Within the spectrum of different pricing strategies, Solution Pricing is the most customer-intimate. To provide an industrial customer with a solution price, which is based on a benefit that the customer will derive from the use of product, service and/or equipment offer, presupposes that the supplier has a high level of technical and commercial integration with the customer. Here the supplier can provide technical knowledge – not readily available to the customer – on how the offer is customized to reduce the customers total cost of ownership or to increase the customer’s value created. Also the supplier will have the means to access tacit knowledge within the customer in order to continue to deliver valuable insights and further improvements as the delivery of the solution progresses. This situation requires a high level of supplier-client trust, whereby there is shared ownership of risk, which is jointly understood, and common agreement to work together to deliver change. This common agreement comes from an appreciation that the resource quantities consumed and the benefits of change can be monetised and shared equably. If a third party is required to verify that profits made will be equably shared, it means the level of cooperation required to make the solution approach work is probably missing.
Solution pricing is different from Value pricing. The objective of value pricing is to obtain a reasonable share of a reduction in the Total Cost of Ownership derived from a differential benefit in use provided by a product or service supplied. Solution pricing seeks to obtain an equitable share of value created whether that value is derived mainly from the product supplied, the support services used or the specialist equipment provided to enhance performance. During the course of providing the solution the balance of product, service and equipment will probably change. In solution pricing it is not the delivered product or service that is differentiated, but the unique, customer-specific solution itself. Hence the benefits of Solution pricing are that it provides a barrier to entry, enhances the customer relationship and can be very profitable if managed correctly.
The two main approaches to solution pricing are:
• A fixed solution price, which has the selling advantage of being predictable, but requires annual or bi-annual reconciliation.
• A customer output-linked solution price, where the customer is billed according to reported production figures. The sales advantage is that external support provided becomes another variable production cost, but the risk of miscalculating the relationship between output and consumption is higher.
The process of designing a Solution price is as follows:
1. Begin to plan a solution by identifying the starting set of operating conditions and an end point. The end point will either be the target reduction in total cost of ownership or an increase in the value generated from customer activities.
2. Consider that a solution will most often comprise three components:
i) The product supplied, which has a potential differential benefit and a profitability target.
ii) The services provided, which will have both a value-added expectation and an opportunity cost (i.e. service resources are finite).
iii) Equipment may be loaned, rented or hire purchased with a potential to reduce product and service consumed and anticipated Return on Investment (ROI).
A Solution Pricing Tool1 can be used to calculate the overall cost and marketable value of combinations of these components.
3. Conduct a sensitivity analysis using Solution Pricing Tool scenarios to consider the impact on the overall profitability of the solution if for example, customer operations were cut by 20%. Also create a scenario describing the desired “end-point” and calculate the profitability and anticipated cost saving/added value generated at this end point.
4. Following this internal evaluation of the priced solution, the proposed solution – including the quantified cost saving and/or value improvement available to the customer – can be presented to the customer. At this point the both party’s responsibilities in delivering the solution need to be understood and agreed. I have written about the interdependencies between supplier and client in a Product-Service model in an earlier Pennog blog.
5. Upon reaching agreement, the execution of the improvement plan should be transparent. Reporting of the development of improvement activities towards the target should be visible to the customer. This is critical not only to manage customer expectations, but to create a link in the mind of the customer between the supplier resource input and the measured performance improvements. Regular internal reporting of the cost of delivering the solution is equally important if the profitability of solution pricing approach is to be guaranteed.
Pennog has many years of experience in preparing and analysing solution offer prices. If you would like to speak to someone in more detail about solution pricing, solution pricing tools or solution pricing analytics, please contact us by calling +44 1484 443001 or by selecting “Capturing Value through Pricing” in the easy contacts form.
1 Please use the easy contacts form to find out more about the Solution Pricing Tool.