People sometimes ask me “how should I price my product?” so I Googled it. I found a LOT of blog posts about pricing. A surprising number recommend “cost plus” pricing. How much does it cost to make your product? How much do you have to sell it for to make money? They say “Sell it for more than that.”
It’s well known that “cost plus” pricing doesn’t work for enterprise software. In fact, it doesn’t work for most high value products of any type.
The alternative to “cost plus” pricing is “value-based” pricing. A few people recommend this. And then they don’t say much about what that means.
Let’s explore this idea a bit more, and see what we can learn.
Of course, the customer cares zero, not one iota, NOTHING, about your problems with making money. OK, they might care a tiny little bit if they want you to be around to support them. But they don’t care very much. It is not their problem if you make money or not based on choosing the wrong pricing.
But customers do care about something. In so many words, the customer has a problem. The problem is costing the customer some amount of money or time or business friction. They are looking for a solution to that problem. Your product may provide a solution to that problem. That’s what the customer cares about – solving a problem.
The first rule of pricing is:
Your product must cost less than the problem costs the customer. No customer will pay more to solve a problem than the problem is costing them.
Corollary: If your product doesn’t solve a problem the customer needs to solve, it cannot be successful.
But the customer has other concerns, not just about the price of your product:
If you put all these customer concerns together into kind of some math, you get the following inequality:
V > P + R + M + C
The customer will only buy your solution if:
The value (V) the customer gets from your solution is greater than the price (P) of the solution plus the risk factor (R) that the solution will or will not work plus the cost of migrating (M) to your solution plus the opportunity cost (C) of not using that money to solve some other problem.
I call this the “Value Inequality.”
To buy your solution, the value the customer gets (solving the business problem) must be greater than all these costs combined.
And to make your sales easier, strive to ensure the value the customer gets from your solution is MUCH greater than the price of the solution. (In math terms:
V >> P + R + M + C
As product managers we have some control over all the terms in that inequality. In the next installment I’ll give you concrete ways to get this inequality working in your favor.
In the meantime, here are three things you can do today to start using these ideas.
I’d love to hear your feedback on this idea. Have you used a model like this for pricing?
Your host and author, Nils Davis, is a long-time product manager, consultant, trainer, and coach. He is the author of The Secret Product Manager Handbook, many blog posts, a series of video trainings on product management, and the occasional grilled pizza.
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