At the halftime show of the Super Bowl, the Red Hot Chili Peppers joined Bruno Mars and played Give it Away. You know the chorus – “Give it away, give it away, give it away now!” Most of us have heard similar albeit shorter versions of that chorus in business many times. The value given away may be a discount, but is often not seen on the invoice. It may be shipping, extended payment terms, some type of customization, or even an ancillary product, and you could be asked to “just include it in the deal.” A VP of Procurement at Pepsico once told me, “That’s the free stuff after price has been negotiated.” If you have the backbone and the rationale to say “No, we can’t give it away,” your profits will increase.
McKinsey & Co. coined some terms several years ago that apply – the Waterfall and Pocket Margin. Those terms have been interpreted in slightly different ways over the years, but the main point is that companies start with a list price for a product or service and there are visible and invisible discounts or “free stuff” that cause the value collected to drop like water over a waterfall. That results in the actual profit earned, the money that can be put in the owner’s pocket, to decrease accordingly. When making pricing decisions, it is important to consider all of the things you are giving away that add value to the customer; and remember they reduce your pocket margin and take money from your pocket.
I am not advocating a “Just Say No” posture. There are times when it makes sense to make an off-invoice concession. However, there are many more times when those concessions cause more long-term problems and should be avoided. When you lower a price or give something away, you create a new reference point for your customers, sales people, and competitors. The most compelling argument for making such a concession is when you are trying to take business from a competitor, but the prospect is unconvinced that your product or service has enough of a value difference to warrant switching. If you just lower the price, it will be the new reference price. It is much better to clearly explain the value difference to the customer and, for a finite period, offer to include some service in the period. It must be very clear to the customer that the offer is temporary to enable the customer to validate the value of your service; and at the end of the introductory period there will be a charge for that service.
SAP is a very large software company that exemplifies the temporary waterfall approach. They developed a new cloud-based platform for IT applications, HANA, which they believe is exponentially more efficient than competing products. They have offered free developer licenses to startups and mature companies evaluating a switch to HANA. That enables those customers to evaluate HANA’s claims. Once those customers move their work to a production environment, standard licenses apply.
The other argument I hear is “It doesn’t cost us much to include this in the deal, so why risk losing it?” There is some truth to that, but the converse is it would not cost the customer much. Would the customer really walk away over something small like that? If so, then we have not done a very good job of articulating the value proposition or demonstrating it.
One of the critical elements in deciding whether it is appropriate to make an off-invoice concession is how well you can control it. If you have the appropriate processes in place that prevent the slow spread of that type of concession throughout your customer base, then it might be worth taking the risk to capture a new customer. However, if it is simple for the sales team to make that concession repeatedly at other customers, you should avoid introducing it now. Waterfall elements, off-invoice concessions, or free stuff, whatever you want to call them, are much like social entitlements. They are very difficult to eliminate once they become pervasive. Your customers and sales people are like the rest of us. We all understand that the freebies may be costly overall, but if eliminating them means a take-away from us – we don’t like it.
The final take-away is giving things away usually costs you money. It reduces your pocket margin now, and it can build longer term damage into your price structure and value proposition. Avoid giving things away now and you will increase your profits in the short and long term.
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