A recent article in the Economic Times reports how information technology services firms have started passing on rising talent cost to clients. According to this article, there is a 4-7% increase in rates for certain types of software projects. These increases reflect, in part if not wholly, the scarcity of digital talent all around.
Every now and then, such news appears in an industry where shortages occur. The automotive industry’s chip shortage is a recent example. Semiconductor chips were in short supply, and car prices went up – even used cars became expensive.
That gives us an opportunity to reflect on how firms look at pricing – and whether there is room for them to do anything differently.
Setting prices based on your costs
Taking all your costs and adding a margin seems to be a foolproof way of arriving at a price. If you sell at that price, everything should work out, right? Well, maybe not. On one hand, you may be charging too much because your costs might be high. There may be inefficiencies on the supply side to address. On the other hand, you may be charging too little and leaving money on the table. The customer may derive greater value for your offerings than you are aware of. In short, going with a cost-plus pricing is unlikely to create advantages especially in industries that offer scope for change and innovation.
Setting prices by looking at your competition
Looking at how your competition is charging fees and placing your rates slightly at a premium or at a discount is another way to go about pricing. This appears to be a better approach, because your offer remains competitive, and any pressure for creating margins is passed back on the delivery side. This is price-led costing. That should take care of inefficiencies, right? Many companies adopt this approach and suffer because it is nearly impossible to replicate the precise advantages that allow competition to set prices in a certain way. The competition may have economies of scale, scope, or some unique supply- or demand- side advantages that don’t apply to your firm. So, if you simply copy the prices and not the value chain, you are in for trouble.
That brings us to a third perspective. How about setting prices to maximize value?
Setting prices to maximize value
Every firm’s strategy is based on a handful of foundational decisions: Who do we serve? What are we good at? How do we position ourselves?
The first question is about the segment of customers the firm aspires to serve particularly well and derive most profits from. The primary segment could be based on industry vertical, geography, size, or a combination of these and other criteria. This segment must obviously be attractive and underserved in some way or the other.
The second question is about unique advantages. What makes the company particularly good at serving these customers? Is there a unique technology, a proprietary asset, a captive distribution channel, a strong brand, or a group of expert individuals that create unique value for this market?
The final question is about helping the customers perceive the difference. How can they tell you are different from others? Why does the difference matter to them? And how much does is matter to them? In short, why should they prefer you over others and pay you more?
Armed with answers to these questions, the firm can approach pricing to capture value.
Questioning the Pricing Paradigm
As author Ron Baker argues in ‘Pricing on Purpose’, a company’s existing pricing paradigm can blind it to opportunities for creating and capturing value. If an IT firm’s pricing paradigm is wholly based on billable hours of IT professionals, a host of value-creation opportunities disappear. Instead, if we are open to align the pricing paradigm to the value a customer derives, new opportunities are open. Customers may be willing to license pieces of software they don’t need to own. They may be willing to pay more for faster implementations. They may be willing to make concessions on the composition of project teams in exchange for performance guarantees.
Most of us know this: Customers get what they pay for. As business leaders, we must look at the flip side: We are what we charge them. Pricing must reflect a company’s entire strategy – its field of play, its unique capabilities, and its value proposition. Pricing is not about copying competitor’s prices. It is about making your value proposition hard to copy.