Making Rational Pricing Decisions

February 14, 2011

12:17 pm

When a business owner tells you how much their product or service costs, have you ever just responded in a surprised tone, “How Much?”  Try it.  It’s an amazingly useful little ploy.  It doesn’t matter whether you believe the price is fair or not, you will be surprised how many times, a person with full pricing authority will make you a better second offer.  Just two simple words coupled with the proper tone have so much power….. “How Much?”

“If you give sales people 10% discount authority, 86.9% of them will discount all sales at 10%.

Now why is that?  What’s going on here?  Why do sales people who have 10% discount authority sell everything at 10% discount and why don’t they outsell sales people of equal skill who don’t have any discount authority? It’s probably a bit of ego tied to winning a deal coupled  with the universal human desire to be accepted piled on to heat of the moment decision making. It’s also a useful lesson to entrepreneurs who have full authority to chop prices on the spot.

Sales, Discounts & Ego
When I was a young sales guy, selling enterprise software, I would call my VP of  Sales the Cave Man.  He took pride in that moniker because he was under the mistaken impression that he was affectionately so named because he was such a tough negotiator.  You know the kind of guy who would drive Priceline’s William Shatner nuts! Whenever I called him seeking a discount for a customer it was easy for him to say no to me.  He always said no.

Truth be known, the real origin of the name was derived from the fact that we sales folk quickly realized that if we wanted the discount, we only needed to get the VP out in the field on a sales call with the customer. Then in front of the customer, with his ego involved in the win, previous no’s quickly turned to yes. In the heat of battle, in-front of the customer, he’d cave! Hence, the Cave Man.

I remember reading an old Harvard Business Review article about a coat manufacturer. It was a father and son operation where the father ran one division and his 2 sons ran the other.  A consultant reviewed the business to understand why the sons’ business was significantly more profitable than the fathers division.  The reason?  The sons had to seek higher authority in the form of approval from Dad to reduce prices. The father had all the authority he needed to eat into his own profitability.

So let’s give this phenomena a name…. how about “I’m The Man Syndrome,” or ITMS for short.

Fighting ITMS
Great entrepreneurs are great entrepreneurs because they don’t like to follow rules and being the boss means no rules. Being the boss means “I’m The Man or The Woman”. But in order to protect yourself from hurting your own margins, here are some suggestions to guard against ITMS.

Set up mechanisms that will insulate your business from emotional irrationality and promotes good business practices.  Here are some examples of guidelines that can take the emotion and ego out of discounting products or giving away services.

  1. Emotionality Insulator –  Set up battle plan prior to becoming emotionally involved in the deal.  The boss needs pricing discounting guidelines just like employees need them.  What is your on-the-spot deal making authority? Develop a policy.
  2. Heat Of Battle Defuser – There may be a good reason to give something away, just make sure that the decision is based in facts and not emotion. Claim the need for approval by a  higher authority (your board, your bank, your spouse, your dog) when deviating from the guideline. Buy yourself time to cool-off.
  3. Accountability Partnership – Set up a rationality check mechanism by developing an accountability partnership with a another entrepreneur, a mentor, a friend, your spouse; just about anyone with more sense than a Magic 8 Ball.

Better Together
When Venture Capitalists make an investment decision, they invest by committee and that is a major factor on why VC valuations are usually lower then Angel valuations.  For a VC to invest, the variables that populate a risk-reward formula including: company valuation, time to exit, expected exit value and expected future dilution, all must be agreed to and voted on by the investment committee.  This pre-set formula and committee structure takes emotion out of the equation and guards against ITMS.

Angels on the other hand tend to invest more on emotions and feelings and “being the man.”  Heck, they’re entrepreneurs and like you they hate rules.

As an entrepreneur, it’s up to you to decide whether you will allow yourself to shoot from the hip while in negotiations with customers, vendors and even employees.  Hopefully, you’re a shareholder in your company. Because if I were a shareholder, I would want the CEO to put a mechanism in place that insures rational decision making and protection of margins.

Additional reading on Pricing and Payment Systems:

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Glen Hellman (@glehel), is an angel investor, serial entrepreneur, and works for venture capitalists as a turn-around specialist. He is the Chief Entrepreneureator at Driven Forward LLC, frequently muses on his blog, Forward Thinking, and works with entrepreneurs to help them figure out what to do and get them to do it.

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