By Al Hahn
Baseball is supposed to be “Americas game” so a baseball metaphor seems appropriate for a discussion of pricing services (sorry football, basketball, soccer and other sports fans). There are two baseball terms I would like to use, so allow me to define them. The first is the "strike zone." This is a region into which a pitcher attempts to throw the ball in order to either get the batter to swing or the umpire to call a strike. It is (please don't notify the Little League authorities if I don't explain it correctly) the area that is bound by the batters knees and chest, and over the home plate.
The other term I wish to use is "sweet spot" Some people use this to refer to their preferred spot within the "strike zone", where they can really hit the ball well. In tennis, this is the area in the center of the racket where you can get a real solid hit on the ball.
There is a growing perception that you have to hit some magic "sweet spot" with your pricing in order to sell service/support contracts effectively. Some companies, particularly those involved in lower end product service and support, think that if your prices are in the "sweet spot", you will get the majority of the business that you bid on.
No "Sweet Spot" For Services
Well, it just isn't so. Prices only have to be in the "strike zone" of the marketplace to be effective. The "sweet spot" theory comes from the belief that service/support contracts are commodities and they are all alike. If this were true, the "sweet spot" might be more relevant; but service/support are not at all alike. I should know, my company provides competitive data and analysis for hundreds of services each year. Service/support contracts, and their prices, are all over the place. There are many differences. Even within a given company's portfolio it is common to find many different levels of service performance: different response times, different hours of coverage, etc. There are also different packages of features. You can have the Bronze, Silver or Gold; Economy, Basic, Cooperative or Premium; the Value-Pack, etc. It just goes on and on.
Those that favor the "sweet spot" theory will argue that it is a phenomenon of low end products, and there is little differentiation in that market. If this is true for you, then check out the folks selling soap, sugar, salt, dead chickens and many other so-called commodities. You could learn a few badly needed skills from them. Real marketers differentiate their products and services. Watch your own buying behavior. Do you prefer a brand of automobile, deodorant, gasoline, shoe polish or even water? What about services? Are you loyal to your broker, hair stylist, cleaners, gas station, overnight delivery service, dentist or bank? Most people do not give all their business to the lowest cost provider. In fact, research shows that only 10 percent of service/support contract buyers are price shoppers.
Two Different Buyers
It works like this. Let's say you are a golfer hoping to improve your game. Investing in lessons and spending lots of time at the driving range, or practicing your putting would probably be the best things to do. You're not in the mood, however, for work. How about some nice new clubs instead? Those titanium "woods" really sound like the hot ticket. So you check them out at your pro shop or sporting goods store. You admire their sleek looks and light weight. Then you try out the feel of some. The prices, however, are a shock. It’s easy to spend $500 or more on titanium. If you're like most buyers, you consider your alternatives, but they don't really excite you... You imagine your friends' envious looks when you unveil your new titanium clubs, and their gasps when you outdrive them by 30 or 40 yards off the tee. Eventually, you rationalize the high price and charge them on your credit card. You don't like the price, but you tolerate it.
True price buyers operate differently. They would start out shopping the bargain bin of discontinued clubs or the close-out sales. They might be interested in titanium, but not at premium prices. Eventually, they buy the clubs they like best out of the sale merchandise.
There you have it. Two different types of buyers. The good news is that 90 percent of service & support contract buyers are like the first type. They select what they want, then see if they can afford it, or ask purchasing to negotiate a better deal for them. It is the service package that motivates them, not the price. This fundamental understanding of buying behavior is important in pricing services and in negotiating their sale.
The Marketing "Strike Zone" Of Pricing
But how does this relate to my "strike zone" theory? Marketers pricing services should recognize the size of the "strike zone" in their particular market. Let's examine software support pricing, as an example. Many companies offer three different levels of support. I'll call them Basic, Standard, and Premium. Common practice would be to price them at 6-10 percent, 16-18 percent, and 22-25 percent of product list price, respectively (see figure 1). The price list might actually list prices this way, referenced to product price, but it is becoming more common to decouple product and support prices. In any case, analysis of hundreds of competitive prices has revealed that these are common prices, however they are calculated. Note that there is a 3-4 times difference between the lowest price (Basic), and the highest (Premium). This is not uncommon, particularly for software support. In fact, we usually find at least a 25 percent difference between one level of service and the next whenever this tiered pricing approach is used. Between the standard offering and the premium offering there is typically 50-100% difference. In the case of our example, the "strike zone" is anywhere between 6 percent and 25 percent. That gives us a lot of latitude in pricing.
This is from the marketer's point of view, however, sitting back in headquarters, far from the front line battles. Salespeople will see it differently. They are looking for the "sweet spot" where they can feel assured of getting a hit. It is my view that what is being sold, and how skillfully it is presented are much more important than the price. True, you are unlikely to win a competition if you are priced 3 or 4 times higher for similar services, and few services are the same despite what the customer claims. On the other hand, you should not lose to a competitor if you are within 10 to 20 percent.
Selling Is Different
The first step is to understand your customer well enough to offer the right level of service in the first place. You have to get in touch with their needs. Help them visualize how great it will be to get your Premium Support, or how awful it would be without it. If there is a large price difference between your bid and a competitor's, you are probably selling different levels of service. I often hear of competitors coming in at 50 percent lower prices, but gross margins for on-site hardware services, for example, only average 35-45 percent, so large price differences are highly unlikely if the services are similar.
What about low-cost service providers? Can't they come in at much lower prices? Well, it is a very interesting question. Smaller companies can certainly run with lower overhead. Corporate overhead only runs about 12 to 20 percent, however, so that theory can only go so far. A truly low-cost service provider would have to attack the direct costs of service delivery, much like Southwest Airlines did in the airline business. I am not aware of anyone with a truly revolutionary difference, however, so I believe that high quality services have similar cost structures in today's markets. And low quality services are not what users really want. What this all means is that quality competitors are most likely to have similar prices for similar services. Although there are many differences in the services offered today, this leaves much of the real competing in the hands of the person doing the selling.
Just Pitch To the Zone
Netting it all out, the "strike zone" of list prices for marketers is typically 3 to 4 times from bottom to top. That means that if a Basic service is priced at $1000, there is room for a Premium service priced at $3,000-$4,000. Having researched many competitive situations, I can attest that this is typical. For sales situations, the "strike zone" narrows to reasonable differences among similar services, at least a 10 to 25 percent difference between prices. You should be able to sell the customer on your solution with that narrow a difference. If you are farther apart, chances are that someone is bidding a different level of service, and the one who has matched the customer's needs will win. For all intents and purposes, there is no "sweet spot" that will guarantee success. Even at the low end, even in today's most competitive environments, you still have to identify and sell service & support to the customer's needs. When you do that, prices will be rationalized and accepted. Remember, customers don't have to love your price, they just have to tolerate it. So don't worry about the "sweet spot", just pitch it on in there.