Why Price is a Great Lever to Create Value
1. Why Price is a Great Lever to Create Value
2. Why Pricing Opportunities Exist
3. Price is Controllable
4. Price Increases Increase Revenue Quickly
5. Proven Price Increase Tactics
6. 10 Ways to Make Sure Price Changes Go Wel
Why Pricing Opportunities Exist
We believe that price is an important and often underutilized driver of enterprise value for a number of reasons that will be discussed in this post. When we refer to ‘price’ we are talking about both the pricing model and the quantum of the price point itself.
If we were to summarize why price is such a great lever of value creation, it would be that:
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price is controllable by management,
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price increases are often avoided by founders / entrepreneurs,
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price increases directly (and often quickly) impact the top line.
There is no better place to raise money than from your own customers, as price increases are non-dilutive and can have a significant positive impact on enterprise value.
While price changes do come with risks, in this post we’ll discuss why we believe these risks are manageable by following proven best practices. We’ll also provide a few recommendations to help you use price to increase business value.
Price is Controllable
Let’s start by stating the obvious. Customers do not like price increases. Most businesses avoid price increase conversations because they can be challenging and uncomfortable. Nobody wants a customer getting upset and threatening to leave.
Founders are particularly likely to avoid price increases because their customers (especially the early customers) can become like family and friends. They often see these customers as instrumental in starting their business, and rightly so. Founders are also more likely to be so passionate about solving a particular problem that they’d rather have more users at a lower price, even if it is less financially beneficial to the company (yes, we’ve seen this!).
What typically happens in early stage businesses, is that in order to get initial traction with a new product or service, the founders sell their product at a low price. Over time, as they gain a foothold in the market and their offering matures, some customer prices remain low. Even if the business has implemented annual price increases, the starting price point for early customers may have been so low that these customers never reach the market rate.
The other common situation that creates a price opportunity is when the pricing model enables customers to get free use. Per user pricing, where user licenses or credentials can be shared, is a good example of this situation. Netflix for example, has historically not enforced a per-location or per-family pricing model however, in recent months they have begun to explore such a change as a way to minimize free use.
Price Increases Increase Revenue Quickly
It’s exciting to place big bets on innovation and launch new products. Unfortunately, as much as management teams don’t like to admit it, neither of these activities is entirely in their control.
Few businesses have track records of repeated success in bringing new product offerings to market because it’s a complex and rarely predictable process. It requires the right timing, a deep understanding of market needs, an effective go-to-market strategy, strong product/service development, etc.
Price on the other hand, is something the management team does control. Every business can have a price list and every management team can decide how they will stick to the price list (or not).
While it could be argued that customer attrition as a result of a price increase is not entirely controllable, we will discuss some tactics that make attrition as a result of price increases highly controllable.
From an investor’s point of view, the investor can be at least partially in control of price by choosing to be in a business that offers a high value or ‘mission critical’ offering. By investing in businesses that have historically low customer attrition, high switching costs and where the price of the offering is a low percentage (i.e. less than 3%) of the customer’s total operating expense, investors can help ensure they are working with a business where the management team can control reasonable price changes.
Use Proven Pricing Tactics
Again, unlike the process of bringing new products or services to market to drive revenue growth (which can take many months or even years), price increases enable revenue to grow from products or services that customers are already using. The impact on the top (and bottom) line can be realized in months, weeks or even days.
There are often opportunities to increase prices without increasing cost because you are working with products or services that already exist. However, as you will see in the recommendations below, if you have a significant price increase to do, we suggest giving a success bonus to the staff responsible for working with the customers to get it done (which will temporarily increase costs).
Overall, while price increase projects can take months to complete, especially if you include the time to conduct thorough market research, these projects rarely get to the size of a new product (or even a major feature) roll-out and can result in a high return for the business in a short period of time.
10 Ways to Make Sure Price Changes Go Well
Businesses have been successfully increasing prices throughout history and so there is no need to reinvent the wheel. Here are a few proven tactics that we recommend:
Add value. This is at the top of our list for a reason. Increasing prices without adding value in some way is a recipe for disaster. However, you don’t need to come up with some big new product or service to do so.
Here are a few ways to add value that can be cost effective and build on what you already have in the business:
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Give away low penetration products to customers that have not already purchased them (i.e. include the product in the customer’s new price, permanently or for a limited period)
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Time price increases with the addition of new features that were already on the roadmap
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Take the opportunity to remind customers how their fees are being put back into product development by showing them a high-level, long-term product roadmap
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Offer customers a chance to see and provide input into new product development by piloting new products
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Offer free training or consulting
Create a ‘rate card’ that clearly defines your price list and can be shared internally, as well as with customers. The rate card helps ensure that pricing is fair and well defined for everyone.
We suggest letting customers know that it is your practice to apply a standard rate card to all customers. Rate cards generally make it easier for everyone to explain and understand prices.
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By applying a rate card across all customers, some customers may get big price increases in order to align with the rest of the customer base. For large increases, in some cases it may make sense to allow some adjustment time before the total amount of the increase kicks in.
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Build annual increases into new pricing models (and contracts) if they do not exist already. Annual price increases are always easier if the customer is expecting the increase (and it is included in the contract).
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Offer discounts for annual payment up front (over quarterly or monthly payment). Many businesses already do this and it’s a good idea because it can reduce the overall price increase (i.e. in cases where a customer can opt for annual up front payment) and it also improves cash flow.
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Explain WHY the price increase is necessary and follow through with updates on any promises. From the customer’s perspective, price increases can be justified if an increase results in getting a product that gives them more value. Many customers will also understand that costs increase over time with inflation. Quarterly webinars to show how the company is investing in the product can help demonstrate to customers how you are adding value.
Perhaps your investment thesis depends on a successful price increase or you’re looking to maximize your return on the sale of a business; in either case, it’s in your benefit to help ensure the business does everything it can to make sure price changes go well.
We’ll conclude this post with our top recommendations for a successful price change:
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Research your competitor’s pricing. If they don’t have prices published on their website, ask your customers if they have done any pricing research (i.e. when they purchased your product). You can also try talking to the customer’s of your competitors, although some may tend to give you the low-end of what they are really paying. Other options include talking to industry experts or hiring a consultant who specializes in pricing.
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Estimate what you think attrition will be at various price increases. Do a sensitivity analysis of price versus attrition and track actual results against your analysis to make adjustments as you go.
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Beware of ‘shelfware’, particularly if you’re in the software industry. This is a product that was purchased (and for which the customer may still be paying) but isn’t used. Some customers may have been happily paying a support (or SaaS) invoice all of these years without using the product and the price increase notification may tip them off to this. You should try to find out if your customers are actually using your product before trying to increase the price. To do this, look for signs of engagement by the customer with your company such as calls to support, conference attendance, requests for quotations or social media activity.
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Review customer contracts to see what has been established regarding price. This is particularly important regarding annual increases as some customers may have already negotiated a fixed annual increase percentage.
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Seek ways to simplify pricing wherever possible. Make it easy for customers to do business with you by reducing the number of SKUs (i.e. through bundle options).
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Test new pricing with a bigger increase than you’re aiming to get. Start by trying the increase with a few customers that you can afford to lose and remember that you can always negotiate down.
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If possible, try to do big price increases over the phone or in-person so that you can provide and receive immediate feedback. Emails are less personal and can create a situation where the customer stews on a big price increase before sharing their feedback.
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Create a script that covers all the key points for a customer call and prepare responses to common points of push back from customers.
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Set a goal for the overall percentage and/or dollars in price increase for the customer base. Focus on the aggregate price increase (on your customer base) as opposed to the % increase you need to get from each customer.
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Assign an owner of the overall price increase and provide incentives to get price increases done (i.e. commissions on the overall outcome). It isn’t an easy job and most staff will avoid it otherwise.
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