What is Economic Value Pricing and How Can it Affect Your Pricing Strategies?
Pricing strategies can be affected by what is known as Economic Value Pricing (EVP), or sometimes called Return On Investment (ROI) based pricing, and is often portrayed by academia with little or no experience of real-world sales and value-based pricing as the ultimate way of pricing a product or service, but unfortunately, it is not.
Economic Value Pricing is a pricing strategy for B2B sales and less so in B2C sales. The idea of EVP is simple. A customer buys a product or service that generates savings or additional revenue (the "Economic Value"). Then the seller, using a pricing method, sets a price as a portion of that revenue increase or saving.
Why Your Pricing Strategies Will Fail if You Use EVP
And here it breaks down. In almost all cases, it is impossible to accurately calculate the actual economic value of a new product or service. Consider this:
A small company with, for example, ten salespeople is planning to replace its current CRM software with a different CRM software. The reason they would do so would be to switch to a CRM with more automation so that sales would be more efficient. But by how much? Will their sales volume go up by 2%? Or 10%? Or 25%? And in addition to the software licensing fee, there is a switching cost, cost of integration, and uncertainty about how much selling time is lost as the salespeople need to be retrained and get used to using the new CRM? Is it hours? Days? Can that cost be accurately projected? Probably not. There is also risk involved – some salespeople cannot work as effectively within the new CRM's constraints. Perhaps the seller of the new CRM has some statistics on the financial impact the installation has had on other companies. Still, every company is unique so those stats may be valid or not, depending on each company’s specific circumstances. The buyer knows this and, for that reason, is unlikely to believe the seller's economic value claim.
A manufacturer wishes to replace a manual manufacturing process with robots, and calculating the staff cost savings is easy, but the value of using robots may not be. There might well be an increase in productivity, and the economic value of that productivity increase can be accurately projected. There might be an increase in consistency and quality, which in monetary value is more challenging, if not impossible, to calculate. But what happens when a robot breaks down? Will production stop? Or slow down? If a manual worker for some reason does not show up at work, others are likely to pick up the slack. And there are other questions. Like: How well will the robot manufacturer support the product? How long will the installation take? As opposed to what is promised. Can the manufacturer trust claims of the robot's quality be believed? Does the manufacturer need to employ (expensive) workers to program and maintain the robots? Will installing robots in one manufacturing line lead to worker unrest and reduced productivity in other manufacturing lines? Questions to which there are no honest, dependable answers make an economic impact calculation impossible.
Finally, here's a personal reflection on Economic Value Pricing. I'm a member of several networking groups. I have several reasons for this. I want to learn from other members, meet interesting people, and ultimately drive business to my company. Not necessarily from other members in these groups, but more likely via referrals. As can be expected, none of these groups make any promises that I will get business at all, but they do come at a cost. How can I calculate the economic value of what I learn from other members? Well, that’s impossible. How can I calculate the economic value of referrals? Again, impossible to do in advance. How can I calculate the value of meeting interesting people? And the list goes on.
More Irrelevant EVP Issues
There are more issues making EVP irrelevant. Few companies are willing to "open the kimono" with such detail that a seller can accurately calculate the economic value of a purchase, and a buyer is further unlikely to believe the various assumptions that a seller makes in such a calculation. The buyer, however, is much more likely to make the calculation and will virtually always do it when it involves a significant capital spend. But again, there will be many assumptions in any economic value calculation, so, in the end, and even with the best intentions, it will be indicative only. Finally, a company's chance to share its internal economic calculation with a vendor is low.
Now, suppose you are the seller, and you manage to get an as-accurate-as-possible economic value calculation done. In that case, whether you, as the seller, made the calculation or through customer analysis and shared the customers shared their findings with you, we still come to the big question: What portion of that calculation will you, the seller take? 1%? 10%? 50%. So, in the end, from a pricing strategies perspective, it has been a futile exercise as the seller still doesn't know what to charge for the product or services sold and still doesn't know how to price the product or service. Maybe the seller thinks 15% is reasonable, and the customer says 5% is reasonable. Or maybe by sheer luck, both parties separately come up with the same percentage number, which in my experience, happens rarely.
So what does academia say about Economic Value Pricing? Well, one article from one of the most well-known and respected business schools in the nation came up with this brilliant recommendation: "Do not price your product or service higher than the economic value calculation." Right. I don't think anybody needs to attend business school to gain that valuable insight. Do you?
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