Why the Product Team Must Own Pricing
Who should own pricing? When I ask students this question, it almost always evokes emotion. Some people respond confidently, while others are more sheepish. And a lot of people think their companies are doing it wrong.
Before we answer this question, it’s important to define just what it means, because there are so many pieces to the pricing puzzle. For example, someone must decide which pricing model to use. SaaS or perpetual license software? Do we price by the seat, the gigabyte, the transaction or something else? Usually, executives decide this, or at least participate in the decision.
Another aspect of pricing is to negotiate discounts. In most companies the sales team does (and should) own this part of pricing.
However, when most people respond to the question, they focus on who is responsible for setting the price, which involves determining the list price and often establishing guidance for discounting. For now, let’s agree with most people. We ask, “Who owns pricing?” But what we really mean is: "Who sets the price?"
Using this definition, the answer is obvious: It must be someone from the product team. These are the people in the company whose job it is to know how much value the product delivers to buyers. And the person setting the price must know value to put in place value-based pricing (VBP).
VBP is the basis for all profit-maximizing pricing strategies. It means we charge based on what buyers are willing to pay, which is a function of the value buyers receive. The product team is uniquely positioned to know that value and determine how much markets are willing to pay.
How do customers decide their willingness to pay? They make their decision using one or both of the following methods: value in use or value in choice.
Value in use is when customers estimate the inherent value they get from buying a product. They will pay some percentage of that value to buy the product. For example, how much would you pay for gas if you’re in the middle of the desert, your gas gauge is on empty and you see a sign that says: “Last gas for 75 miles”? Probably a lot. That is value in use.
Value in choice is when buyers compare your product with an alternative. If they decide they get more value from your product, they will buy it. Imagine a busy intersection with a gas station on each corner, and your gas tank is empty. How much would you pay to buy gas at the most convenient station if all the other stations are charging $2.25? Probably much less than what you would pay in the desert. That is value in choice.
To use VBP, a person must understand the value that the markets and market segments receive from using your products. They must be able to put a dollar value on it. Even more challenging, they must understand value in choice. This means knowing competitors, their prices, how they are different (better and worse) and how much buyers value those differences.
Who inside your company understands this value? The product team. They know the competitive landscape and understand how your buyers make decisions. And because they must understand all these things, they should be responsible for setting prices.
Your finance team should not own pricing. Finance has the desire—but not the knowledge—to set prices based on value. Although they care about margins and understand costs, finance people don’t know the value their products deliver and they don’t know their competitors’ products. If finance sets prices, the only method they can use is cost-plus pricing.
You might argue that sales could set price. After all, great salespeople are value-focused; they try to understand value from each buyer, which aligns with VBP. However, they have two strikes against them. First, salespeople have the incentive to close deals quickly, which often means dropping the price. Second, they don’t see the entire market, only their specific customers. Someone needs to aggregate this information to provide companywide guidance.
An additional reason the product team should set prices: They determine what the next product will look like and which features have highest priority. Whoever makes that decision is who I want to own setting prices.
Why? Because companies should strive to make products that buyers value more. To do that, they must choose the best new features, ones that add more value to their product in the minds of their buyers. If product management owns setting prices, they are in that exact mindset. They get to decide which new capabilities might give them the ability to charge more.
What is different if finance sets prices? Again, the only way finance has to set prices is cost-plus. They take the cost and add a margin. When deciding whether to add a new feature, product management then would only need to determine if buyers are willing to pay more than the cost plus the margin. If the answer is yes, then put the feature in. If the answer is no, omit it.
This would be especially onerous for software companies. The marginal cost of manufacturing any new feature is near zero. This would allow product management to say yes to virtually anything and still meet that rule. The product manager has no incentive to find new high-value features. The company won’t charge for them. Hence, the company ends up with only slightly better products.
If sales sets pricing, product management doesn’t need to understand the value of their product. When deciding which features get priority, they would just rely on sales. In fact, when sales sets pricing, they become the de facto product team. To make it worse, each new capability sales asks for will be based on direct customer requests. It’s a surefire way to ensure that the company only builds incremental innovations.
The right answer is to let product management set the price. Their goal should be to choose the price and product features that maximize the profitability of the product. They can trade off the importance of customer requests against the value of brand-new capabilities. They have control of both important levers, price and product.
If you want to maximize profits, the product team is the only section of your company with the knowledge and incentives to effectively implement VBP. More important, if you want to create more valuable new products, the people who define the next product should also be in charge of setting its price.
Check out more articles from this issue of Pragmatic Marketer.
Looking for the latest in product and data science? Get our articles, webinars and podcasts.