Pricing Strategy in the Frozen Ocean
One of the most difficult parts of selling any product or service is finding the right price that will both give you the margins you need to run your business profitably and be palatable to your customers and clients. This balance is only highlighted when your work in an extremely competitive industry.
In 2005, Professors W. Chan Kim and Renée Mauborgne of INSEAD published a book called Blue Ocean Strategy. The idea is that companies either live in a Red Ocean (markets that are overcrowded where companies are continually trying to stay out of the red) or they create Blue Oceans (their own markets where they strive for product differentiation and low cost production). In working with our clients, the Giersch Group has identified a sub-ocean of the Red Ocean: the Frozen Ocean. The Frozen Ocean, much like the Red Ocean, is a highly competitive space, sometimes with low margins, but the unique point about the Frozen Ocean is that once a company acquires a customer, they usually do not leave.
Pricing in the Frozen Ocean requires very specific strategy. This resource reviews the different aspects that must be addressed when pricing in the Frozen Ocean.
The Frozen Ocean
If the Blue Ocean is where there is little competition because you’ve created a new market, and the Red Ocean is where there is lots of competition and you are searching to acquire customers from the competition, the Frozen Ocean is where there might be lots of competition, but customers almost never leave their service providers. Therefore, in your space, you essentially have 100% market share. Which means you have no competition, but you also have no customer growth. It seems crazy that there could be industries where customers never leave their service providers, but think about these examples:
- Small Manufacturing Companies.
Finding a good manufacturer is difficult. There are so many pieces: setting up the line, buying materials, creating molds or forms, acquiring the expertise, organizing shipping, quality control, and so much more. So when you find someone who can make your product, you stick with them. Yes, sometimes it is expensive. But the expense of changing is much more expensive. - Accountants.
There are thousands of accountants out there waiting to make sure your business files its taxes on a yearly basis. Some of those accountants are not very good. But companies keep coming back to them year after year. This isn’t because those companies are unaware that they aren’t getting the best advice. Rather, it is difficult to change accountants. Getting a new accountant means finding new candidates, interviewing them, figuring out if you trust them, making sure they work well in your industry, helping them understand your business, answering their questions as they wonder why your last accountant did things this way or that way, etc. So instead of finding a new accountant, businesses just decide the current accountant is good enough.
Where do we find the Frozen Ocean?
One of the key distinctions of the Frozen Ocean is the inertia that customers have. It is very difficult to get them to move to another service provider. We often find the Frozen Ocean in industries with the following characteristics:
- High switching costs or inertia.
- Similarity of products across sellers.
- Growing relationships between customers and businesses leads to high level of customization.
Components of Pricing
Pricing products and services should always start with a clear understanding of costs, which can be broken down into three categories.
- Direct Costs: An expense that can be completely attributed to the production of specific goods or services, often called variable costs.
- Related Overhead: All costs not including or related to direct labor, materials or administration costs that relate to the production, delivery of the product or services, often called fixed costs.
- Selling, General and Administrative (SG&A): The sum of all direct and indirect selling expenses and all general and administrative expenses of a company. The idea of this category is that these costs tend to be fixed and do not directly contribute to the delivery of the product or service.
After all expenses have been accounted for, a reasonable margin that allows for profitability should be calculated and added to the expenses. This is the price of the product. For more information on the components of pricing, review our Pricing Strategy resource.
Pricing Strategy Related to Long Term Customer Value
Pricing is about more than just covering costs. More than almost anything else, pricing can affect how clients and customers view you and your enterprise. Price too low and clients wonder why you don’t think you are worth more. Price too high and clients think you’re overpriced for the service you provide. Therefore, pricing strategy should be considered in different situations.
One-Off Transactions
Some businesses rarely have repeat customers. In these cases, businesses should strategize on ways to get the most margin out of each transaction. Generally, each client will receive the same level and amount of service, and margins will end up being small. In this case, overall profitability will rely on high volumes of sales and a significant number of customers. This is the epitome of the Red Ocean.
Long-term Clients
In service and business-to-business enterprises, rather than having customers, often you will have clients who continue to interact with the business on a long-term basis. In these cases, pricing the first engagement is a delicate situation. The business must balance pleasing a potentially highly profitable, long-term client with the need for a strong margin and not setting a precedent. Usually, businesses will end up on the side of winning the client with sometimes slightly lower prices and making it up in the long-term.
Pricing Strategy in the Frozen Ocean
Unlike the normal Red Ocean, in the Frozen Ocean, once you win a customer, they stick with you forever. Overall profitability may still rely on large numbers of customers and high volumes of low margin transactions, but there is also repeat business. However, with low customer growth, every new customer is critical to revenue growth. Who knows when the next customer will come along? Therefore, when pricing the first job to a potential Frozen Ocean client, it is not abnormal to see steep discounts with the expectation that prices will rise on later jobs.
For more information, please visit the Giersch Group at http://www.gierschgroup.com/ or contact us at prosper@gierschgroup.com
