Value-Based Pricing Driving Innovation in the Supply Chain

by | Jan 14, 2012 | Pricing, Quantify Customer Value, Why LeveragePoint?

One of LeveragePoint’s customers is introducing our value-based pricing platform to its suppliers! At first this may seem counterintuitive. Most companies adopt value-based pricing because they want to capture the value of their innovations in higher prices or greater market share. Companies under commoditization pressure use it to equip their sales forces with the logic they need to defend margins. Why would you want to give such a powerful tool to your suppliers?

One approach to business popular over the past few decades has been to squeeze out costs and to ‘rationalize’ the supply chain. The goal of some procurement and supply chain managers has been to drive commoditization and make sure that all inputs are easily substituted. The result has been dramatically lower costs and steep declines in prices that have benefited many consumers. But there has been a cost to this behavior as well. Increasingly companies are delivering easily substituted and disposable products themselves. Profits have gone down along with costs as buyers find that products built from commoditized substitutes are themselves easily substituted. Some consumer companies have been able to compensate by building brand power, but this is more difficult in B2B where buying decisions are based on economic value. (See Figure 1: Commoditization Cycle)

A different strategy is to build economic differentiation into the supply chain, by helping ones suppliers to provide inputs that drive differentiation. This requires collaboration between buyer and seller. The buyer has to provide the seller with the information on its business model so that the seller can support it with meaningful innovations. And the buyer must also be willing to compensate the seller for the increased value while at the same time controlling costs so that it also captures part of the value. This is a very different approach than the grind down your suppliers’ behavior that we are used to. It takes a visionary company to encourage its own supplier to adopt value-based pricing. But companies that do take this approach can drive up the value of their own offerings and win the profits they need to reinvest in innovation. (See Figure 2: Differentiation Cycle)
Of course a successful strategy will need to blend both approaches. Buyers need to know what is differentiated and what is commodity. The commodity component of an offer, and there is almost always a commodity component, should be priced at the market price. The differentiated component should be priced on economic value. The LeveragePoint platform implements Economic Value Estimation or EVE™ to make it clear what value is commodity and what value is differentiated. Adoption of the LeveragePoint platform across supply chains can lead to more diverse solutions that are able to compete on innovation and drive higher profits!

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