Why Is Pricing So Hard to Execute?

An earlier article of mine discussed pricing being related to customer perceived value rather than actual value. No matter how much you believe something should be worth to a customer, it is his or her perception of that value that determines what price you will get for your product or service. Unintentionally, another article on LED lights touched on pricing and perceived customer value, as well as how to change that perception.

The Big Red Car commented on how true this is, and how frequently executives often make this mistake. Ironically, Car's next article was about discipline. While he was mainly referring to the right way for an executive to discipline others, the concept of self-discipline arose as well. And here is the connection.

Let's say you are selling consulting services (where did I get that idea?). You are convinced you can help your potential customer tap into a $10MM market with 50% gross margin. Your work, then, is worth $5MM. Now, they will need to spend another $3.5MM in preparatory costs and other fixed costs to be in that market, so the net value of your work is $1.5MM. Of course, you want your customer to have a nice, big 3x return on investing in you, so of the $1.5MM in profit, you want at least $1MM to go to the customer. If your customer CEO believes the market, believes the numbers and believe you can and will execute, then the perceived value of your work to the customer should be $500K. Period. If it takes you 1,000 hours or 10,000 hours or 100,000 hours of work to get there, that is the price you will get. If it takes you 100 hours, then your effective rate is $5,000/hr; if it takes you 100,000 hours, then your effective rate is $50/hr. In the first case, you are the best consultant ever; in the last case, it might not be worth the deal. Either way, you are not getting more than $500K on the deal, and if you get less, you are walking away from money the customer is willing, able and happy to pay.

So why is it so hard? Why do people continually over and under price their products? Why did the CEO of a client of mine continually market on value but sell on price, almost always selling at a price point below what the customer was willing to pay, and throwing in consulting services at a loss to boot?

In a word: Discipline.

What is discipline? Discipline is the exercise of self-control to stop oneself from performing activities that one rationally knows are bad and to motivate oneself to perform activities one knows are good. In general, discipline is actually the exercise of the rational part of the mind over the emotional.

People become emotionally caught up with their products and services. They want the deal so badly, or they want the personal validation (in the above example, self-esteem boost) right now. Those emotional needs override the rational knowledge as to the right price and weaken the executive's position.

In many respects, the challenge in pricing, which is just one part of marketing, is similar to the challenge in market selection. Most executives want to focus on as broad a market as possible, in order to increase the opportunities for revenue growth. Yet, all real-world experience has shown that targeted and focused markets increase the probabilities of growth. You need to focus and, counter-intuitively, give up on many markets in order to succeed in a few. And yet, time and again, I see executives who actually know this yet cannot bring themselves to do it. They lack the discipline (or support system) to enforce their rational knowledge over the fear in their emotions.

Despite all of the automation in the business world, despite all of the algorithms and spreadsheets and CRM and big data and analytics, decisions are still taken by human beings, and they must be, because they are decisions. We humans are subject to emotional strengths and failings, and need discipline to manage them to our own benefit.