The pricing envelope: setting minimum prices

One of the areas where pricing and sales often collide is the setting of minimum prices. For companies that produce physical goods there is a clear floor to pricing: you want to cover production costs and overhead. For software and services however, marginal costs are often very low. In theory low to negligible marginal cost mean that each dollar of revenue is effectively a dollar of profit. In practice this rationale doesn’t hold. Below are 8 points to consider when you set minimum prices and when you deviate from minimum prices.

1.    Operational margin
What is your operational margin, and how high do you need it to be? At a high level, you need to take into account overhead and growth cost to make sure your pricing is sustainable. Especially in high growth organisations cashflow will become a problem if you set minimum prices too low.

2.    Customer acquisition cost and break-even
For subscription models you may spend more on customer acquisition than the first year revenue of that customer. This makes sense if you expect customers to remain subscribed for a long time, i.e., multiple years. Most investors will expect that the break-even point for a contract is reached in about 18 months (less is obviously better). This approach requires a lot of investment upfront but once you have a customer base with steady subscription revenues it quickly becomes sustainable.

3.    Lifetime value of the acquired customer
Some organisations have a lot of potential to grow. When you sell to a subsidiary of a multi-national company you may land additional contracts in other parts of the organisation or create upsell and cross-sell opportunities. Under these circumstances a low price can make sense. It is important to make sure that a small deal would also have a small scope, so that you can secure a larger contract down the line. Also, this approach should not occur outside of your targeted accounts.

4.    Opportunity cost of pursuing smaller deals in favour of larger deals
Your sales teams can only do a limited number of deals per year. How many mostly depends on the length of the sales cycle. Small deals do not close a lot quicker than average sized deals. When you allow sales executives to work on small deals they will lose that time in their schedules to work on more profitable deals.

5.    Establishing a beach head in a new segment, geography or customer organization
When you have no existing customers or customer references in a market that you want to enter you will consider ‘buying the market’ with a deal below minimum price. This should always be a targeted effort because in the long run it is not sustainable. Consider that customers in the new market might not be price sensitive at all. They might hesitate to buy from you because of risk perception or because they do not know your brand. If this is the case you can think of alternative solutions to dropping your price.

6.    Windfall deals
At times inbound deals pop up where the buyer has already made a buying decision and the sales process is very short. Often these deals represent small customers that may not be able to afford your minimum price. In these cases the cost of acquisition in minimal and applying the average acquisition cost does not make sense. These deals can be healthy if the customer is not expensive to serve, and the the low price does not set a precedent for other customers in the same segment.

7.    Perception of price and quality in the market
Customers talk. When you do business in a tightly connected segment or a small country your customers will have a sense of what the neighbours are paying for a similar deal. Although your sales executives can explain the differences between deals, you do not want to destroy your own price point in the market. Don’t discount below your minimum price for a middle of the road deal: more important customers will ask you for the same level of discounting.

8.    Operational burden and effort to serve
How much does it cost your organisation to serve a customer? If you have a costly tailored approach to implementations and support you cannot afford to bring on many small customers. It would be more efficient to bring on fewer larger customers. Needless to say, your operational approach should be in line with your target market.

General advice

Create clear guidance on the minimum prices you want your organisation to use. Follow up on the prices quoted to customers and make sure that exceptions are handled by a deal desk function. This is the only way to prevent every deal becoming an exception and to monitor that your minimum prices are appropriate.

It is hard to make sales executives walk away from deals that they are personally invested in. Instead, be tough on qualification and sales process upfront to make sure your sales executives invest in the right deals (and drop the bad ones quickly!). 

Only sacrifice minimum prices temporarily for designated target markets and key accounts. Treat exceptional deals as marketing costs on which you want to see a return on investment. Do not allow exceptions to minimum prices outside of your target segments, or at least ask yourself if you would be willing to spend marketing budget on the acquisition of the ‘exceptional’ deal.

When confronted with many small opportunities below your minimum price, ask yourself if this can be a separate segment that can be served at a lower cost. Some ways to achieve this include: selling via other channels such as partner sales, simplifying the offering for customers with fewer needs, creating terms of service that reduce the cost to serve, and offering a more basic SLA. Keep in mind that the new segment should be large enough and profitable enough to warrant such a drastic move.

Focusing on a single segment with alike customers allows you to optimise processes and reduce the cost to acquire and serve a single customer. This gives you the option to either increase operational margins or offer lower minimum prices.

Lastly, both small and large deals can hurt pipeline velocity. What is often overlooked are the potentially very large deals that sales executives will pursue for years without a clear compelling event in the customer organisation that forces a sale within a reasonable timeframe. Deals that are twice the size but also take twice the time to close, bring in the same revenue per unit of time. These ‘whales’ in your pipeline can really drive up the average customer acquisition cost and, indirectly, your minimum price.

If you'd like to work through some of these considerations and do a workshop to look at minimum prices in your organisation, please reach out via the contact form.