B2B enterprises that are most advanced in value-based pricing strategy embed understanding customer value in their innovation process. Innovation is important, but not the kind that involves letting a bunch of engineers design the best product or service that they can conceive and then “throw it over the wall” to marketing and sales. Letting the scientists and engineers run free may be great for primary research, but it doesn’t help when we are ready to develop those insights into marketable products and services. That’s when the CFO has to set cost targets and refuse to fund the outlays necessary to launch a new product or service until someone can figure out how to make it cheaply enough relative to the value created. That requires understanding which features are of what value to whom. A sign that finance is not doing its job and that the marketers are out of control is when great new products are being launched with lower gross margins than the products they replace—sadly a frequent occurrence.
In innovation, you need to have value-based rules articulated by the CFO. “We are not going to fund the tooling and the investment in launching any new product until we see the customer value that’s going to justify a particular price point. Only then can we understand, based on the cost of the product, whether this price is more profitable than what we’re selling now.” This puts pressure on the development team to identify the customers who will pay for a new technology.
The development team needs to look at the cost of each feature or service enhancement in planning as part of an offering. “Is the cost of this feature low enough to justify it, given what people are willing to pay?” This may slow the development process, but it forces the team to go back and say, “Is there a more cost-effective way of doing this?” If there isn’t, then maybe some segments don’t need to have all of these features or all of these services. This way of thinking also forces you to create more flexibility in the offering. As a result, when sales reps are talking to a customer they can pick and choose the elements of the offering based on what creates value for a customer in a particular application.
Instead of getting R & D to build whiz-bang products, get them to build profitable products that are in line with customers’ perceptions of value. Make sure you have price points that you’re building to and therefore cost levels that you’re building to, rather than prices and costs coming after you’ve already designed the product.
Note, this post was adapted from “Emerging from the Great Recession: 8 Keys to Driving Profit Growth and Customer Value from the C-Suite” by Dr. Thomas Nagle. Download the white paper to get more insights from Dr. Nagle and understand how to build a customer value-based organization, and bring value to pricing, sales, and product innovation.