SPEAKER_01 0:16

Okay, this week we're going to talk about why pricing is more of a system rather than just something that you think as an afterthought. And in fact, it's a very integral part of your business strategy. So last week, as a reminder, we talked about being a price taker versus price maker and how to use that to your advantage depending on which side of the coin you sit on there. And as I said, this week we want to talk about the system associated with pricing. I mean, the reality is that you can have almost two identical businesses in terms of the product and service they offer and maybe even the prices they charge today, but how their price is structured could have a huge impact on how those businesses perform in the long run. So that is one might have a pricing system that actually scales, which allows them as their business grows, their margin either holds the same or expands. Whereas the reverse can be true. The business A, for example, might have exactly the same pricing today, but a weaker system, and actually their margin deteriorates as they grow, which is obviously not ideal. So today we're going to talk about unit pricing and why that fails. You know, what are all the negatives associated with unit pricing? And then we're going to talk about alternative pricing methodologies like fixed, TID, and modular and sort of explore them. And finally, we want to really understand how to cost out your pricing so you've got a clear version or view on what your margins look like as you scale, which is something you want to get right now before you continue to grow. If you've got a new business, absolutely. But even if you've got an existing business before you put in place growth plans, you want to know that that growth is actually going to translate into more or at least the same percentage profit. So, Amanda, before we get into the system, we've really got to diagnose our sort of current pricing strategy. So how maybe you can take us through that.

SPEAKER_00 2:11

Thanks, Drew. And I think before you start sort of looking at your pricing structure, you really got to diagnose the symptoms or understand what's actually happening in your business. So before you start anything, what I always recommend for our clients is to actually look at the last 12 months of sales data. And it's really important to actually get this over 12 months rather than a shorter period, just in case you're in any sort of cyclical business or a business that requires any discounting around certain periods of time because of, for example, obsolete stock or upgrades or so forth. So what you'll do is then pull up the split between your full price sales or services and when you've actually had to discount them over the last 12 months. And in a handful of industries, discounting is necessary, it's a structural issue. So think of, for example, supermarkets come to mind. You know, supermarkets they always run on promotionals. It's a very sort of tight cutthroat sort of industry. There's the all the majors sort of compete with each other and the margins are very compressed. But if you're in an industry that doesn't require discounting, but you are still discounting, that's a diagnostic problem. And it really leads to one of three causes. The first is around the fact that the product is either mispriced, plain, or simple, or a combination of those. The second could be around the fact that the value is real but it hasn't been sufficiently built in the customer's mind. So the price is misrepresented. So think of the fact that you're not really showing the value to the customer. And lastly, it could be that the value exists, it's genuine, but it's been communicated badly. So think about your reach. So it's really the same symptom in all these three causes. And most owners sort of treat these discounting the same way. They think that cutting pricing and moving on would actually fix the solution, but that's really backward solution. What it really does is causes the perception in consumers' minds that they undervalue your product. They think that every time they buy something at a discount from you, that that's it's a trained behavior for them. So they expect it time and time again. So the cleanest proof of this is actually JCPenney. Back in 2012, the new CEO back then was Ron Johnson, and he walked in and he did something that was really rational on paper, but irrational based on what was already trained in the consumer's mind. And what he did was he scrapped it, there was about 590 sales events a year, which is huge. But at 590 sales events a year, and he scrapped the coupons and he scrapped all the half-price sales and so forth, and he replaced it all with one honest, everyday, fair and square price. So there was no more games, no more sales, just a real number. But it was an absolute disaster because of that trained behavior. All the first quarter sales actually fell close to 20%. And for the full year, the company posted a net loss of nearly a billion dollars. And as you can sort of appreciate or assume, Johnson was actually gone within 17 months. And it wasn't that the fair price was uncompetitive. In actually, in fact, in some cases, it was actually cheaper than what a sale price would have actually been. It failed because the trained behavior of the consumer. They spent decades training consumers that there's always going to be a sale. 590 sales, in fact, a year. So the honest number wasn't good enough. So you really need to diagnose your discounting before you design anything. If the cause is actually mispricing, then the architecture is actually the right fixed, whether it be fixed, tiered, modular, whatever the number really needs to be. If the cause is under communicated value, no amount of clever tiering will actually save you because the number isn't actually the problem or the method around it. So Stuart, once someone's actually looked at all of that and understands discounting isn't the core issue, what's the next mistake that they default to?

SPEAKER_01 5:35

Unit pricing meaner is probably the next biggest mistake. And I don't think people really consciously invite or think about or implement a unit pricing model. It's just a result of actually not consciously thinking about pricing as a strategy and a system. And so unit pricing is really about charging a rate per hour per delivery, per seat, per site, per click, per outcome, per unit of product sold. All these things are unit pricing. And there's some common weaknesses with unit pricing that we just really want to think through. And look, there's going to be some products and services that are priced on a unit basis, and that's exactly what the customer expects. And actually that aligns up with you know the customer's value as well. But I think that there's a lot of product services that don't need to be priced this way. And this is the whole point is take a step back and really design your business strategy, your business model, your business system. And pricing is obviously, you know, one of those first things. The first challenge with unit pricing is that it's really cost plus. You know, you decide what it's going to cost you to deliver a certain product. And if we're talking about, say, a service, how many hours will it take to do this work? And then you add your margin on top of that to deal with overheads, other expenses that aren't directly related to that assignment, then plus the profit that you're looking to make. But the problem with uh hourly rate is that it doesn't really reward efficiency. You know, if you're able to do the job a lot more efficient than your competitor, then you're gonna charge your customer less. But also it rewards a practitioner who takes longer and really penalizes one that does the work faster. The same shows up in a product category as well, so not just a service business. If you, you know, really focus on unit pricing when you're selling a product, then what you're doing is educating your customers, much like Mina used the JCPenney example, you're educating your customers to really focus on price. The textbook example of this is uh Service Station, you know, and how they price petrol. Of course, if they're a few cents off, if they're literally only sort of five cents off their most local competitor, their volume falls off the face of a cliff. Because ultimately, you know, there's not much you can differentiate from a value perspective when you're talking about petrol. You know, it is what it is. You put it in your car, you might have a couple of different fuel options, but beyond that, you're certainly a price taker. The other thing with breaking it down to unit pricing is that you're asking the customer to really focus on cost rather than value. So, what you're trying to do is educate the customer why buying a particular product or service from you delivers more value than it costs. And ultimately that's what you need to do. And we've spoken about that in previous episodes. But if we think about, you know, in a supermarket, how they give you a per hundred gram price point, so you're able to then compare prices between different products, you know, that is a bit of a race to the bottom unless the product category is able to differentiate in terms of quality or uniqueness or something like that, some sort of brand value. At the end of the day, most people are really just going to compare what it costs per hundred grams, and it's a bit of a race to the bottom. So unit pricing certainly almost promotes that as opposed to promoting customer looking or focusing on end value. And then finally, depending on your category and industry, sometimes customers end up gaming the system. So, really common one obviously is if some software charges a per user price, you know, you go and share your login details with other users, you only pay that one per user price, and of course, the customers can game the system that way. Similarly, if you're charging by the hour and you say, look, I'm gonna quote four hours to do this work. Well, of course, clients or customers that might not necessarily understand the time involved and the processes involved, particularly even QA processes to ensure that you're delivering quality work, they might end up negotiating and say, Well, I'll pay you three hours or two hours if they don't really see the value. So unit pricing has a lot of challenges, I guess. And also, I should say, in terms of gaming the system, the other thing too is like if you're in professional services and you're charging an hourly rate, one of the challenges with charging an hourly rate is that you almost dissuade your clients from calling you and calling on you. So you know they might have a question, but if every time they send an email or pick up the phone and ask a question, they get a bill, then they're gonna always think twice about whether they want to do that. And ultimately, you know, your job is to try and encourage more custom rather than discourage it. So, really, I guess we can sort of frame the downsides with unit pricing is that it doesn't always give you the ability to scale. So, what you really want is a pricing system that rewards more sales, either through higher margins, ability for you to be able to generate higher margins or rewards customers buying more from you. And also, you want a pricing system that promotes the customer to really focus on the end value. No one's going to ignore price completely, but you want it to be one of many considerations, not the only consideration that they focus on. So, Mina, if unit pricing, if we acknowledge that there's some downsides with unit pricing, what other systems, pricing systems, could we consider? And I think it's important, you know, to think about this, not in totality. You might use unit pricing for many of your product or service categories, but what categories can you use other pricing models? Mina, can you take us through that?

SPEAKER_00 11:03

So there's really just three options fixed, tiered, and modular. And choosing between them isn't really a preference, it's really a diagnostic, as we we sort of spoken about previously. So to determine your pricing structure, you really need to ask yourself and be honest with yourself about three questions. Does your delivery stay roughly flat no matter who buys? Is the first question. And the third is if your customer actually wants to build their own scope. So think of like a customized product, or do they just want to tell them the number? So fixed pricing is really the answer when the delivery is standardized. So one scope, one price. And the payoff is the fact that as your delivery gets more efficient, so your engine gets more efficient, you keep that upside for yourself. So think about, for example, Australia posts flat rate satchels, they're a clean product example, one price per box size, regardless of the destination or how heavy it is, because the cost to process it for them is relatively the same. It doesn't move from parcel to parcel. You know, even if you're in the service-based business, legal vision is probably a good example. Flat fees for sort of standardized legal work like contracts, trademarks, and so forth, rather than billable hours. So it's rather standardized for them to deliver and it barely moves from client to client. Now, tier pricing is when your customers genuinely cluster into different brands of need or budget. So you're not totally reinventing complexity for its own sake, you're meeting people where they actually sit. So from a simple entry point up to a very comprehensive one. So the one thing to watch is not pricing the base tier so low that it cannibalizes the tiers above it. Now, Canva is probably the best illustration of this. Now we previously brought up Canva in a previous podcast, and they really have four tiers. And the first one's a free tier, then an individual tier, then a teams tier, and the fourth tier is actually an enterprise tier that Canva sort of specifically relaunched in 2024 to completely or compete directly against the the likes of your Adobe's and your Googles and so forth. And then they really only did that once they actually had the scale to justify it. Now, just as a backstory, their valuation actually went from 26 billion to over 40 billion US dollars because of their value price, or what we we would assume because of their value pricing. What they focused on was actually their pricing structure on for these four tiers, and they've monetized it in a way where they actually provided enough value for each of these tiers for them to increase the users and as such increase the business valuation. And finally, there's modular, and this is where people usually picture it in one way. It's like a menu of add-ons. So I like this sort of picture this in the way if you think of your Dell products or your Apple computer products where you've got a baseline MacBook, for example, and you add-on, you get to select your hard drive, your memory, and so forth. There's a genuine sort of customer-facing menu where the buyer gets to pick the components and watches the price build in front of them, but the underlying product is actually the same. So Shura, I think you've got some more practical examples of uh modular systems. Can you walk us through it?

SPEAKER_01 13:55

Only because you asked nicely, Mina. So the thing with modular pricing is that we've got to understand that there's kind of two ways that you can do it. You can have one where the customer drives the modular pricing through their own decisions. So that's the example of the PC example that Mina just gave you. But also you can use a modular system to still come up with how you price, but use a modular system to get to that one price. So the customer's not making any choices, but you're just building the price out depending on the product or service that you're offering. So an example to you know, extend on Mina's example, an example like IKEA is a good one where you know they'll have a sort of base wardrobe that they might sell you, and then they'll sell you drawer inserts or a different door style or some interior lighting within that wardrobe or a different hanging configuration. And each of these options come with a different price, but they can pitch the starting price at as very low. You know, the basic wardrobe only costs you, I don't know what it is, $200, whatever it might be. But you know, if you want all the bells and whistles, then of course a wardrobe's going to cost you $300, $350, whatever it might be. But in a category where price can be the key attraction to at least get customers in the door, get them onto your website, get them into your bricks and mortar store to look at the product, that pricing system works. It works in aviation too, and EasyJet in Europe has been using it for years. And I see Jet Star is just starting to use it as well, where they'll say, okay, here's your basic seat, but if you want extra leg room, if you want check-in luggage, if you want carry-on luggage, you know, they all attract uh an extra charge. But in a category where there's a lot of price competition to try and win the customer to be able to advertise an aeroplane seat for you know 50 bucks or whatever it might be if you're running a special, and then add the add-ons beyond that. An example where the customer doesn't have a choice and doesn't really see the pricey model is Airtasker. So if you jump on Airtasker and you post a task, the platform helps derive the price. So it will look at what the task category is, where the location is, the estimated time to complete that transaction. And using those three components, it will help the person pitch a price for that particular job. So it doesn't leave the maths to the individual, it's got a pricing system behind it. And this is a great way to sort of look at pricing because you, as the business owner, can decide what are the components of cost and what are the components of value. And in what circumstances does the customer or client influence that cost of value and allows you then to come up with a pricing model to actually match your cost structure, but also then match the customer's value outcome. For example, in a service business, there might be a particular add-on or activity that you do that might not actually take you a lot of time, a lot of man hours. It might be because you've got a proprietary system or process or something or a tool that you've developed, and you might be able to deliver substantial value to a client within one hour. Well, unit pricing would say you've got to charge a very high hourly rate to do that. And that might sort of throw everything out. But with modular pricing, you might say, well, if we're able to add this thing, it only adds an extra hour. But I'm going to add a little bit more than that in terms of value onto that pricing structure using that modular approach. Now, the downfall with modular pricing is we've got to be really clear about scope, what's included and what's excluded. So, really, there's four things we need to be really explicit about when we build a modular system. Like I said, the inclusions and exclusions. And we need to be clear from this from a customer perspective also, but from a system perspective. So anyone that's doing the pricing within your business understands how it's going to work. The key assumptions that pricing was built on. So for example, you might be might be an assumption that you're going to provide, you know, the customer is going to provide this information on a timely basis. And so we've not priced in the cost of delay or rework as a result of the customer not doing what they're supposed to be doing. What triggers out of scope work? You know, so when do we through the process have to put our pens down and say, hang on, we can't, we've got to adjust the price because something's adjusted. And then finally, what done looks like. So how do you know when you actually finish? So what is the deliverability or you know, so it's very clear between you and the customer what done looks like. The next element when thinking through a modular pricing system is really thinking about customer loyalty and how do you reward that? How do you reward a return customer? How do you return reward a customer buying more from you? Because of course, repeat customers tend to be the most profitable. You know, they ask less questions, there's less returns, less rework, these sorts of things. So you certainly want to make sure that you build something into your pricing structure to really reward that. I would resist the temptation to use discounting as a reward because I think, like Mina's example before, you don't want to train your customers to expect a discount. But things like priority access, faster turnaround times, preferred scheduling, these sorts of things can you can still deliver the same product. But what you're sort of saying is I value is you as a client and you're going to move up to the top of the list if you ever need more stuff from us, whether it's services or a business or product, I should say, because we're really rewarding your custom. Now, Mina, modular pricing or the success of moduling pricing really is premised on the idea you understand what it costs to deliver a product and the components of that cost. How do we go about getting a good understanding of that?

SPEAKER_00 19:30

I think the thing to highlight here is the fact that the architecture itself around pricing doesn't save you, right? Because if the business model is wrong, then everything else will fall apart. So whatever model you choose, your cost base really sets a minimum viable price. And that flaw isn't negotiable. It's the fixed fee that lasts forever. It has to move when your costs actually move. And a really good example of this is if you recall Porter Davis Home. They were one of Australia's largest volume builders. And they went into liquidation in March 2023 post-COVID. They had 14 companies, they had uh 1700 homes, I think it was mid-construction across Victoria and Queensland, and all work stopped immediately. And if you look at actually what happened underneath, it was a pricing problem. Porter Davis had signed thousands of fixed price building contracts through and after COVID, and though they were tied into those fixed price contracts. And despite this, and despite construction prices being sort of tripled, I think it was across the period, they had to honor those prices. So what ended up happening is the floor of those or the cost base of those homes drastically increased, and there was no longer any margin to be made on those proper on those properties. Once there was no margin left to absorb any gaps in sort of material price increases, labor price increases, and so forth, the business essentially fell apart. There was no cash to keep it flowing. And this isn't really a story about bad luck or material prices or the construction industry or COVID or anything like that. It's a story about a fixed price architecture with no mechanism around understanding the floor, the cost base. So when the floor itself or cost started moving, they didn't actually fix the problem. And the fix wasn't really complicated, in my view, in this respect, because there should have been something built into the contracts around sort of some sort of escalation clause or a requote trigger, or if a home isn't built within a certain time frame from when contract is signed, you know, it could be repriced at that point in time. But whatever the architecture you pick, whether it be fixed tier or modular, it needs to protect your floor underneath it so it doesn't get out of hand. So, Stuart, I think that's everything for now. What should someone actually go and do with all of this?

SPEAKER_01 21:31

So, Mina, I think we've got a developer pricing system, and there's really a couple of steps to go through and do that. The first one is, as we talked about, to sort of reflect on your own experiences. So, how has pricing been has pricing worked up until today? We did some work for a client recently and they had a pricing structure where they would use ranges. So if the client wanted X, you know, charge between X and Y. And interesting, when we investigated their pricing structure, everyone was charging at the lower end of that range just because it was easy to get it set. And we implemented a modular pricing system for them so that it helped people, the people that were serving the customers to come up with a price that really had a direct relationship with the value and the cost. So that was a really interesting thing that we identified and something that you would have missed if you didn't reflect back on current pricing. So that's the first step. Second step is then to choose what pricing architecture is going to work the best for your business and your industry. So whether that's fixed or tiered or modular, like we've spoken about, or whether it's just continue with a unit pricing structure for some of your core products and then adding a fixed tier or modular on top of that. Remember the key thing that we spoke about, we want it to scale well as your business grows. We want it to maintain or enhance margins. And we also want to make sure that we're asking the client or promoting the client to focus on the important things. Third, once you've got that or chosen that architecture, you need to build it out. So what's included, excluded, what are the key assumptions underlying that pricing model? What's the change trigger to change the pricing and you know the completion criteria? So everyone, both the customer and the people inside your business that are running the business engine, have a clear eye idea of what done looks like. And then have a process in your business where you can really interrogate cost because understanding what that flaw looks like is critical and it's a critical when you first establish pricing, but it's an ongoing process. So every 12 months you should be really interrogating that and seeing whether your pricing system needs to be adjusted accordingly. Having a pricing system, I think, is probably one of the most powerful things you can do in within your business, and it's not a difficult thing necessarily to roll out, particularly if you've got something you've chosen the right system that is coherent with your business because it'll be coherent with the way customers see value as well. And as we've said before, you know, increasing price, if we increase price by five or 10%, and as long as our cost doesn't change, often it doesn't, that drops to the bottom line. So it is most it's one of the most valuable things that we can do. And look, I think any business that doesn't have a pricing system and a coherent and robust pricing system, I think is leaving money on the table and is a risky business because if you're just spinning a wheel to determine your price, you know, you're really relying on luck rather than design. Okay, we'll leave it there for today. Next week, we're going to talk about repeat and referred business, which is probably the main source of business growth that a lot of small to medium enterprises rely on. So it's certainly worthy of a conversation. Until then, bye for now.