24 July 2008

Performance-based pricing

By Jim Pinto

Products in the automation industry have traditionally been sold with “cost-based” pricing, selling price based on manufactured cost, with target gross and net profit margin multipliers. But global competitors are ready to compete with lower profit margins. So, the traditional cost-based pricing model now has flaws.

The tactical response by large automation suppliers is to offer broader ranges of products, software, systems, and services. But this still has the effect of reducing overall profit margins. The problem lies in obsolescent cost-based pricing.

Pricing is a zero-sum game between the supplier and customer. The focus must move to win-win, simultaneously providing greater customer value and higher supplier profitability. Performance-based pricing is the answer. It allows the up-front cost to the buyer to be relatively low, and offers the seller a high return based on performance.

Performance-based pricing is “insurance.” It guarantees when suppliers provide more, they will earn more. Buyers also receive insurance through paying only for the performance delivered.

With performance-based pricing, suppliers get the opportunity to manage customer value and be closely involved with generating additional profits for both sides. With the risks come added revenue and profit opportunities for the suppliers.

Related links:

• Performance-based pricing:
  http://jimpinto.com/writings/performancepricing.html
• China targets the Achilles-heel of Capitalism:
  http://www.isa.org/InTechTemplate.cfm?Section=ViewPoint1&template=/ContentManagement/ContentDisplay.cfm&ContentID=68714
• Is Performance-Based Pricing the Right Price for You?
  http://hbswk.hbs.edu/item/3021.html

Behind the byline

Jim Pinto is an industry analyst and founder of Action Instruments. You can e-mail him at jim@jimpinto.com or view his writings at www.JimPinto.com. Read the Table of Contents of his book, Pinto’s Points, at www.jimpinto.com/writings/points.html.