August White Paper 2/2016: Is Value-Based Pricing Right For You?

IS VALUE-BASED PRICING RIGHT FOR YOU?August Whitepaper

VALUE-BASED PRICING WHITEPAPER BY AUGUST JANUARY 2016 2

Many B2B companies now agree that setting their prices solely on costs or competitors’ prices is a good way to leave a lot of money on the table – anywhere from 3 to 8% in unclaimed profit. To prevent that leakage, more and more companies are now trying to set prices based on the customers’ point of view. Whether they call it “customers’ willingness-to-pay”, “customer value propositions” or “value-based selling”, the basic idea is the same: narrow the gap between the value the company creates for the customer and the amount it earns for the offering.A number of Finnish companies have now made value-based pricing a key strategic focus area. For example, Neste, the oil refining company, has publicly announced a plan to increase its customer focus and provide its customers with more differentiated offerings. Kemira, a chemicals company, has gone through a successful transformation from being product-driven to a customer-centric organization. Many engineering and capital goods companies, such as Cargotec, have also focused recently on developing their value selling capabilities. Is value-based selling for you? Some companies have succeeded with their value-based selling campaigns, but many more have failed. Embedding a value-based selling mindset as part of the sales culture is not easy, despite all the advances in analytics, and for some businesses, it may not even be desirable.

IS VALUE-BASED PRICING RIGHT FOR YOU?

Some companies have succeeded with their value-based selling campaigns, but many more have failed.


Value-based sales attempts fail for many reasons. Sometimes the sales team overestimates the product’s value to its customers, and refuses to see that their offering has no real differentiation from their competitors’. The market may be shrinking, reducing the margin of surplus value. The product may also be too simple and intuitive to be appropriate for a value-based sales approach. Value-based selling (defined here as a deep understanding of the customer’s perceived need and the capacity of the offering to fulfill that need) is best suited to the sales of complex and tailored solutions. Some companies have tried selling standardized (or even bulk) offerings using value-based selling practices and tools, but this is a challenging proposition. Typically customers buying standardized or bulkier offerings are unwilling to work with the vendor as intensively and deeply as value-based selling practices require.This does not mean that sellers of standardized or bulk products cannot find pockets of additional value. For offerings with these characteristics, dynamic price management, as described in Figure 1, may represent a better choice:

Dynamic price management involves understanding customers’ price elas-ticities (i.e. the change in demand after change in price) and optimizing the prices accordingly. It shares the same goal as value-based pricing – capturing customers’ willingness-to-pay – but takes a different route to get there.

IMPLEMENTATION IS TOUGH

There is always “willingness to pay” to be captured

Types of business / offering:

Customers’ willingness to pay estimation:

Value selling approach:

Bulk, undifferentiated

Complex, tailored solutions

“Grey zone”Market data analysis Business case, conjoint

More dynamic price management Value based pricing

Figure 1: Framework for capturing customers’ willingness-to-pay


Whether the company chooses value-based pricing or dynamic price man-agement, the first step is to determine customers’ willingness-to-pay. For either kind of value selling analysis, the three most popular methodologies to uncover that number are “stated preference”, “revealed preference” and “customer business case analysis”.

Once the seller has a solidly researched estimate of the customers’ will-ingness-to-pay, the next step is to determine the best approach to apply that information to the sales process. Depending on the kind of sale, the two best approaches are likely to be value-based pricing or dynamic price management.

GETTING A GRIP ON CUSTOMERS’ WILLINGNESS-TO-PAY

• Stated preference (i.e. ask customers): Giving your customers a survey is the most direct way to uncover their willingness-to-pay. Typical survey types include traditional mail or online surveys with multiple questions sent to selected respondents. More sophisticated survey methods include conjoint analysis, which can be a good way to understand customer preferences regarding completely new offerings, but may require some training to use and interpret.

• Revealed preference (i.e. observe customers): Conducting experiments and analyzing existing market data is another good way to estimate customers’ willingness-to-pay. However, this method will not work for new offerings: existing market and sales data presupposes an established and easily defined market.

• Customer business case analysis (i.e., think like customers): Perhaps the most popular route B2B sellers take to quantify their product’s perceived value is to analyze the performance of their customers’ current processes and estimate the value their solution would bring to their process. Calculating a customer’s busi-ness case is perhaps the least ‘scientific’ of the methodologies, but it may be the easiest to apply to a wider range of circumstances (e.g. in selling tailored solutions).

Willingness to pay estimation

Value driver analysis

Product feature analysis

Stated preference (ask customers)

Revealed preference (observe customers)

Customer business case analysis

(think like customers)

Adapted from Breidert et al. 2006: ‘A review of methods for measuring willingness-to-pay’

• Expert judgements

• Customer surveys

• Conjoint analysis

• Discrete choice analysis

• Lab experiments

• Field experiments

• Auctions

• Market data

• Consumer panel data

Direct surveys

Indirect surveys Experiments Observational

data

Figure 2: Different means to estimate customers’ willingness-to-pay

“Embedding a value-based selling mindset as part of the sales culture is not easy, despite all the advances in analytics, and for some businesses, it may not even be desirable.”

5VALUE-BASED PRICING WHITEPAPER BY AUGUST JANUARY 2016


The value-based pricing process usually consists of:1. Identifying and understanding what drives the customer’s perception

of value2. Quantifying and communicating your solution’s value to the customer3. Generating that value for the customer and capturing a fair share of

the value createdSuccessful value-based pricing requires a clear, detailed understanding of the customers’ willingness-to-pay. It also requires the company to design the offering, sales capabilities, and overall customer management approach around those willingness-to-pay insights. As value-based pricing is typically conducted in a multi-stakeholder setting, the seller should identify the key stakeholders along the customer’s decision journey, and then pull the right levers to maximize value for each stakeholder. Traditionally, companies selling complex solutions do this by determining the next best competitive alternative for the customer and then comparing it against their own. The idea is to show that the company’s solutions add more additional value than the available alternatives:

VALUE-BASED PRICING TO CAPTURE CUSTOMERS’ WILLINGNESS-TO-PAY

Value

Next best competitive alternative

Offering’s positive

differentation

Offering’s negative

differentation

Total economic

value

Depending on the customer’s case, value (or price) can be determined by e.g. per process output, hour, transaction

Sum of value drivers (e.g. increased revenue, decreased costs)

Relevant expertise across org. should be utilized in quantifying value

Customer’s costs associated to the offering (e.g. switching costs)

Value (or price) of differentiation

Reference value (i.e. NBCA)

Figure 3: Typical value-based pricing approach


Value-based pricing usually works best if the seller and customer have a long-established, mutually beneficial value chain collaboration relationship (or are otherwise committed to working together). Established collaboration makes it easier to share knowledge and data, build more determination to gaining mutual business benefits, and ensure continuous business and capability development on both sides of the table. Sellers must carefully determine and select which customers are worth the effort of establish-ing a value chain collaboration, and which of the smallest customers are non-strategic, and not worth the effort.Successful value-based selling initiatives can be found in the capital goods industry. For example, elevator and escalator company KONE has empha-sized customer centricity and differentiation in order to accelerate growth in its maintenance business. KONE’s value-based selling approach can be summarized into four steps: 1. Understand customer needs and competition 2. Define the offering to customers3. Deliver on the promise4. Verify with customers that they believe the value proposition has been

delivered. By following these four steps and using digitalization to improve the customer’s experience and level of engagement, KONE has succeeded in fulfilling its stated aim of “delighting the customer” and maintaining a “passion for performance.”A global chemicals wholesale company offering solutions to various in-dustries has also systematically practiced value-based pricing for years. Value-based pricing has worked well for this company for a number of reasons. First, the level of differentiation of the company’s solutions com-pared to competitive alternatives has been regularly reviewed to ensure that solutions’ value drivers are truly meaningful. Second, the company has focused on further developing its sales tools all the time and main-taining a dialogue between marketing and sales in order to communicate the value to the customer in the most efficient way. Value selling has also been high on the senior management agenda, so executives have kept sales capabilities up-to-date through continuous training and coaching. Finally, the company has successfully implemented value-based pricing early on in the solutions’ lifecycle, capturing the customers’ full willingness-to-pay in the absence of good competitive alternatives.Successful examples of value chain collaboration can be found in the retail sector. Some consumer packaged goods (CPG) and fast-moving consumer goods (FMCG) companies have established formal collaborations with certain retailers to increase the efficiency of the whole value chain from assortment development to distribution, marketing, and sales. These collab-orations are prime examples of practical (and well-functioning) applications of value-based pricing. The CPG company’s business case to the retailer includes reduced complexity in retailer’s shelf product assortment that makes distribution more efficient, in-store operations more streamlined, and promotional spending and activities more targeted. At the same time, the CPG company will also benefit similarly from manufacturing and managing a narrower assortment of products.

Successful value-based pricing requires a clear, detailed understanding of the customers’ willingness-to-pay.


Broadly speaking, dynamic price management refers to setting the “right” price for every customer, for every product, and in every channel. Dynamic price management is based on analyzing historical market and sales data to model customer behavior and forecast future customer demand. In other words, the goal is to look at past price deviations for clues about what the market will bear at a given point in the future. The key phases in dynamic price management are illustrated and described briefly below:

Traditionally, dynamic price management has been most popular with businesses that sell perishable goods or have clear capacity constraints, such as the hotel and airline businesses. Today, however, an increasing number of B2B industries find they can benefit from dynamic price management. Other clearly established B2B markets that provide commoditized or “no-frills” offerings, such as chemicals, steel and logistics, have now found advantages with dynamic pricing. Customers’ priorities (e.g. demand, needs) and market dynamics (e.g. competition, capacity situation) will nevertheless evolve over time in these industries. By closely watching the

DYNAMIC PRICE MANAGEMENT TO CAPTURE CUSTOMERS’ WILLINGNESS-TO-PAY

1. Collect data: The data necessary to execute dynamic pricing includes for example historical sales, demand levels, prices and inventory levels. Any other pertinent information on the market should also be incorporated into dynamic price management approach.

2. Segment market: The heart of dynamic price management is the segmentation of customers into mi-cro-markets. Customers can be segmented according to their preferred distribution channels and purchas-ing frequency, for example. A successful customer segmentation will find price elasticities in a number of distinct segments.

3. Forecast demand: Based on these elasticities, analysts forecast future demand per product or service for every customer segment at selected price points.

4. Optimize: Dynamic pricing can be used to maximize profit, revenue, customer loyalty or market share – or some combination of these four goals. Analysts develop algorithms that codify customers’ price elasticities and dynamically generate new prices that optimize the company’s objectives, sometimes even at the level of the individual transaction. The calculation engine used to generate these prices is typically either built or bought, depending on the level of sophistication necessary.

Collect data Segment market Forecast demand Optimize1 2 3 4

Figure 4: General dynamic price management approach


evolution of these priorities, sellers with more adaptive pricing can maintain the maximal value in every situation.Dynamic pricing can be used for virtual goods as well. For instance, an IT company faced multiple challenges related to loss of sales, eroding margins and high cost-to-serve. It lacked a good grip on its customers and was clearly losing its pricing strength, especially with respect to its smallest customers. The company implemented a price optimization software package and simultaneously adopted a more dynamic price management approach. First, managers segmented their customers into three distinct categories based on their opportunity size, and second, they defined a sales model for each of the segments. Using advanced analytics, the company set the best possible prices for deals in each category. Not only did dynamic price management raise profit margins, it improved the sales staff’s motivation and drive because they now had more concrete and useful sales tools for price setting.Beyond its advantages for bulk and established offerings, dynamic price management can be useful in situations with high capacity change costs, helping sellers wring the most revenue out of the available capacity at any point in time. Although the benefits are clear, so are the practical chal-lenges companies face when trying to apply dynamic price management: Maybe the largest challenge in price optimization is deriving solid price elasticity estimates. As this usually requires a lot of analytical firepower, many companies may see it as an impractical alternative. But through careful planning, this analytical capability can be developed over time.

An increasing number of B2B industries find they can benefit from dynamic price management.


MAKE THERIGHT CHOICEAs the examples mentioned above show, value-based pricing and dynamic price management are suitable in different contexts. To decide whether either approach would suit your offering, you should:1. Compare the cost-to-serve of your offering against the price you ulti-

mately get to see where value may be leaking.2. Evaluate alternative approaches to plugging the identified leaks. Bench-

mark your sales and pricing model against your competitors’, under-stand the importance of your offering in the customer’s processes, and evaluate the available competitive alternatives to your offering.

3. Evaluate the gap between your current sales and pricing capabilities and the defined target state and determine what competencies you need to add.

4. If those competencies can be filled profitably, apply the improved sales and pricing models.

These four steps are only the beginning of your evolution toward becom-ing a value-based selling company. Now, you will need to follow-up the execution of the sales and pricing models, measure the additional value captured, and then continue adjusting and enhancing the sales models.Ultimately capturing more of your customers’ willingness-to-pay depends on refreshing your sales and pricing strategy and enhancing your sales capabil-ities. Whether you try value-based pricing or dynamic price management, you will need to ensure that your organization is equipped for the task. Beyond acquiring particular competencies, the organization also needs to work together as one. Sales, marketing, and product development should share information and knowledge with each other about their markets and their customers. Understanding the customers’ willingness-to-pay demands close cooperation. Every unit needs to collaborate to tailor the best possible solution for the company’s customers, and ensure that the maximum value continues to be captured throughout the offering’s lifecycle. But before you begin any of this work, be sure think through whether value-based pricing or dynamic price management is the best choice for you.


Markus Valoaho is a partner at August. He has 16 year experience in consulting – topics in commercial management agenda being in the core of that. He can be reached at [email protected] Martikainen is an associate manager at August. He is a spe-cialist in commercial excellence related topics such as pricing, key ac-count management and sales steering in general. He can be reached at [email protected]

About AugustAugust is a leading management consulting company in Finland. We ad-vise our clients on a broad range of topics, including Strategy and M&A, Operations, Sales and Marketing, and Organization. Our team of more than 20 professionals includes a strong mix of experienced seniors with an extensive background in consulting and young talents with outstanding academic records from top universities.

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August White Paper 2/2016: Is Value-Based Pricing Right For You?

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