Pricing Strategy in Industrial Markets: Beyond Cost-Plus
Cost-plus pricing is easy to defend internally and easy for a competitor to undercut. It ignores what the customer would pay to avoid a failure.
What cost-plus cannot see
Cost-plus pricing takes the seller's cost and adds a margin. Finance likes it because it is auditable, sales likes it because it is simple to quote, and it protects against selling below cost.
It carries no information about the buyer. The same valve may go into a water line where a failure is a nuisance and into a process unit where a failure stops production. Cost-plus charges both customers the same, and a competitor with lower costs can undercut the price in both.
Segment by what failure costs the customer
Value-based pricing starts from the customer's economics, and for industrial products the most useful question is what happens when the product fails or arrives late.
Exhibit 1: A simple segmentation of industrial customers by cost of failure, and the pricing approach for each.
| Segment | What the customer values | Pricing approach |
|---|---|---|
| Critical application | Reliability, technical support, guaranteed delivery | Price to value; bundle service and response commitments |
| Standard application | A dependable product at a fair price | Market-based pricing with modest differentiation |
| Commodity purchase | Lowest total cost | Compete on cost, or decide not to compete |
Building this takes work, since someone has to talk to customers, quantify downtime and map the catalog to applications. Once built, it is far easier to defend a price with a customer's own numbers than with a margin target.
Where it breaks down
Most pricing projects fail after the analysis is finished. The segmentation is sound and the price list is updated, and then the sales team discounts back to the old level.
The reason is rarely analytical. A salesperson paid on volume gains nothing by holding price and risks losing the order, so asking that person to defend a premium is asking them to act against their own pay.
In one composite engagement, an equipment distributor rebuilt its margin reporting by category and moved sales incentives from revenue to gross margin contribution. The change aligned selling behavior with the economics the new reporting showed. Read the category profitability case study.
Five questions for the leadership team
- Do we know which of our customers use our product in a critical application?
- Can our salespeople state what a failure costs those customers?
- How much does the realized price for one item vary between similar customers?
- Who can approve a discount, and is the reason recorded?
- Does anyone in sales earn more by protecting margin?
If the last answer is no, fix that before changing the price list, because the incentive change and the pricing change should take effect together.
Key takeaways
- Pick one product line and list the applications where a failure would be most expensive for the customer.
- Ask three customers in those applications what a day of downtime costs them.
- Compare realized prices across customers for the same item and look for unexplained spread.
- Review whether your sales compensation rewards volume, revenue or margin.
Find the margin your pricing leaves behind
We can segment your customers by the value they place on reliability and support, and align pricing and incentives to it.
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