You know those infomercials that offer you a $50 “value” for only $19.95? Who are they to tell you what the value is? How do sellers decide what to charge? They usually decide on that value in one of four ways:
The first two methods have the advantage of being reasonably easy to calculate, and are grounded in objective reality; the third method is not worth commenting on but all too common.
Value-based pricing is usually a major improvement over the first three “inside-out” approaches, because it forces the seller to think from the outside-in, and look at pricing from the customer’s point of view. Depending on what’s being sold, it can provide an excellent way to break out of the commodity trap and realize a premium for their product.
But when we get into the world of complex B2B sales, there are two serious flaws with VBP. First, it can be enormously difficult to precisely calculate the value a product brings to customers in general and even more so for specific individual situations. It requires a lot of knowledge of their business, their markets and their processes. Customers themselves, who know more about their own businesses than the salesperson ever will, often don’t know what something is worth to them until they buy it and apply it, and even then the question usually remains unasked and unanswered. What’s the value of a glass of cold water? It depends on whether you’re in a restaurant or on a desert island.
Second, VBP is not always realistic. There is a very loose connection between perceived value and the actual price someone will pay for something.
In B2B selling, VBP generally is better than cost-plus and me-too pricing, but it’s still not the complete answer to the question of what something should or could be sold for. There is another way, called Willingness to Pay (WTP). It combines the realism of cost-plus and me-too with the customer focus of value. It’s real because it’s proven in daily experiments called transactions. You can conduct focus groups or talk to customers all day long to find out what they value, and none of that information will amount to a hill of beans until you test it by having people put their money where their mouth is. Ask them to make a decision. The decision is simple: will they buy your product for the offered price?
WTP is customer focused because it resides solely in the mind of the customer. It is personal, situational, and psychological, which is the world that salespeople live in. As we’ve seen earlier, even a $20 bill can have a wide range of different values, depending on the customer’s situation or state of mind.
Value will tell you what something is worth, but not what someone will pay to get it. Buyers care less about what something is worth than about how little they can part with to get it. Sellers care less about what something is worth than about how much they can get for it.
Value is theory, but WTP is reality. The key word is pay. Pay implies an actual decision that carries consequences. The decision costs real dollars and may be subject to questioning by others. I may think something is “priceless” or extremely valuable to me, but would often balk at paying what something is worth to me. Someone may write a book whose advice can literally change your life and make you tons of money, but you would never pay thousands of dollars for it.
If you ask people what something is worth to them, their answers are essentially meaningless, because they may not know exactly how they feel about something until they have to make a decision—to put their money where their mouth is. It’s measured every day in the decisions that buyers make, the purchases they close or the deals they walk away from.
The greatest drawback of WTP is that it can be complicated and difficult to figure out for each individual buyer, because there are so many factors that can bend the number up or down. But that complexity also furnishes the best opportunity for a prepared, informed and ingenious seller to find myriad ways to structure an offer that provides the best win-win outcome for both parties. In the next article of this series, we will dissect that complexity and examine the anatomy of willingness to pay.