In working with tech companies and talking to service leaders, seven common pricing shortcomings emerge again and again. These pricing sins cost companies revenues and margins, lengthen sales cycles, and annoy both sales directors and customers. These sins occur in both essential and value-added services, whether revenues are recurring or not, and have both strategic and executional impacts.
Sin #1: Value is Lost in the Pile
Services are different from products. They are intangible. Products maintain their differentiation in bundles, but services dont. Order a McDonalds Happy Meal, and you know you get a burger, fries, drink, and toy. I bet 95 percent of the population of the United States knows that. Every family also has auto insurance that costs 250 times the price of the meal. But what services are in your auto policy? There may be 30 services, but most of us could only name two or three. As the size of service bundles grow, the ability to communicate the value of individual services within that bundle diminishes.
Sin #2: One Size Fits All
This symptom manifests in several ways in services pricing. One of the key problem areas is using the same pricing approach for both essential (ES) and value-added services (VAS). Price is like water. It tends to find the lowest level. As a result, if you price VAS and ES using the same approach, your value-added services will routinely be underpriced.
The problem with one size fits all is that some customers who might be willing to pay more are underserved. Others who want to pay a lower price for fewer services may be vulnerable to competitors.
Sin #3: Missing the Value-Service Connection
Let's say you have gold-, silver-, and bronze-level service agreements. And let's say that 90 percent of your customers cluster at the same bronze level. Here one size fits all is not by intent, but may be the result of ineffective segmentation and offering design. The missing link here is the value-service connection.
I have also seen this play out so that 90 percent of customers are at the gold level. In each case, the problem is the same. The needs of different customer groups have not been adequately evaluated and addressed. This may represent a significant missed opportunity. In one case, this segmentation and offering design work resulted in a 60 percent increase in revenues.
Sin #4: Weak Competitive Intelligence
The truth is that customers lie. It's not personal; it's just business. It is simply in their best interest to tell your sales directors that your prices are too high. Sales directors, in turn, report that to sales and service managers. Too often, service organizations have little objective evidence to counteract this negative price pressure.
Over the past two years, I have had the opportunity to work with several professional service organizations whose salespeople complained loudly that PS rates were just too high. In two of these cases when we benchmarked their rates against peers, each had the absolute lowest rate of 20-plus peer organizations. The lack of competitive price intelligence leads to two adverse pricing consequences. First, it may cause you to set lower list prices than you otherwise might. Second, it may cause sales to increase discounting resulting in lower contract prices. Either way, revenues and margins suffer.
Sin #5: Ineffective Execution
The realm of pricing execution begins with the handoff of the pricing strategy to the sales group and involves the process of price management and the work of the sales directors themselves. Case in point: I was hired to be the vice president of strategic pricing at a middle-market software company, but my first 18 months of work in the job was focused largely on fixing execution. One symptom of ineffective execution is discounting, and in this company, it was rampant. Pricing strategy is useless if sales discounts the strategy into oblivion.
The TSIA Market Rates Study reveals three types of professional services prices. Roughly half of PS organizations discount little. These firms report the highest margins. Roughly 20 percent discount heavily, 20 percent or more most of the time. These firms have much lower margins. This same study shows no correlation between discounting and close rate. In other words, discounting is a bad sales habit that has no demonstrable upside and costs dearly in PS margins.
Sin #6: Service Price Based on Product Price
Now before you threaten to lynch me or stop reading, hear me out. Software maintenance, the poster child of service price based on product price, has been a goldmine for the industry. No debate. Looking toward the future, however, maintenance is a big fat target for budget cutters, especially where SaaS competitors are emerging and for all practical purposes eliminating maintenance. As we move into this brave, new world, is there a role for product-based service prices? Of course. But increasingly services need to stand on their own, with their own value props, distinct from the products they serve.
Sin #7: Focus on Revenues, Not Profit
Let's say you have a customer with a service requirement that may be equally addressed by two offerings of your personal service and automated service. Personal service requires three people for three days, or $22,500. The automated service can solve their problem for $10,000. If you are focused on revenues, you want to sell the people. Assuming 20 percent operating margin, that's $4,500 profit. The profit on the automated service is 60 percent, or $6,000, because it is software. If you are focused on profit, you want to sell the automated service. So the focus on revenues vs. profit takes you to two different customer solutions. Focusing on profit aligns your interests with those of your customer. Both you and your customer are better off with the automated service.
About the Author
Tim Matanovich is president of Value and Pricing Partners (VPP), a TSIA Consulting Alliance Partner and winner of the 2012 Recognized Innovator Award for Excellence in Consulting. VPP specializes in technology pricing where services are an important part of the value prop. Tim may be reached at firstname.lastname@example.org.