What It’s Worth

Volume 2 Letter 1

The factory smelled of it, workers got skin rashes because of it and for employers and workers alike it was a big headache. For years the owners of small metal working shops had to endure the constant smell of decomposing metal working fluids needed to cool and clean the products being manufactured. Some tried adding chemicals to reduce the smell. These chemicals ranged from household bleach to biocides, some which produced formaldehyde gas, but nothing really worked. The only solution to keep the smell and skin rashes in check was to change out the fluid (at great expense) once a month.

Finally the perfect product was developed. Workers loved it – no more skin rashes and no more smell. Employers loved it because if used regularly it could extend the fluid’s life from 30 days to a year or longer which meant fewer expensive fluid changes and unions loved it as it provided safer working conditions for their members. Yet three quarters of the way through the year only 24 of a forecasted 12,000 boxes had sold. The rest sat on the shelf, unsold for lack of demand. How could such a great product not sell?

They are many things that can be attributed to this product’s failure but one of the key reasons was ineffective pricing. The company was charging $2.00 per 50-gallon (225litres) treatment per month. A closer look revealed the price was wrong for three reasons:

1. Low price signaled an inferior product: Competitive treatments that were ineffective (and produced formaldehyde gas) cost $9.00 per treatment. At $2.00 per treatment the manufacturer signaled the market that their product was inferior to the ineffective treatments currently in the market.

2. Low price upset the distributors: Distributors who made their livings selling replacement metal working fluids saw this product as a threat to their livelihood. The more of this biocide treatment they sold the faster they would go out of business. To ensure the suppliers could replace their lost metalworking fluid income with sales of biocide treatments the product would have to sell above $6.00 per treatment rather than the current price of $2.00

3. Low price didn’t consider customer value. Customers who had to replace their metal working fluid every month not only had to pay to replace the fluid but also had to pay a truck to haul away and dispose of the old fluid. For the customer any price under $39.00 per treatment would have been a significant savings (not to mention reducing the environmental impact of having to dispose of the fluid).

So a price somewhere below $39.00 and above $6.00 (and preferably >$9.00) would have been perfect for both suppliers and users. Not only would it have encouraged distributors to push the product more but also it would have brought significant profit gains due to both increased sales and higher margins.

When pricing your products or services:

1. Understand your total cost to deliver the product or service to market. If delivered costs are greater than the value the market puts on the product then you do not have a sustainable product.

2. Never cost plus price. Cost plus pricing does not communicate the value to the customer and can hurt distributors margins. The $2.00 price in the example is a result of cost plus pricing.

3. Understand the value the product brings to each customer segment. Different customer segments can have different values for the same product so price accordingly. If possible price the product or service separately for each segment being careful to ensure the customer sees the product or service as being distinct for them. (Strip away some features or create geographical price boundaries to separate segments).

4. Understand the value that the competition brings to the market. Often competitive products are different and solve portions of the customers’ problem. What is the value they bring? If the customer doesn’t use your product how much will it cost them to do the same thing another way? In our example above the cost was $39.00 to remove and replace 50 gallons of fluid. (Remember sometimes the competition can be “do nothing” or “status quo”).

5. Avoid parity price. The additional value delivered by a product or service should be reflected in the price. Find and promote the differentiating factors so products and services do not fall into that black hole of interchangeability and low bid wins.

6. Communicate the value to the customer. A key component of everyone’s job is to communicate and educate the customer about the value that your products and services bring. This communication must be adapted to each customer segment and can range from being very tangible “this is exactly how much money you’ll save (or make) by using our product” to very sublime – “you deserve it” – “reward yourself”. Pick the price and message to suit the segment!

Remember the oldest lesson of all: that no invention from the wheel to the airplane is more valuable than the service it delivers to a customer. But please don’t leave it to the customer to figure out the value your product or service brings them! The chemical company described above never did figure it out -nor did their customers until a competitor came with the right product, the right message and the right price.

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