LOWERING THE TOTAL COST OF OWNERSHIP
Three ways companies can charge more in tough B2B markets
By IMD Professor Stefan Michel - November 2014
Although "trust," "brand" and "reassurance" do matter to most B2B buyers, companies wanting to charge a price premium generally have to make the numbers work. This means showing the customer that their product or service generates economic benefits despite the higher price. They can do so by positioning what they sell in three different ways:
The first two approaches save the customer money by lowering the total cost of ownership (TCO)—including the cost of acquisition, possession, usage and recycling/disposali. The third way, by contrast, is revenue-based. But all three approaches allow the supplier to charge a premium by shifting the focus away from the price and establishing a different reference—that is, by moving from a product view to a solution view.
Saving money in the future
The first approach can be easily illustrated with a remodeling project for a single-family home (see table below). Provider A offers insulation for €25,000 that would reduce energy consumption by 81 kWh/m2, while provider B charges a higher price of €28,900 for much better material that will cut consumption by 103 kWh/m2.ii
Provider B charges a price premium of €3,900 compared with provider A, or 15.6% more. However, over 20 years, and assuming that the price of energy increases by a moderate 5% per year, the savings with provider B's insulation are more than €7,000 greater than with provider A. Net savings are also greater with provider B (see graph below).
Saving money somewhere else
The second approach refers to a situation in which a product should not be directly compared with a competitive offering, because it changes how the customer creates value. Consider an innovation by Bossard, a Swiss fastener company, which removes the need to lubricate fasteners on factory assembly lines (disclosure: I am a member of the board of directors of this firm).iii
Assume that 40 fasteners are needed to assemble a coffee machine, 10 of which need lubrication for sealing and anticorrosion. If each of those 10 fasteners takes 10 seconds to be lubricated, that makes an extra 100 seconds of work per machine. In addition, the mechanic has to handle all indirect work related to the lubricant (procurement, inventory, cleaning, etc.), which adds another 30 seconds on average. So in total that's more than two minutes of extra work per machine.
Bossard addressed this problem by inventing Ecosyn-Lubric screws, which are pre-lubricated with a dry coating and do not require any handling and cleaning on the assembly line. The assembling company therefore saves a little over two minutes per coffee machine. Based on the full cost for a Swiss worker of CHF 56.30 per hour,iv the saving is CHF 2 per machine, or CHF 0.20 per screw.
Based on these numbers, Bossard can charge more than the competitor's price of CHF 0.15 per screw but no more than CHF 0.35 (see figure below). However, there might even be a higher willingness-to-pay (WTP), because pre-lubricated screws guarantee a more consistent and less error-prone usage than manually lubricated ones.
The hidden benefit of this approach has to do with superior customer insight. Companies such as Bossard can never win on price and are forced to understand the economics of their customers' processes. This insight is not free—it requires substantial investments in relationship building and workflow analytics. However, because Bossard understands customers' economics, it can further innovate and improve its processes. This is a strong differentiator in an otherwise commoditized fastener market.
Generating higher revenues
The third approach involves showing how a better product leads to higher revenues that outweigh the higher costs. A good example is Hiestand, a Swiss industrial bakery that provides ovens in which fast-growing convenience stores can bake frozen croissants and rolls to perfection. Hiestand offers to provide the oven free of charge including installation, maintenance, and required training, so the stores only pay for the croissants and other bread products.v
Store owners quickly point out that the oven is not really "free" and requires a lot of shelf space. This means opportunity costs in terms of lost revenue of CHF 20,000 per square meter per year, adding up to CHF 60,000 if the oven occupies three square meters. Even if the fresh-baked croissants sell better than regular ones and justify a small price premium, this comes nowhere near to compensating for the CHF 60,000 in lost revenue.
However, the economic benefit of the oven comes not from selling more croissants but rather by increasing the overall traffic in the store and at the gas station. Baking bread creates a wonderful scent that makes people come back more frequently to fill their tanks, eat a small breakfast, and do a little daily grocery shopping. Hiestand demonstrated this effect by comparing the sales revenues of stores before and after the ovens were installed, proving that store owners can increase profitability despite spending more on croissants and sacrificing precious shelf space.
Shift the focus
Getting cost-conscious B2B customers to pay a higher price isn't easy, but it can be done. Companies that want to charge premium prices generally need to make a savings or revenue case so that the conversation with the customer is not just about price. If B2B companies can get this right, gain the customer's trust, build a strong brand and maybe even add a little emotion to the mix, then the promised land might become reality.
Stefan Michel is professor of marketing and service management at IMD, where he directs a blended learning program on "Pricing Excellence in Tough B2B Markets." This article is part of the course on Value-Based Pricing. He will also direct a new IMD "Global Leadership in the Cloud" program on pricing. For more information on this new program, please email email@example.com
He also directs IMD's EMBA program.
i Cespedes, F. V. (1994). "Industrial Marketing: Managing New Requirements," Sloan Management Review, 35, p. 47; Hutt, M. D., & Speh, T. W. (2012). Business Marketing Management. Stanford, CT: Cengage Learning, p. 47. I added "recycling/disposal" since these costs can be quite significant and will likely increase in the future.
iii Fasteners are screws, nuts, and bolts. But "mechanical fastener" sounds much more technical. Similarly, glue producers are in the business of "chemical fasteners."