Recently through a series of misadventures, I bent one of the bolts that keep my car’s Brembo brake calipers in place. I could not find the specific replacement part nearby, so I borrowed one that is ¼” shorter and, with some adjustments, I was able to make it work as a temporary solution. When I returned home, I took my car to the shop and ordered a replacement. A short while later, the mechanic called and told me the only option he found was to order a pair of replacement bolts at a price of $225. We were both in shock, but since that is the only bolt that will fit my car and they are only sold in pairs, I agreed to pay. I also realized the seller understands how to price exclusive and specialized products.
Some people might think the seller was gouging me by charging that much for a 5” bolt, and that was also my initial reaction. However, after thinking about it, I concluded the seller was simply pricing strategically. The bolt is a specific size and shape not used elsewhere; it is a critical component of the braking system, so customers are very unlikely to just do without; and there is only one manufacturer of it. In short, it is a specialized and exclusive product that rarely needs to be replaced and customers generally have a high willingness to pay. The manufacturer smartly ignores the cost to produce the bolt, and prices it high, reflecting its exclusivity.
Unfortunately, not all companies are that strategic when setting prices on their specialized and exclusive products. We have spoken to and worked with prospects and clients who just add a target margin to their costs when setting prices, regardless of how specialized their products are. Our advice to them is price to value, and specialized products tend to have higher values. So, the first step is – estimate the value to your customers. Remember – value is a measure of how your product affects the customer compared to their next best alternative. Specialized and exclusive products have few substitutes, so it is not simply a matter of identifying competitor prices.
To estimate value when there are no direct substitutes, consider a few simple questions:
- Would this product improve the buyer’s revenue generation capability?
- Does it add new capabilities to the buyer or enable more efficient revenue generation?
- For example, higher and more certain up-time in production equipment can increase production
- How much incremental revenue could be generated by using this product?
- Does it add new capabilities to the buyer or enable more efficient revenue generation?
- Would this product reduce a buyer’s direct costs?
- Can the product eliminate other products or manual tasks?
- How much money could it save the buyer?
- Would this product reduce a buyer’s indirect costs?
- How and by how much?
- Remember, buyers often place a lower value on reducing overhead costs as compared to reducing direct costs.
- Could this product reduce physical or regulatory risks?
- Lower costs of compliance or insurance savings have value
In my case, the bolts reduced risk and lowered my direct costs. My next best alternatives were (1) my temporary solution with the slightly shorter bolt, (2) find a junkyard who had the bolt or used calipers, or (3) new calipers. Sometimes I drive that car on a racetrack and a brake failure could be catastrophic, so option (1) was too risky. My online searches for new or used substitutes only resulted in options to buy a set of new replacement calipers, for close to $1,000. I may have been able to find used calipers or maybe even a used bolt if I had been willing to spend more hours looking for them. However, my time is worth something, and I was not inclined to spend it on more searching.
Estimating value to customers is just the start. You still must set a price and it should not equal the full amount of your value estimate. If the customer does not benefit at all from buying your product instead of the next best alternative (because they paid it all to you), there is no reason to buy from you. For example, it would be foolish to try to sell me the caliper bolt anywhere near $1,000, because, at that price, I would rather have completely new calipers. Also, the higher the price of the replacement bolt, the more inclined I would be to spend time looking for alternatives.
It is important to remember your estimates of value to the customer are not guaranteed, and when customers pay upfront, they are taking a risk. They are investing in potential benefits, and they will be expecting a return of four or five times their investment. Make sure your price gives them a healthy return on that investment.
As usual, these are generally simple concepts, but they require detailed actions. The key is to be disciplined, follow the process in detail, and avoid taking shortcuts. It can be tempting to use rules of thumb and set prices on groups of products using common margin targets, but that leaves money on the table. Many companies have made substantial profit improvements by identifying their specialized and exclusive products, estimating their specific values to customers, and raising prices accordingly.
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