Outcome-Based Pricing: Managing Risk Through Customer Value Q&A

by | Oct 20, 2021 | Pricing

HomeBlogPricingOutcome-Based Pricing: Managing Risk Through Customer Value Q&A

For our September Webinar, Timothy Matanovich, Chief Enlightenment Officer at Value and Pricing Secrets, explored the key factors that impact the successful implementation of outcome-based pricing strategies. After the session, he answered questions from the webinar audience. In this blog, we share his live answers.

Are there any industries in particular where Outcome-Based Pricing has taken off in popularity? Are there any industries where you see strong opportunities for Outcome-Based Pricing over the next 5-10 years?

In terms of popularity I can only talk about the number of companies that I’ve worked with. In my experience in the area of B2B and technologies, the area of managed serves is the fastest growing. So that’s the place [I would look at]. Any industry can get involved in this if they want to take that step. But those are the kinds of applications where I see outcome-based selling really taking off.

Are there certain types of risk you’ve seen clients frequently fail to anticipate when structuring outcome-based contracts?

I’m going to come back to what I said about strategic customers. That’s the risk. I was delivering a seminar for the American Marketing Association a number of years ago, and I was talking about the economics of discounting. We’ve got a lot of people watching that do value-based pricing and they understand that a 1% discount in price can very easily translate into a 5% cut in profitability. And I was in the middle of this class and I was talking about the economics of this and one of the participants came up during a break and he said, “let me ask you a question. Is that really true? Then I said, yeah. And he said, “oh no, I’ve got to call my CEO. He was just on the golf course talking with one of our customers and gave this really big price discount, and I don’t think he understands what that’s going to do to our profitability.“

So that’s the one. Take a very hard look at who you want to get in bed with, and then look at the economics of the decision before you do it. More than one company I’ve run into have done a pricing decision, and then two years later their costs are underwater, or their costs are higher than expected. They’ve got people working onsite, figuring out how to pay them. But they are stuck in the contract and they have to deliver or they’ll get bad reputation in the market. So that’d be my guidance on that.

How does cost-per-unit factor into Value-Based and Outcome Value-Based Pricing?

You can make the value-based claim that you’re going to be able to help a manufacturer reduce their cost per unit. And based on that, they pay you a fee for whatever your process is, whether it’s your hardware or software or process that helps them do that. And that’s traditional value-based pricing. You’re making that promise and, over time, what you’re still going to have to do is demonstrate and document they’ve gotten that value, because that proves that you’ve done it, but your price is not at risk.

Outcome-based pricing says we are going to reduce your cost per unit over the next 12 months by, say, 5%. And if we don’t do that, then we’re going to pay a penalty for not achieving that target. That would be the outcome-based pricing approach to that. So you need to make the call. Is your price at risk or not? That’s really the defining line for outcome-based pricing.

What are some best practices for communicating service value on a regular basis?

I’m going to give you two things. The first one is that I had to help my son get his car repaired. He needed new brakes. And when I drove down this road near his house, I saw car shop after car shop, and I had the choice of dozens within a mile of his house. But as I drove down the street, one of the signs on the street had a display and the sign said “we have 1,255 five-star reviews from our customers.” And after I saw that sign three or four times, they then said “during the first half of the year, we got another 155 five-star reviews.”

I could say, “look, all these people are going to charge about the same thing. How do I distinguish between 20 different auto shops? Well, this shop has got a lot of satisfied customers, and because of that, I would trust my son’s car with them.” So that’s a very practical example. The question becomes what is relevant and meaningful to your customers right away.

Now, the second part of that is that you need to continue to maintain the value. There is what’s called the L.A.E.R. model, and some of you may have run into it: Land, Adopt, expand, Renew. And the idea is that during the sales process, you go through these four stages (and this applies to products that are sold as a service, as well as a pure services, or some combination of the two). If you were adopting a SaaS service model for your products, then you are moving to a services business. You cannot treat your products just as products when you move to a SaaS model.

What the L.A.E.R. process recognizes is that in a service environment, you’re going to go into a client (let’s you’re bringing a new software to market or bringing a software product to a new customer). And the customer says, “yeah, I’m willing to try that.” You’ll get the functional manager, saying, “yeah, this is good, so we’re going to try it. We’re going to try it for the next six months with a particular business unit. If this works out, then we’re going to move it to the move to the next level and maybe expand it to a second or third business unit.” Now, if you do that, then what do you have to do? The question is what price you’re going to charge at the front end. And typically, you may want to agree to a lower price at the front end to get this trial.

Now, the problem with that is that you don’t want to set yourself up for this price in the long term. So there has got to be a conversation at the front end of the trial, confirming the ultimate pricing that we’re going to get to. You need to get that confirmation upfront. Then you move into an adoption phase. The adoption phase is where you make or break it in that trial. You may be underwater with services during the adoption phase, because you’re trying to persuade this customer that this is really good stuff, and that they need to use it. Then you’ve got to go to the expand. Now we’re going to roll it out to business unit number two, three, and four.

And then finally, after the course of your original contracts when it’s time for renewal, they’re going to say, “you know, everything’s working really fine. Do we really need to pay you this much money?” This is the four-stage process when it comes to services, that’s the way you need to think about it. You need to think about it as a long-term kind of sale, that you’ve got a number of sales interventions, and you need to make sure your salespeople are capable of making that sale. And you need to make sure the incentives are aligned with that kind of a sales process.

And to add onto this, the concept of value stories is really a powerful one because in some cases customers understand the value, but in many cases they don’t know it. So your ability to communicate and tell the story in a convincing way is really vital to your ability to capture the price, because there’s not only the actual value delivered that you can demonstrate in a model, but the questions of “can I get behind this? Can I relate this to people in my organization? Can I take your presentation and travel with this presentation to other people in the organization and they’ll get it?” So, those are things that come into mind, and why I think a value story is really important.

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