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Let’s talk about prices. How do you set yours? To what degree do you consider your costs when you do so? These are questions I find myself asking more and more often, as I come across situations in which costs have driven the approach to pricing.

This typically looks like, “It costs us X to make our product. We want to make Y profit. Therefore, the price is X+Y”. In pricing theory, this is called ‘cost plus’. If so many people do it, you might be wondering why this is problem. Well, let me give you three reasons why I find it problematic and what you can do about it.

1. Nobody cares 

The first and biggest problem, in my opinion, is that nobody really cares what it cost to make your product. Sorry. Worse yet, if they think about it at all, it’s probably because they think you are ripping them off. 

Think about the last time you bought a sandwich. Did you worry about how much it cost them to make it? You probably didn’t give it a thought. I’d argue that most often that’s because you don’t care. If you do, it’s because you were comparing *what you think it cost* to the price. The comparison is unfavourable…“£4 for a sandwich that cost them 50p? How dare they!?”

Cost plus can work where the markup (profit) is somehow agreed up front as being fair. Most of you are not in that world, though.

2. Profits are the first thing to go

If the product does not sell as well as you’d like, the most common response is to drop the price. But ‘in flight’ it is often difficult to do very much about your cost of production. If the price goes down but costs remain unchanged, your profits are going to get squeezed. Not good. 

When the product does not sell as well as you expect, it’s usually because customers are not perceiving or experiencing the value you anticipated. The cost plus model, because it is disconnected from value, does not help you avoid the low-value trap.

3. Costs are more of a given and less of a constraint

The cost plus model presumes a cost to which you add a markup. It doesn’t have much to say about what that cost should be. If you are smart, you will constrain your costs, however, in the world of software that can be especially difficult. Why? Because you don’t really know how that works; you work in terms of features and sprints rather than a budget.

This is a kind of a side-effect of the cost plus model. It treats your costs as a given and says, “What is the right price?” rather than forcing you to think about what profit you want to make and ask, “Is this the right cost?”

In identifying these problems with the cost plus pricing model I do not mean to suggest that your costs should have no impact on your pricing. Clearly a viable business must charge more for its products than they cost. But what I do mean to suggest is that where this kind of thinking goes wrong, it is your problem and neither prospects nor customers will care.

So, if the ‘cost plus’ approach is a bad choice, what is a better choice? This is a tricky question to answer in general, but for companies who are principally building software platforms or applications you might think about it this way:

Understand that your product is going to have a value in the marketplace. our job is to understand this and then extract a fair share of that value in terms of profit. How might you go about this? Here is one approach:

1. Undertake a comprehensive value proposition design process. This helps identify the key problems you are solving, for whom, and what their actual value is (in the mind of the customer)!

2. Use market analysis and sales forecasts to determine the expected value of the product over time. This is necessarily likely to be probabilistic so you are going to end up with a “pricing region” rather than a specific figure.

3. Determine the minimum amount of profit you would like to take due to this product. That is, you set the profit in advance.

4. With these data points, you can project a minimum and maximum that your product can cost to make.

5. Now use a technique like Impact Mapping to focus your development on high-value features and constrain your development & maintenance costs to budget.

It’s fair to say that this is a more complex model of pricing and comes with its own risks attached. It requires you to have a clear handle on your value proposition, to do effective market analysis, and to manage development to a budget.

None of these are easy things to do but all are worthwhile in themselves. And the bonus is that you can access pricing models that will generate more profit and protect your profit better when things go wrong. Time to take a look at your prices?

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This week I’m taking a look at Demand Innovation. So, what does that term mean? It is the process of driving the development of new products/services (innovation) by looking inside existing customer value chains to find new, possibly more valuable, problems to tackle (demand).

Slywotzky’s view & my advice

A key author in the space, Adrian Slywotzky, argues that large businesses can get stuck in a ‘no growth zone’. Often, this is because they assume they already know everything they need to about their customers. The problem is that many of their assumptions are likely to have been partly wrong, and the ones that were good still have a shelf-life; they may not age well.

I would argue that it’s not only large business that are in the “no growth zone”. It’s hardly unusual that SMEs or scale-ups looking for growth go on the search for new customers and a broader value proposition, rather than challenging their assumptions and exploring further up into their existing customers value-chains and trying to create demand there.

My advice? Go deep before you go broad. Especially when you take into account that existing customers are those with whom you (hopefully) already have a good relationship with and have built up some level of trust. At the very least you know where to find them! Looking for new problems there has to be easier than starting from scratch, right?

The example

Slywotzky uses the example of a company in the pharmaceutical transport business (i.e. running fleets of trucks to move pallets of, e.g., painkillers from a pharmaceutical company loading dock to a hospital loading dock). Whilst essential, this is a relatively low-value activity in the value-chain of hospital supply.

By not treating the hospital as a ‘black box’ into which drugs get poured and examining the hospital value-chain, the company was able to identify that warehousing, stocking, and dispensing drugs to wards were activities that are (a) not core, (b) complex (c) costly, and (d) potentially risky (e.g. when the wrong drugs end up in patients). When the hospital recognises this problem, it creates new demand.

The solution

The company then created a solution for the hospital to specify the drugs required each day, by each individual patient, and to supply a ‘robot’ that could be wheeled directly from the loading dock to the ward where it would correctly dispense each patient’s drugs for that day.

While the hospital would likely maintain an emergency supply, this significantly reduces the need for managing pharmaceutical inventory and potentially eliminates the risk of dispensing errors on its wards. Reducing cost and improving ‘service’ delivery - a massive win for the hospital and the company.

Note that this is still recognisably the value proposition of ‘delivering drugs from pharmaceutical companies to hospital patients’ but re-imagined to solve a deeper problem for their customer.

This solution was possible because this ‘transport’ company was able to:

1. Look past its own identity and, “the way we do things”, to look for new problems and new opportunities to create value. 

2. Throw away some of its assumptions about the customer and their real problem, and explore demand further up the value chain

Having successfully done this once, it was able to repeat the exercise. Through finding a related problem in the value-chain and expanding the sphere of the problems they tackle, they were able to create new demand within the customer and new value for themselves.

Questions to think about

Where do you stand on Demand Innovation? Here’s a few questions to think about: 

• When was the last time you explored your customer value chain for unaddressed pain and problems you could deal with?

• Are you occupying a high-value position in their value chain? 

• Do you assume you know everything you need to about your customers experience and their problems?

• Do you need more and better business?

• If so, might this be a good time to throw away some of those assumptions and explore their value-chain again?

For more please see, Demand: Creating What People Love Before They Know They Want It. Or anything by Adrian Slywotzky, really. (Can you tell he’s a favourite of mine?!) 

Until next time…

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The next guest blogger on The Art of Navigation is Kim Guest. I am delighted for Kim to share her experiences finding balance amidst the chaos of starting a business.

#Balanceforbetter - it was a great hashtag this year. Something that I think said more about people themselves for a change rather than a cause, and I love people. My name is Kim Guest and I am an Entrepreneur, Founder and CEO of isoshealth. I am currently fascinated by ‘balance’, in both my product, my team and my customers, but most of all myself. 

After 2 years of taking an idea from my heart to your screen, and into the lives of hundreds of people, I spend quite a bit of time asking myself if I have the right balance. Of course, I don’t – who does? But that time and space to ask the question and the decision-making to act or not to act is something that is a huge part of my ability to keep going.

This journey is not easy - it does not win you friends, nor give you financial security - and is not great for your health. It’s constant messages of ‘You must have absolute faith in what you are doing, to the exclusion of all doubt’ to, ‘We must go and pivot now’ are loud and confusing. Somewhere, your Balance is in there. Easy, huh?

I am 49, a single parent to 2 young men, and International Women’s Day this year, in particular, speaks to me about how much the working world has changed. I refused to share with my first employer that I had a typing qualification, so that I didn’t have to do secretarial duties. I took this entrepreneurial step over 2 years ago, driven to be more involved, participative and accountable for the change I want to see in health and wellness. I felt a lot of frustration that the boundaries of a large business made innovation impossible, and in a number of senior roles the constraints outweighed the impact I thought was possible and necessary. And so, I slowly adjusted my lifestyle to accommodate less routine, less income, more isolation, more uncertainty - and jumped. It was subconscious at first, then purposeful, and it was exhilarating.  

The high for me is to be able to drive real value through technology, for trained professionals to provide health and wellness services to people; virtual clinic time with Dieticians, Physiotherapists and Psychologists, letting you Balance your Nutrition, mental and physical health to stay healthy. The lows are having to play the game in terms of starting a business, because there are surely unwritten rules. The biggest frustration is the ‘eco-system’ surrounding the start-up community. It is messy, uncertain, unclear and at its worst, unethical. I believe that most of the uncertainty comes from the lack of structure in peoples’ roles around you. Everyone does a bit of everything, a mixture of raw skills and high emotion is a heady cocktail, trying to drive clarity around the difference between ‘help’ and ‘accountability’.

I learned early on that lots of people were likely to react well to my mission - who doesn’t want themselves or their family to be healthier? Or was that to me talking about my business or my business talking about its value? I had to quickly learn to identify the real ones, the ones that I needed onboard and the ones that would stay if I invited them. This, with the professional guidance of Matt (The Art of Navigation), has culminated in what will be a longer lesson in balancing expectation. If I have one thing yet to master as a Founder and CEO, it is the balance of expectation. Blind optimism is not welcome everywhere in your strategic thinking.

And so, I look to the beacon that is balance - weighing up the past and the future, the needs of my business, my customers and my family and, most importantly, recognising what I need and looking for the insights that help me to be better at balance.

Head over to isoshealth to find out more about Kim’s work.

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I think it’s important for a business leader to consider the scenario, “What if the business does not work?” Of course, it’s not something that anyone wants to contemplate. But it does happen, and how you respond to it could have a great deal of impact on your stress and happiness.

Typically there are two ways that this situation plays out:

• Failure of demand

• Failure of execution

In a failure of demand, there has usually been some hypothesis about the existence of a profitable market that does not pan out. In a failure to execute, it means the market may have existed but the business loses out through making the wrong moves or has been too slow in exploiting it. 

A large enterprise can often absorb the shock of a failed product - multiple ones, even. For a startup/SME, however, it can quickly become an existential issue. The investment required to test the market (especially if a product is developed) can be enough to seriously compromise its future.

When things go wrong like this it is both painful and sad for all concerned, but its not necessarily the worst possible outcome. A failure can be a great learning experience and, after taking some time to recover, it is possible to start again with a new idea, team, or both. But in many cases this is not what happens. Why? 

It’s often the case that people have a lot invested - both financially and emotionally - in their business. The ‘sunk cost fallacy’ may then lead them to throw good money after bad in keeping the business alive. Realistically, the more pragmatic move might be to shut it down.

It’s been my experience that smart, determined, people can often find clever ways to ‘preserve the corpse’ so that, while the business is no longer alive in any meaningful sense, it continues to live on for quite some time as a ‘zombie’.

Why is this a problem?

1. It’s depressing. A zombie business tends to tread water and never quite creates the momentum it needs, which drags everyone down.

2. There is an opportunity cost to be paid in terms of other ventures that you could be pursuing instead, but are not.

3. Lastly, while it may be that a rabbit can be pulled from the hat and the zombie business comes to life, more likely it will shut down at some point. You’ve just stretched out the hurt. No one needs that. 

This last point is a difficult one because there is a good chance that, despite all the evidence that you may be wrong, you still *believe* in your business. After all, if you didn’t -you wouldn’t have started it in the first place. There is a tendency to hang on as long as you can. Understandably, so. 

It may not be fun, but the wise thing to do is to think up front about what kind of meaningful signs of life and progress you should expect from your business. Put a system in place to evaluate these on a regular basis. Know what decision you will make depending on what you find.

Here are some concrete steps you can implement:

1. Evaluate your investments - If you are already in a business, recognise that what you have invested so far does not justify making future investments. You need a way to objectively evaluate future prospects. Read some poker books and look into the ‘sunk cost fallacy’.

2. Be realistic - Face up to the possibility of failure. It could happen. Read some stories of entrepreneurs who have failed. Some were able to turn it into a positive, growth, experience that improved their future ventures. It probably won’t be as bad as you fear.

3. Set progress milestones - It’s okay to be generous in how you define these but you will know what constitutes real progress and what looks like treading water. For example, “The business *must* deliver an MRR of at least £X by year Y”

4. Seek support - Put in place a system for getting objective feedback, advice and support, such as regularly checking in with a navigator or advisor. It needs to be someone who, if they suggest things are trending the wrong way, you will give a hearing and really listen to what they say.

You don’t need to publish this or talk about it in within your business. It’s here for you as a backstop and a way of getting a better perspective into whether you have a thriving business worthy of your blood, sweat, and tears or not.

If you don’t, have a wake, give it a Viking send-off, lick your wounds, and then go on to do something better.

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This week brings the first guest blog post for The Art of Navigation, and I am pleased and excited that Denise McQuaid has agreed to share her thoughts on leadership and organisational culture.

My conversations with business leaders are off to an intriguing start for 2019. Brexit is of course featuring as a major concern, but I am hearing time and time again about a specific fear, centred around acquiring and developing new capabilities and talent to support their growth plans. Added to this is a concern about how this impacts the culture of their organisation.

The war for talent rages on. Business leaders are feeling that pressure more than ever, despite the many programmes to attract and retain talented teams.

I have been hearing three dominant themes:

Time: Leaders are struggling to reconcile the time challenges of trying to grow their business and focus on their long-term goals, whilst simultaneously investing in their employees and finding ways to differentiate themselves in a flooded marketplace.

Skills: Leaders are recognising that they are not knowledgeable enough about the emerging skills that could add value to their business. They are having a problem with establishing the metrics for the new skills that are emerging and how these employees might fit into their organisation.

Technology: They are struggling to quantify the impact of technology and to understand how things like AI, big data and evolving platforms fit into their business plans.

Together these concerns often mean that the ‘softer’ aspects like organisational culture are not addressed or are a lower priority. I believe it essential that this balance is redressed. Establishing the right culture is an essential part of creating businesses that find the right answers to these other questions.

What does good cultural leadership look like?

Most businesses have well established priorities: grow the business, improve operational excellence, innovate and, possibly, transform. In my opinion, leaders must also make the following themes - that mainly describe culture - equal imperatives:

Be role models. I believe this is an integral part to business success. Leaders must be transparent about their own need to learn and develop, and be willing to share how they are going about it. They must embrace vulnerability. Not understanding new technologies is not a failing - understanding what you don’t know is knowing too!

Reinforce the value of learning. Leaders must put learning at the heart of the organisational culture. Reinforcing learning across your team is vital, as is the celebration of both the learning and the outcomes.  This is especially true when the project wasn't completed as smoothly as everyone would've liked.

Build sustainable processes to support development. Leaders should be expected to coach and develop their people. At a minimum, everyone should know what they need to improve and where they can go in the organisation. Don’t let time and lack of understanding stop the support you give your team.

Reinforce shared values. Employees should be able to link their everyday tasks and responsibilities to the values in the organisation. People need to understand why what they do is important.

Leverage problems as opportunities for real world learning and development. The idea of an ‘acceptable failure’ needs to be created and defined. Removing fear is key and becoming an organisation that sees problems as opportunities will open a much more communicative and safer environment.

In many ways these are not strategic, long-term actions. They can be achieved quickly and without huge cost. Their implementation will lead to a culture where the broader problems around time, skills and technology are much more likely to be addressed in a rational and effective way.

Find Denise on LinkedIn