B2B specialty products are building blocks in complex industry value chains. The firm developing a new specialty product is two or more links upstream from the ultimate end users. Understanding of the financial value of the product in solving the end users’ problem comes indirectly, and often distorted, from the firm’s customers.
How does a firm set pricing for the product when they are dependent on their customers for information about both the problem end users face and the financial value of the solution? How do they know their customer’s information about end users is current or correct? Without unbiased knowledge about the value to end users, the product developer may default to cost-plus pricing.
Cost-plus pricing is simple but leaves too much profit and revenue growth on the table
Product developers use cost-plus pricing because it’s simple. There are two steps. First, calculate the cost of production. Second, add a portion of this cost as markup for the firm to earn its target rate of return. Cost-plus pricing needs no understanding of the financial value the product creates for the firm’s customers or for the ultimate end users.
Understanding what end users judge as the value of the product helps the developer capture more of the financial value they’ve created. Such understanding in the case study profiled later helped a specialty product firm capture $5 million a year more in profit and resulted in 25% revenue growth.
Understand the value your specialty product offers to downstream users
For a B2B specialty product, price isn’t the most important question. Rather, what is the end user trying to achieve? What is the end user’s most severe pain point? What is holding back an end user from recognizing the value to them inherent in the new product?
Catalytic questions1 help make sense of what users judge as financial value and how much they will pay. Such provocative questions start with: what is, why not, what if.
Two obstacles keep specialty product developers from asking catalytic questions. One, how does a developer determine that their customer, usually a key account, is informing them correctly of what the ultimate end users consider as value? Individuals will sometimes shade the truth for reasons that make sense inside the customer’s organization. Two, how does a developer, without serious disruption of relationships with the developer’s customer, independently determine the truth of what the ultimate end users see as the problem and assess as value?
Interviewing by an objective third-party can find out what ultimate end users judge as value
Case Study: Identifying the “right” problem produced $5 million/yr more in profit
A value-pricing research project for a client began because an important customer of the client asked for a cut in price for a specialty product. The product was a major building block in their customer’s product. Their customer’s customers, the ultimate end users, were oil companies. The client’s customer insisted the client needed to lower the product price or else end users would replace the customer’s product by a radical new product.
Synthesis of the specialty product took purpose-built equipment and was labor intensive. After several failed development efforts to cut labor costs by experimenting with equipment automation, the client engaged me to understand how the end users valued the customer’s product.
As a series of elicitation interviews with individuals in the oil companies progressed, I heard the need for lower price from procurement agents. When I interviewed supervisors of the equipment using the customer’s product I also heard the need for lower price.
However, as the result of catalytic questioning, I uncovered and verified the true financial value to the supervisors. They had more than two decades of smooth running using the customer’s current product in expensive purpose-built and long-lasting equipment. They were not about to exchange this experience for building a new piece of expensive equipment for an untried product.
Next, without disclosing the client’s identity, I interviewed key individuals in the client’s major customer. I discovered the high priority for the customer’s radical new product came as a top-down directive from their CEO. Remarkably the customer’s market research expert understood the end users’ real problem but because of a political minefield did not tell the client.
With the knowledge and analysis gained from the interviews, the client developed a price increase presentation to their customer. The confident presentation made it clear the client understood the financial value to the end users of the product containing the client’s building block. It also laid out steps the client would take for major price increases in the specialty product over the next few months.
The price increases were instituted. The customer passed along similar price increases in their product to the end users.. The client captured $5 million more each year in profit and the revenue delivered by the product rose by 25%. (Sales volumes have increased in the 20 years since these and subsequent price increases were initiated.)
the financial value of a new or current specialty product to the ultimate end user.
1. (2007) Nickerson, J., Sillverman, B., and Zenger, T The “problem” of creating and capturing value Strategic Organization 5 pp. 211-225