Pricing is one of the most challenging decisions that small business owners must make. It determines revenues and profitability; it communicates value; and ultimately is responsible for the success or failure of a business. Setting a price becomes even more difficult when the company in question is selling something complex that includes both a product and service component. Software that requires upfront integration and ongoing maintenance is a typical example. These complex sales if priced incorrectly can lead to dramatic losses on an unprofitable deal or turn the potential client off entirely. With so much at stake, business owners need to invest time in studying how to price.
Challenges of pricing complex sales
Complex sales are difficult to price for several reasons.
First, there are too many unknowns. Unlike a simple packaged good, a complex sale requires performance over a prolonged period of time during which a company’s cost structure, financial health or focus can change. They usually also require upfront customization, integration or consulting with the level of effort varying dramatically from client to client. Setting a firm price in the face of so many unknowns is difficult.
Second, execution of the sale usually involves multiple cost centers each with their own drivers. An enterprise software sale could easily include ten or more cost drivers each responding differently to given circumstances. Understanding each driver and the interplay between them is essential for ensuring that pricing covers potential changes in costs.
Finally complex sales tend to have a long sales cycle. It could easily take 9 to 18 months from initial contact until a deal is reached. During that sales cycle costs can vary dramatically, invalidating any price that may have been given to the client at the beginning of the negotiation.
Manage pricing risk risks
Managing these challenges is feasible with proper planning.
Provide pricing ranges not specific prices at first. Both buyer and seller need to have a general sense of how a contract will be priced. This is important to ensure that you don’t waste further time if you plan to price in the $500,000 range and the client expects to pay $20,000. Giant differences like that are very difficult if not impossible to overcome. But beyond a range, its best to avoid locking your company to a set price until you are able to secure more information. A tolerance of 10 to 30 percent is a guideline for ranges but should be adapted to your industry. Don’t be afraid to aim high at the top end of the range. This will leave the customer pleasantly surprised when your final price is in the middle.
Agree to a pilot project before establishing specific pricing. Pilot projects serve as “limited-scope test runs” that benefit both the buyer and seller. The pilot allows you the opportunity to assess the true effort required to execute on a full-scale engagement for the client. This leads to better pricing decisions. It also allows the client to test a limited version of what you offer and identify what features they want and which ones they can do without. The pilot also allows you to determine how much value your solution offers the client. The greater the value offered the higher the pricing that the project can support.
Be flexible. Contracts with clients for long-term, complex sales should always include clauses that provide some flexibility if circumstances change. This flexibility includes: renegotiation of the contract if material changes take place; separate budgets for customizations not envisioned in the project; adjustments to price based on changes in key cost drivers and more.
Use a pricing structure that reflects the cost model. A good pricing strategy will take into account the timing of the incoming cash from the client, the overall profit margin and the recurrence of the revenues when calculating price. All costs should be taken into account when establishing the price, including interest costs if you need to borrow money to execute the initial part of the sale. Many complex pricing models include an upfront fee for “onboarding” plus annual recurring fees for the service.