B2B pricing strategies feature/March 2008/B2B Marketing magazine/Sue Tabbitt

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Pricing is one of the fundamentals of marketing. Pinpointing the optimum sales price for a product or service can have a vast influence on its success in the market. But how scientific a practice does this need to be?

It depends who you talk to. Take a formal marketing course and you may be terrified to deviate from accepted wisdom; ask an entrepreneur and they may tell you they stuck their finger in the wind for their reading of what customers might or mightn't accept. There's also an inescapable need to test the market, so businesses usually have to allow for an element of trial and error, and be prepared to adapt and refine before they find the number that works.

Getting the pricing right in your own business is something few outsiders can do for you. Experts can help you test the market, research competitive positioning, and apply theories that have worked in similar scenarios, helping you hone your strategy until you fall within an acceptable safety margin. But they can't guarantee a magic price that will cause sales to rocket and market share and profits to flow your way.

Whole theses have been devoted to the subject of best-practice pricing. For example, a chapter on the subject can be found at http://www.cim.co.uk/MediaStore/pdfs_services/Pricing%20for%20Profit%20Chapter%201.pdf on the Chartered Institute of Marketing's web site. This comes from the book, Pricing for Profit, by Colin Coulson-Thomas, head of the 'centre for competitiveness' at the University of Luton. The book is dripping with academic advice, uses terms like 'econometric modelling' and makes the whole process sound very mathematical.

But what if you're more of a gut-feel business, and want to throw caution to the wind and try something new? New approaches to pricing are emerging all the time, and organisations that refuse to leave their comfort zone risk having market share torn from under them as their rivals adapt from readily to the way customers want to buy.

Several strong examples exist in the IT industry, where forward-thinking vendors are always thinking laterally to find new ways to create budget among business customers.

For example, free software has challenged the traditional world of software licensing. So too have alternative delivery models such as the increasingly popular pay-as-you-go hosted software model, which encourage companies to treat business applications not as a capital asset that will depreciate over time, but as a utility they pay for each month, without the burden of being responsible for its upkeep.

Customers may end up paying more for the functionality overall, but many don't mind, as this comes from a different part of their budget, and the costs are predictable and manageable - and can be stopped if the software is no longer needed. As software becomes more complex, and technologies pace of development accelerates (creating risk of early obsolescence), businesses like to know they aren't going to be lumbered with an expensive product that's holding back their progress. Pay-as-you-go models mean they can upgrade relatively easily as technology moves on.

Removing the perceived risk from a customer is a major marketing challenge. This has led many industries to introduce try-before-you-buy promotions, and no-results-no-fee offers. While these aren't pricing strategies so much as marketing strategies, their results say a lot about the impact of removing barriers to purchase.

Leeds-based B2B marketing company, Perfect Marketing offers a service on the basis that, if it doesn't produce results, the client doesn't pay. Its subsidiary, Results Based Marketing, specialises in generating B2B sales appointments and leads for clients.

To ensure that the service isn't abused, the agency chooses its clients carefully. A three-month testing period, paid for by the client, enables multiple approaches to be tested (telesales, email marketing or direct mail, or a blend). Once an optimum approach has been determined, the client is moved over onto a '100% risk free' marketing model, where they don't pay anything unless an agreed service level is achieved.

"This works both ways - if we over-achieve, we get rewarded financially over and above the agreed rate," notes Jamie Hutchinson, RBM's managing director.

The strategy works too. "Generally we find we convert 86% of our own sales meetings now, compared to 32% previously, as clients are much more comfortable," he says, adding that a similar approach would work well in PR, "where, traditionally, huge monthly retainers are often paid regardless of results," Hutchinson notes. Indeed, the model could apply to any B2B industry where customers traditionally pay for time rather than a product.

Where competition is intense, the pressure to find new pricing models is at its keenest. Take the afore-mentioned PR industry. Here, agencies seeking to differentiate themselves from the masses, and lure clients by proving the worth of their services, are increasingly thinking outside the box on pricing.

Jenna Gould, who runs a small PR agency in Norwich called Media Jems, launched a 'pay as you go' PR programme last year and claims this has sparked great interest among customers. "Very few PR agencies offer Pay As You Go as it can mean high efforts for lower returns, and tends to be charged at a percentage of the relevant advertising cost, which may still be very expensive," she says.

For creating press releases, the firm charges a flat fee for copywriting, then a flat fee for distribution, regardless of who it goes to. A short-term press monitoring service is also offered as standard within the price. When trying to up coverage by getting clients mentioned or quoted in relevant magazine articles, the firm charges a flat PAYG fee for the administration involved in getting the client in front of the journalist.

"These options give business clients who are on tight budgets, or who are sceptical about the value of PR, to test the water and try out some proven PR strategies without having to commit to an ongoing fee," Gould explains. "It works from a branding perspective too, making me accessible to more businesses through referrals and recommendations."

When you're selling a service, it's easy to be creative and flexible with pricing, but what if you're trying to cost a physical product?

Someone with strong views on the subject is marketing guru and author Robert Craven. His strongest message to B2B organisations is not to be afraid of scaring away 'cheap' customers - those that choose their suppliers based primarily on cost.

In his book, Kickstart your Business, Craven gives an example of a company with a 30% growth margin that wants to attract more customers. It is faced with two choices - drop its price by 10%, or increase it by 10%. The thought of pushing up prices in a competitive market can be frightening, but Craven argues that any customers that defect are those that are not worth keeping.

"These are the pond-life, the customers that shop around on price - you don't need them," he urges. "If your service and value-add is good, the rest will stay. If you put your prices up, you can afford to lose 25% of your customers and still maintain the same amount in your back pocket. If, on the other hand, you drop your price by 10%, you're going to have to work much harder just to stand still. Don't be a busy fool!"

These sentiments tie in with a general trend towards 'premiumisation', where vendors are switching focus towards higher end products that appeal to customers prepared to spend a bit more for better quality. This signals a growing acceptance that the high-volume commodity business is a hard slog with increasingly little reward. (Fortunately, this realisation coincides with the fact that, very slowly, even customers are recognising that cheap products and cheap vendors are bad news.)

Craven maintains, then, that the best approach to pricing is to aim high, rather than risk giving your products and services away too cheaply. "The market is very honest," he notes. "If you're really charging too much, people won't buy from you." Price yourself too low, and customers might doubt your credibility."

When it comes to services, Craven concurs that moving away from selling 'time' is the way to go. "This encourages people to work slowly and relationships tend to deteriorate," he says. Fixed prices fit more comfortably with firm's budgetary constraints, and leave the customer feeling they've had better value for money, enhancing loyalty and encouraging closer relationships. (Customers tends to stay away if they feel every call they make or meeting they attend is charged for.)

Money-back guarantees (eg if a job isn't completed with seven days, or if the customer isn't delighted with a seminar), or offering to be paid as a percentage of what you save a client, are other ways to improve relationships and make customers more confident about buying, Craven notes. "American-minded businesses often double the money back, to show how convinced they are that their product or service will work for the customer."

If businesses want to maintain margins on their products, while appearing to offer customers improved value, they can make something more appealing by repackaging it or bundling it with promotional extras.

Gus Desbarats is the founder and chairman of Alloy, a product design consultancy used by BT among others, which applies some of these techniques. The company also favours differential pricing - ie adjusting prices according to the different expectations and needs of different customer groups.

"For us, pricing isn't so much a science as a structured activity," he says. "We match our target yield to capacity and overhead and ensure that our standard rate achieves this. But we then have a number of other factors we can apply, for example offering bulk discount for large projects." 60% of Alloy's capacity is accounted for by large outsourcing deals worth over £250,000 a time.

Because such deals carry less of a new business overhead than smaller projects, this creates room for manoeuvre, allowing Alloy to be more generous on other new business - for example, by underestimating the work involved, to impress new clients.

Because product design is a global business, it is affected by pricing pressures in other markets. As more work is farmed out to cut-price markets such as South East Asia, Alloy tries to focus on clients that want to pay more for value, rather than getting into the discount game which could threaten quality.

Instead, Alloy prefers to be creative, matching its pricing strategy to the customer's situation. It will take a joint-risk approach if a client needs to diversify but hasn't got the funds, and offers a licence model to smaller clients. "What we do is very front-end, so we have to insist on something in the way of a paid fee, but then we will sell a licence - ie we retain the intellectual property to the design and grant licences to use it," Desbarats says. "This is fairly innovative in our market."

Alloy is confident enough in the value it offers that it is also prepared to 'let go' of clients that drain its resources without returning much profit. Having achieved a massive uplift in business for a Hong Kong based company, increasing its market share from 5% to 25% in four years, Alloy found it was working very hard for the client without really making any money from it. "We let them vanish and, sure enough, we more than replaced the business very quickly. We needed self-confidence and belief during the transition, but the decision paid off."

This is at least as important as knowing the 'rules' of the pricing game. Being confident in what you're offering means you're more likely to be willing to break the rules if you think the gains will be worth it.

If you're still not convinced, take advantage of the Internet which makes it easier than ever to test pricing. "You can tell very quickly from a quick test on eBay or Google Adwords how a test price point is perceived," Craven notes.

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Optional boxout:

The dos and don't of pricing

Do:

" Check out what rivals are doing, and establish where your offering fits (is it comparable or higher value)
" Consult pricing experts if you lack confidence
" Test the market before committing yourself
" Think laterally and be prepared to be creative, using innovative pricing strategies which will spark customers' interest - and make them think differently about how they value what you're offering
" Work out different pricing models and bundles to suit different client bases
" Consider raising prices before dropping them, to lend credibility to your brand and help filter out low-profit customers who drain resources

Don't:

" Let theory and formulae prevent you from trusting your gut instinct
" Be afraid to play around with pricing on the Internet using eBay, Google Adwords or similar
" Make the mistake of blindly following others in your market - be prepared to strike out and try new pricing models. So long as you work out how you are covering your risk, and have solid contingency plans, don't be afraid to experiment
" Lack confidence. A company that's proud of its products and services, and knows they are better than cheaper equivalents on the market, won't need to discount
" Confuse price with value

Another optional box

Pricing theory

Clearly, it costs a company money to design, create, distribute, promote, sell and support a product or service, so the cost to the customer must allow for all of these factors, and then add on a reasonable profit that the market will tolerate. Pricing must also take into account the supply and demand relationship. Pricing a product too high or too low could mean a loss of sales for the organisation.

On this basis, the theorists advise that optimal pricing considers:

* Fixed and variable costs
* The competitive climate
* The business goals of the organisation
* Proposed positioning strategies
* Target customer groups and their willingness (and ability) to pay

Recognised pricing strategies include:

" 'Penetration pricing' - setting a low price to increase sales and market share, when a company or product is new
" 'Skimming' pricing - setting an initial high price and then gradually lowering it to broaden your market (skimming profits off the market layer by layer)
" Competitive pricing - using your rivals as a benchmark to determine pricing (matching, undercutting, or perhaps gambling on the fact that pricing high will appeal to customers seeking better quality)
" Product line variations - pricing different products in the same product range at different price points (the greater the features and perceived added value, the more the customer will expect to pay)
" Bundling: bundling a group of products and giving the customer an overall discount
" Psychological pricing: more of a consumer tactic, but still applicable to B2B marketers - eg £199.99 somehow feels a lot cheaper than £200.
" Premium pricing - upping the price to reflect the exclusiveness or superior value of the product
" Optional pricing - offering optional extras along with the product to maximise its turnover (eg toner, paper, warranties and other after-sales services)