Maybe playing hard-to-get will get him moving on what he’s willing to pay.
Thanks for your help Mark; I’ll let you know how it goes.  Jason

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I think he’s on the right track.  Hopefully he will write back and let us know how it ends.

 

Photo by Leo Reynolds