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This article first appeared on Industrial Distribution.
How do you calculate willingness-to-pay (WTP), or do you at all? In 2014, I posed that question to readers of the Zilliant blog and it continues to be a favorite post. Four years later, the topic is still top-of-mind for B2B company leaders. Recently, I read a great MIT article on the weaknesses of one popular approach to measuring WTP. The concept is evergreen and one that continues to spark curiosity. Today, I’ve got a follow-up question:
What happens when you don’t know WTP?
Let’s consider a day-in-the-life scenario for a busy sales rep. The business leadership is seeking a 5 percent increase in profitability for the year. The moment of truth arrives.
A rep is giving a price quote and she has two options: Do I risk the sale by quoting the higher price needed to boost profits, or do I offer a discount in the hopes of closing the sale quickly and locking in the revenue and slightly lower profits? All too often, the choice is made to go with the lower-risk approach and offer the discount. After all (so the logic goes), if you lose the deal then the profit is zero so don’t be greedy — take the business off the street. I’d wager we’d all take that option when faced with the same dilemma.
This is a natural human behavior in the face of uncertainty about the WTP. It doesn’t matter if she is compensated on margin, revenue, or some combination. There’s an undeniable risk of losing the sale entirely by quoting a price that’s too high and to the sales rep, it feels like playing with fire to push for a higher price when she has no idea what this customer is willing to pay for this order. How sensitive are they to price really, and what price will make the customer walk away entirely? She simply doesn’t know.
While this risk-averse behavior is explainable for an individual sales rep, the aggregate effect is that companies routinely leave money on the table. I’ve seen a common pattern where significant portions of a company’s margin erosion, or failure to achieve profitability targets, is actually self-inflicted and caused by this fear-driven over-discounting. Even worse, when this tendency to over-discount rears its head in long-term agreements and contracts, the self-inflicted profit loss is effectively “locked in” for years to come and often results in unrealistic pressure on other parts of the business to somehow make up for these losses.
When you don’t know WTP, the risk versus reward dynamic takes over.
This is why WTP is such a powerful idea for improving profitability — it allows sales reps to win the business at the right price without putting their deals at risk. WTP is the missing ingredient which levels the negotiation playing field. Over the last two years, we’ve developed a diagnostic method to analyze a business’s historic transaction data and measure the direct financial impact of sales reps not having this critical WTP information — how a customer will respond to price — at the point of sale.
We’ve learned that, in aggregate, B2B companies are losing profits in an amount nearly equal to 1 percent of total revenue each year solely due to missing WTP and the risk-averse pricing behavior that results. That may not seem like a large amount, but it’s just one component of much larger pricing problems we analyze with our full diagnostic process. In truth, most companies suffer from a wide variety of pricing maladies in varying degrees. The overall severity of the combined problems is significant, having a range of 1.9 to 16.1 percent of total revenue. The good news is a healthy portion of these hidden pockets of profitability can be captured with optimized, market-aligned pricing.
Barrett Thompson leads the Business Solutions Consultant team at Zilliant, aligning solutions to customer needs and promoting pricing and sales best practices among our customers. Over the past two decades, Barrett has built and delivered optimization and pricing solutions to Fortune 500 businesses in diverse vertical industries including: building materials manufacturing and distribution, industrial components manufacturing, semiconductor manufacturing, office-supply distribution, hardware-software distribution, pharmaceutical and medical-device distribution, telecommunications and multiple travel & transportation verticals.