Pricing power is a simple concept. It really reflects the ability of the selling entity to set or raise prices to the point where they capture the value provided to the buyer. I have written about the USWNT players’ personal pricing power and pricing power in healthcare, however, occasionally there are external factors that seem to limit a company’s ability to use their pricing power. When that situation occurs, remember there are multiple components of price – the value you capture is not limited to the price of your product or service.
Kawhi Leonard recently gave us an excellent example of capturing multiple components of price while exercising his pricing power. Leonard was a highly coveted NBA free agent. He had recently led the Toronto Raptors to the NBA Championship, and won the Finals MVP in the process. He could sign with any team, and several teams were prepared to pay him huge amounts of money; however, the NBA salary cap rules set a maximum on how much each team could pay. His current team could pay more than any other team, but Leonard realized other teams would pay more if allowed. So, he looked for other ways to capture value.
In addition to being paid a ton of money, Leonard wanted to go to a team with a chance to win a championship. The LA Clippers would be contenders if they signed Kawhi, but other teams had potentially stronger lineups. Leonard told the Clippers they needed to trade for Paul George, another superstar, as part of any agreement for Kawhi to join them. To close the deal, the Clippers traded a record five future draft picks, plus an agreement to swap two more picks with Oklahoma. Although Leonard was limited in how much money he could be paid, he ultimately captured much more value than the headline price the Clippers are paying.
It is not hard to put that NBA free-agent transaction in the context of any business transaction. For years in most industries, buyers have agreed upon a price with sellers and then requested other concessions. A Procurement VP at Pepsi once referred to those concessions as the “free stuff.” McKinsey developed the concepts of pocket margins and the waterfall in recognition of sellers making those concessions. Kawhi simply executed the converse of the waterfall and extracted some concessions from the buyer.
We can imagine other scenarios where a seller should have pricing power but it seems like it is limited – where the seller adds more value than the buyer’s next best alternative, but something limits the buyer’s ability to pay. For example:
- The buyer has limited funds remaining in the current period budget
- There are statutory rules that limit how much more than the nearest competitor a buyer can pay
- A buyer is measured on “savings” and is worried about the optics of paying much more than competitor prices
In these situations, it is critical to identify all the potential sources of value you offer and try to capture those as the seller. Years ago airlines began offering non-refundable tickets in exchange for lower prices. The buyers were price sensitive and looking for lower prices. Non-refundable tickets gave the airlines more certainty of the revenue stream, which is a source of value to them. Similarly, many hotels will offer lower prices for travelers who pay up front. In the B2B world, that would be similar to decreasing payment terms from 45 or 30 days to 10 or 15 days in exchange for a slightly lower price.
Anytime a customer or prospect tells you they prefer to buy from you, but something is restricting their ability to pay your price, consider your options to extract more value:
- Accelerated payment terms as in the example above
- Auto ACH where you draw funds from the customer bank account upon delivery of the product
- Standing orders or automatic shipments where the customer agrees to place an order for an extended period of time. You, the seller save some sales expense and reduce the number of times the buyer needs to choose between you and competitors.
- Consolidated shipments to reduce your pick, pack, and shipping costs
- Separate fees for services that you provide that differentiate your offer versus competitors
- Restocking fees for returns
You get the idea. The point is not to change your business model. It is to identify ways to capture more of the value you provide your customers. You can lower your cost from your standard business model in exchange for a price that is lower than the true value you provide to the customer, or you can charge separately for certain features that are competitive differentiators while charging a product price that is similar to competitors.
When McKinsey developed the pocket margin concept, their point was you can’t simply measure prices because you may be giving value away to customers in other areas. The reverse is also true. If some factors are limiting your ability to set a price that captures your value, look for other ways to capture that value – like Kawhi Leonard did.
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