Price Intelligently (Guest post Erik Grueter)

We are pleased to welcome Erik Grueter today as guest blogger on the European Pricing Blog. Enjoy his post on the science of supercharging your profits by means of a well-crafted value based pricing strategy.  Have a look at their blog at http://blog.priceintelligently.com/ for some more excellent pricing content. 

Supercharge Profits with a Value Based Pricing Strategy

Great companies don't just stumble into the perfect price for their product. They know that there is a huge amount of science and strategy that goes into sales, marketing and product development. Simply guessing at how all of that effort should be priced would be downright wasteful. 

Instead, what the best companies do is price their products along a value metric. They do this by  determining the core value their product provides, then breaking that value down into its smallest unit. Finally they charge for that unit along a sliding scale. We will discuss how to apply this strategy to your business, and show you the enormous impact on growth value-pricing can have by reducing customer churn. 

Unlock revenue by determining your value metric

Pricing along a value metric is difficult. It requires you to do deep customer research through surveys and customer discussions. You’ll need to determine the value your product provides that is ultimately driving a customer to purchase. What is the core value you offer that the customer requires from your product? Once you have determined this, you’ll need to determine the smallest unit of that value. For example: If you are a farmer selling eggs, you are not likely to sell half of an egg. 

Pricing along a value metric makes the second step in this pricing process much easier. Once you have determined your value metric is eggs, you can price along a sliding scale for the number of eggs sold. A family might only need a dozen eggs, while a restaurant might need 1000. You can think of your pricing tiers as the three or four most likely places a customer would slide their value requirements along that scale. This makes your pricing much easier to understand and more transparent to customers. 

As your company grows, you can continue to add additional value metrics to grow revenue. David Skok's blog provides a great example of how one can accomplish this. Have a look at the below chart:

Skok’s chart demonstrates how to increase the number of dimensions in your business model. Let’s say that you have been charging only for the number of eggs your customer purchases. You could add an additional revenue stream by offering customers a home delivery service. Families could pay a subscription for monthly delivery service. Restaurants might need you to make deliveries each week.The survival of subscription based software companies depends heavily on its ability to scale pricing along a value metric, and upsell current customers into higher tiers, because all subscription based companies experience churn. 

See the below graph, also from Skok’s blog, comparing two companies with differing churn rates. Even a fairly low 2.5% churn rate can cause a significant difference in growth over time. Imagine how fast your company would grow if your customer churn was at zero. Imagine how much faster you would grow if customer churn actually went negative! Explosive growth of that nature is possible with the right pricing strategy.

Utilize your value metric to achieve negative churn

Negative Churn means you are making more from upsells to current customers than you are losing when customers quit your service. Have a look at that above chart again. It is clear the massive impact a reduction in churn can have on growth. If you price your product or service properly, it is possible to achieve negative churn in your business.

When you price along a value metric customers who require more units of value over time will continue to add more and more money to your bottom line. These hippos will happily eat more and more of your product as their company grows larger and more dependent on your value. Additional features aside, these big customers will have a clear understanding why they are paying more as they scale. 

Pricing along a value metric also lets you grab entry level customers in the early stages of their company’s growth. You can drive adoption to smaller enterprises without lowering your quality perception simply by providing fewer units of value. Even if the number of value units you provide is small, you can still be perceived as a top product if the quality of what you are providing is high. As long as the number of customers who require more value from your product over time increases, you can scoop up customers at every stage in the buying cycle 

Think back to the last legendary startup story you heard. Undoubtedly, blazing fast growth was a huge part of that story. By pricing along a value metric and employing multiple pricing dimensions, you ensure that your customer retention is high and that your customer churn is low: perhaps even negative !

Guest post : Erik Grueter, Price Intelligently