No matter what you sell, one of your most important decisions will be what pricing model to use to set the price you charge the customer. And if you’re in the B2B space selling complex or custom products, the decision you face is formidable.
B2C vs. B2B Pricing Methods
In the B2C space, where you sell directly to the buyer or through a distributor, you have a great deal of help setting the price. End-users and distributors will inform you how much they’re willing to pay, and thanks to the Internet and Amazon, the selling prices of millions of items are readily available. Apps can even independently monitor the price of common items and alert you when a better price emerges, notifying you that you should consider adjusting yours to compete directly.
But in the more complex B2B world of often customized products and services, businesses generally follow three pricing models used to calculate selling price:
- Cost-based pricing
- Value-based pricing
- Competitive or market-based pricing
Let’s briefly look at each:
Cost-based Pricing—When using cost-based pricing, you must calculate the “all-in” cost of what you are selling; this includes labor, materials, all overheads, and any other costs required to produce the item. For a service, this includes labor, materials, travel, parts at cost, personnel overhead costs, spare parts depreciation, meals, travel, and communications.
Next, you apply a markup to the “all-in ” cost that your company believes is required to produce the expected profit. However, especially for spare parts, your markups can frequently turn off the buyer and create distrust. The distrust occurs when you use the same markup percentage for proprietary and commercial parts available from Grainger or Best Buy.
For example, your company decides spare parts should deliver a 50% margin. If you have a custom controller that costs $1,000, the formula tells you to sell it for $2,000 – and most customers would accept that price. But what if you use a 1HP motor that costs your company $150 and is available in single-unit quantities at Grainger for $175? Your pricing formula tells you to offer it for $300. Most industrial buyers would realize it is a standard part and check prices online. When they discover that your $300 motor can easily be purchased for $175, they feel that you are ripping them off to $125. In many cases, this plants a seed in the buyer’s mind that all your prices are overpriced and you are dishonest, which is not the outcome you want.
Value-based Pricing – With this pricing method you must determine the benefit the buyer will gain from each item and then decrease it so that both you and the buyer share some of the benefits from the purchase. This method works for physical products, software, and services, but does not apply well to spare parts. Where used appropriately, it is the most manageable price to defend and works well when your sales pitch includes an ROI.
Competitive or Market-based Pricing—In this method, the person setting the pricing standards looks at competitive prices and works backward to see the financial results of matching or slightly beating these prices.
However, the big problem in this pricing model is finding a competitive price for a complex or custom part or service. There may not be one publicly available for use as a reference point. In some cases, you can instead make an educated guess that comes close to the actual competitive selling price. However, because you may not know if your educated guess is accurately compared to other market standards, this approach is not safe to use across the board under all circumstances.
Selecting the Right Pricing Model for Your Products and Services
My British friends have a great expression – “Horses for Courses” – meaning something has been chosen because of its specific qualities or unique skills. In other words, depending on the circumstances, choose which pricing approach you will use for each unique situation. It does not have to be a one-size-fits-all or one-pricing-model-applies-everywhere approach.
In every case, make sure you make enough profit to keep everyone happy without feeling as though you either gouged your customer or left money on the table. Listen to customer feedback and heed market changes to ensure you’re maintaining the flexibility needed to be successful – both with your bottom line and in satisfying your customers.
To learn how to price spare parts, click here.
About Middlesex Consulting
Middlesex Consulting is an experienced team of professionals whose primary goal is to help capital equipment companies create more value for their clients and stakeholders. We continue to provide superior solutions to meet our clients’ needs by focusing on our strengths in Services, Manufacturing, Customer Experience, and Engineering. If you want to learn more about how we can help your organization understand and choose a pricing model, please contact us or check out some of our free articles and white papers here.
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