PWC has a Competitive Leadership ModelSM that it is encouraging companies to use to organize their strategic thinking. As part of this it asks “How well does your business target and segment customers for maximum customer profitability?”
Is this the right question? At LeveragePoint we believe that before asking “How profitable are my customers for me?”, you should ask “How much value am I creating for my customers?”
Before you can claim value you have to create it, communicate it and then capture value in your sales process. In B2B, the critical value conversations (should) happen during sales. And B2B companies have to equip there sales people to have these conversations.
To create and communicate value your sales force has to be able to communicate the three or four things that you do better than your competition. This is what really matters. If you do exactly the same thing as your competition then your value doesn’t really matter, the market will set the price. By better we mean the impact your solution has on your customers business:
- Where do you decrease costs and by how much?
- How do you increase revenues and cashflow?
- Do you reduce capital expenditures? Under what conditions do you do this?
Value-based pricing and selling is based on granular answers to questions like these. And it is your sales force that has to be able to answer these questions in sales conversations.
Another problem with PWC’s point of view on segmenting customers for maximum customer profitability is that most companies do not actually know the true cost of acquiring and serving their customers. Uncovering this kind of cost information and then applying it to customers is an important and non-trivial exercise. People often think in terms of fixed and variable costs (over the long term all costs are variable), but in pricing, the most powerful way to think about costs is in terms of sunk costs (which you ignore as you can’t do anything about them) and avoidable costs, which are critical in making pricing decisions. Your minimum price is the one at which you are profitable after taking into account the new costs you take on in making the sale.
Before you try to segment your customers in terms of how much profit you are extracting from them we suggest you segment in terms of (i) how much differentiated value you are providing (using Economic Value Estimation™ or EVE™) and (ii) how much of that you value you are capturing into your pocket price (your pocket price is the amount of money left in your pocket after all of your cost of sales, discounts, cost to serve). This gives you a grid like that in Figure 1: Matrix of Differentiated Value x Margin. In order to construct such a matrix, you need to understand the value you provide in each transaction and your margin on each transaction. This is one of the things that the LeveragePoint platform does.
Some people assume that one wants to be in the lower right matrix: deliver as little value as possible while winning high margins. But in today’s hyper competitive economy most accounts in this quadrant are likely to drift over to the lower left, the commoditization quadrant. Value-based pricing and selling is the most powerful way to win a sustainable advantage, one in which you provide differentiated value and capture a fair amount of that value into your prices.
*“Competitive Leadership Model” is a service mark of PWC.
*“Economic Value Estimation” and EVE” are trademarks of Monitor Group, licensed by LeveragePoint Innovations Inc.