Pricing B2B services on value, not cost

Ask a service business how it sets its prices and the answer is often some version of the same thing: we work out what it costs us, add a margin and check that we are not far off the competition. It is simple, it feels fair, and it is easy to defend internally.

It is also one of the most common reasons good businesses earn less than they should. Cost-plus pricing says nothing about what the work is worth to the customer. It ties the price to your own costs, so that becoming more efficient leads to lower prices instead of better margins. And it leaves pricing decisions to habit and to whoever is negotiating, instead of to a clear view of value.

This article looks at why so many B2B and service businesses underprice, how to think about value from the customer's side, and the practical steps that make a difference: segmenting, packaging, governing discounts, raising prices carefully and measuring what you actually earn.

Why so many companies underprice

Underpricing rarely comes from a single decision. It builds up over time, for reasons that are easy to understand:

• Fear of losing the customer. Salespeople feel the loss of a deal much more sharply than the margin given away on the deals they win. So they lean towards lower prices.
• Pricing from cost. If the price is cost plus a margin, it never reflects the value delivered. A project that saves a customer a large sum is priced the same as one that saves them little.
• No one owns pricing. In many businesses, prices are set once, adjusted occasionally and negotiated deal by deal. Nobody looks at the whole picture.
• Discounts become permanent. A discount given to win a deal three years ago is often still there, long after the reason for it has gone.
• Prices lag behind costs. Wages and other costs rise every year, but price lists are updated rarely and cautiously, so margins shrink quietly.

The result is that many service businesses are better at delivering value than at capturing it. The good news is that this can usually be improved without changing the service itself.

Start with the customer's value

Value-based pricing starts with a simple question: what is this worth to the customer?

For B2B services, value usually comes in one of a few forms. The service helps the customer earn more, for example through higher sales or faster launch of a product. It helps them save money, for example through lower operating costs or less downtime. Or it reduces risk, for example by avoiding fines, failures or delays.

Try to put rough numbers on it. Say a company sells maintenance services to industrial customers. If an unplanned stop at a customer's plant costs them a significant amount per hour, and your service reduces the number of stops, the value of your service is linked to the hours of downtime avoided. That is a very different starting point from the number of technician hours you spend.

You will rarely be able to calculate value precisely, and you do not need to. The point is to understand roughly how large the value is, what drives it and which customers get the most from it. Talking to customers is the best way to learn this. Ask what problem they hired you to solve, what it would cost them if the problem were not solved, and how they measure whether your work was worth it.

Your costs set the floor for your price. The customer's value sets the ceiling. The interesting work happens in between.

Understand the next-best alternative

Customers do not compare your price only with the value they receive. They compare it with what they would do instead. This is the next-best alternative, and it is one of the most important factors in pricing.

The alternative might be a competitor. But it might also be doing the work themselves, hiring someone, using a cheaper but less reliable supplier, or simply doing nothing and living with the problem.

For each main customer group, ask:

1. What would they realistically do if we did not exist?
2. What would that cost them, in money, time and risk?
3. In what ways are we better or worse than that alternative?
4. How much is that difference worth to them?

The difference between your offer and the next-best alternative is what you can reasonably charge for. If you are clearly better on the things the customer cares about, you can charge more. If you are roughly the same, price will matter more. Being honest about where you stand here is more useful than any amount of internal confidence.

Segment your customers

Customers differ in the value they get, the alternatives they have and how much they are willing to pay. One price for everyone means some customers pay much less than the service is worth to them, while others are priced out.

Useful ways to segment B2B customers include:

• By value received. Customers for whom your service is critical, compared with those for whom it is a nice-to-have.
• By needs. Customers who want a full service with high availability, compared with those who want a basic service at the lowest cost.
• By size and complexity. Large customers with many sites and stakeholders often need more coordination, but also get more value.
• By buying behaviour. Some customers buy on relationship and quality, others run formal tenders focused on price.

Keep the number of segments small. Three or four is usually enough. The aim is not a perfect model, but a practical way to stop treating all customers as if they were the same.

Package and tier your offer

Once you understand your segments, packaging is how you turn that understanding into prices customers can choose between.

A common approach is to offer two or three tiers. A basic tier covers what everyone needs. A middle tier adds the things most customers value. A premium tier adds faster response, more support, extra reporting or dedicated people for those who need it and will pay for it.

Good packaging has a few features:

• Each tier is clearly different, and the differences are things customers actually care about.
• The basic tier is good enough to be useful, but leaves out things that the most demanding customers want.
• Extras that only some customers need are priced separately rather than included for everyone.
• The middle tier is designed to be the natural choice for most customers.

Packaging also helps in negotiations. Instead of discounting the same service, you can offer a different package. If a customer wants a lower price, the conversation becomes what they are willing to give up, not how much you are willing to lose.

How discounts leak margin, and how to govern them

Discounts are one of the biggest and least visible drains on profit in B2B businesses. Each one seems small and reasonable at the time. Added together, they often take a large bite out of revenue.

The leaks come from many places. There are discounts in the price list, special deals for individual customers, volume rebates, free extra work, extended payment terms and services delivered beyond what was agreed. Many of these never appear as a discount in the accounts at all.

Say a company has a list price of 1,000 for a service. After a negotiated discount of 10 per cent, a year-end rebate of 3 per cent, and a few hours of unbilled extra work, the price actually earned might be well under 850. If the margin at list price was 20 per cent, a large share of it has gone. Small numbers add up quickly.

To bring discounts under control:

1. Make them visible. Calculate the realised price for each customer: what they actually pay after all discounts, rebates and free extras.
2. Set clear rules. Decide who can give which discount, up to what level, and what the business gets in return, such as a longer contract, higher volume or a reference.
3. Require something back. A discount should be a trade, not a gift. If the customer gets a lower price, the business should get something of value.
4. Review old deals. Look at customers whose discounts were agreed years ago and ask whether they still make sense.
5. Follow up regularly. Look at discount levels by salesperson, segment and customer at least once a quarter.

The aim is not to stop all discounts. It is to make sure each one is a deliberate decision.

Raising prices without damaging relationships

Many businesses avoid price increases because they fear losing customers. As a result, they wait too long and then need a large increase all at once, which is much harder to explain. Smaller, regular adjustments are usually easier for everyone.

Prepare properly before you raise prices:

• Know your numbers. Understand which customers are profitable, which are not, and how much each one matters to the business.
• Decide by segment. Not every customer needs the same increase. Customers on old, heavily discounted terms may need a larger adjustment than those already paying a fair price.
• Identify key relationships. For the most important customers, plan the conversation individually and in advance.
• Prepare the team. Salespeople and account managers need to understand the reasons, believe in them and know how to handle questions.

When you communicate, be clear, early and honest. Explain why prices are changing, whether that is rising costs, improvements in the service or a move to a clearer pricing model. Give customers enough notice to plan. For key customers, talk to them in person rather than sending a letter.

Protecting key relationships does not mean exempting them from price increases. It means treating them with care: listening to their concerns, being flexible on timing or packaging where it makes sense, and showing them what they get for the price.

Expect a few customers to push back, and some to leave. If every customer accepts an increase without discussion, the price was probably too low. Losing a handful of unprofitable customers can even improve results.

Run small pricing tests

Pricing feels risky because the consequences of a wrong decision seem large. Small tests reduce that risk.

A few ways to test without putting the whole business at stake:

• Offer a new package to new customers only, and compare how they respond with existing customers on the old terms.
• Try a higher price in one segment, region or service line before changing it everywhere.
• Present quotes with two or three options instead of one, and see which customers choose.
• Tighten the discount rules for one sales team for a quarter and compare win rates and realised prices with the others.

Decide in advance what you will measure and how long the test will run. Keep the test small enough that a bad result is easy to absorb, but large enough to learn something real. Many businesses are surprised to find that customers are less price sensitive than the sales team feared.

What to measure

Pricing improves when it is followed up with the right numbers. The most useful are usually:

• Realised price. What customers actually pay after all discounts, rebates and free extras, compared with the list price.
• Margin by customer. Which customers are profitable once the real price and the real cost of serving them are taken into account. This often shows that some large customers earn very little.
• Discount levels. Average and spread of discounts by segment, salesperson and product, and how they change over time.
• Win and loss rates. How often you win at different price levels, and the reasons given when you lose.
• Price increase realisation. How much of a planned increase actually came through.

Look at these numbers together, at least quarterly. Patterns often appear quickly, such as one segment with consistently deep discounts, or a few customers who cost far more to serve than they pay.

Where to start

You do not need a complete pricing strategy to make progress. A few focused steps can make a real difference within months.

1. Calculate the realised price and margin for your 20 largest customers. This alone usually reveals where money is leaking.
2. Talk to five or six customers about the value they get from you and what they would do instead.
3. Set simple rules for discounts: who can approve what, and what the business must get in return.
4. Pick one service or segment and design a clearer package or a modest price change. Test it, measure it and learn.

Pricing is one of the few levers that can improve results without adding cost. A business that understands the value it delivers, and charges for it with confidence and care, is in a much stronger position than one that simply adds a margin and hopes for the best.