Developing a pricing strategy is often a misunderstood or poorly executed facet of business. Most businesses allow the market or competition to determine the pricing expectations for the industry. For the most part, the PEO industry has been no exception. When reviewing PEO pricing amongst various players, the vast majority price within a relatively tight administrative fee range. This is not likely by design but rather by default. This article will cover pricing strategy options, common pitfalls and the correlation between pricing and perceived versus actual value.
Perceived Versus Actual Value
What is the difference between perceived and actual value and what role does this play in pricing, customer satisfaction and market expectations? Perceived value is the expectations a buyer has based on a number of factors, including pricing. Actual value is the benefit driven by the provider, in this case, the PEO. The variance between perceived and actual value is what influences customer satisfaction and future market expectations.
The hospitality industry provides a good example in this area. A consumer’s expectations are different based on whether they book a room at the Ritz Carlton or Motel 6. Both establishments provide a room, bathroom, etc. However, the customer’s expectations vary based on each hotel (perceived value). When a company meets or exceeds a client’s expectations, customer satisfaction is high. These customer expectations at the time of purchase are starting point or perceived value. Actual value that meets or is greater than perceived value yields high customer satisfaction. Actual value that falls short of expectations equates to low customer satisfaction. As you will note in the hotel example, the perceived value or starting point expectations differ based on which hotel the customer is booking.
Pricing should be commensurate with perceived value and service should meet that perceived value to ensure high customer satisfaction. The byproduct of high customer satisfaction is repeat business, referrals and the elimination of buyer’s remorse. Buyer’s remorse can lead to poor brand equity and negatively impact future sales.
A company that states we will always exceed our customer’s expectations creates a self-fulfilling prophecy of ultimate disappointment. If a company exceeds its customers’ expectations continuously, it inadvertently sets new expectations. Sooner or later that company will not exceed these higher expectations and the actual value will fall short of the new perceived value, thus ultimately creating lower customer satisfaction. If a company provides greater service than the perceived value, it should charge for it. Otherwise, its pricing strategy is leaving profit on the table. This is not to say that a company shouldn’t strive for superior customer service, it should. Rather, it is to illustrate that pricing should be commensurate with actual value and in line with driving appropriate perceived value.
So how does the difference between perceived and actual value coupled with market expectations and customer satisfaction play out in the PEO industry and what impact does this have on pricing? A PEO that charges premium pricing is required to justify that pricing with a superior offering and premium customer experience. Executives often state “we do not sell on price.” We agree that a low cost leader pricing strategy does not have long term viability within the PEO industry. However, an executive team that states the company does not sell on price needs to design a PEO that is able to sell on something else. It is not enough to state that the company does not sell on price and then provide the market with a vanilla offering. A premium offering must accompany a premium price point.
Market Penetration And Competition
The PEO industry is a relatively new industry and thus has a low market penetration rate. Most estimates place the industry penetration rate at five to seven percent. Moreover, there are alternatives to the PEO model that buyers can choose in lieu of a PEO. When reviewing competition (which is a factor in your pricing strategy), a PEO should recognize direct competitors and alternative substitutes. While the market penetration is relatively low, competition levels are climbing. This means that a PEO must pay closer attention to their pricing strategy now more than ever.
Generic Pricing Strategies
Below are a few generic pricing strategies that we’ll review.
- Cost Plus Pricing
- Competition Pricing
- Premium Pricing
- Bundle Pricing
- Low Cost Leader Pricing
The two most common pricing methods are cost plus pricing and competition pricing. This is not because they are the best method of pricing but rather because they are the easiest to determine. Cost plus pricing utilizes COGS and adds profit to determine pricing. Competition pricing reviews the market competition and prices accordingly.
Low cost leader pricing is dependent on internal efficiencies that exceed that of competition. For example, Walmart and Costco are phenomenal players with low cost leader pricing due to their superior ability to manage their supply chain better than competition.
A low cost leader price strategy is not advised for the PEO industry due to unpredictability with overhead. For example, if a PEO is looking to utilize a low cost leader strategy, it virtually necessitates that it operate on an internal high deductible insurance platform. The result is the PEO can price more aggressively for insurance. If the PEO doesn’t price appropriately for the claims tail, it has the propensity for an implosion down the line. The lack of predictability in maintaining a low cost factor with insurance due to claims volatility is why the low cost leadership pricing model is short sighted within the PEO industry. Moreover, there is value that a PEO drives that can be capitalized on with pricing. The PEO offering is not a commodity and its price should not reflect a commodity price strategy.
The two advised pricing methods for a PEO, from this author’s point of view, are the premium pricing or bundle pricing methods.
Premium pricing takes more work to identify what the market will accept and also necessitates that the PEO drive increased value over its competition. If the PEO has a vanilla offering, it is better to use competition pricing and try to win on service. With premium pricing, a PEO sets an expectation for superior value (perceived value) and therefore must deliver upon these expectations to create superior customer satisfaction. A PEO that charges premium prices but under delivers will have client attrition issues and its brand equity will suffer.
Bundle pricing is the act of selling numerous goods or services at a reduction as opposed to if it were to sell each a la cart. A PEO that offers a tiered price system can provide discounts on services as the client moves up the price tiers. This allows the PEO to sell a higher tier of service (more touch points equal greater client retention) and the client feels they are receiving a better deal due to the better price per service (although their total price is higher but they are getting more for it).
Pricing elasticity is the correlation between price shifts and units sold. For example, if a PEO charged a $1,500 per WSE admin annually and moved that price to $1,400 would there be a dramatic shift in number of sales? Conversely, if a PEO charged $1,500 per WSE and increased its price to $1,600 would there be a dramatic drop-off in sales? Understanding the pricing elasticity of your PEO offering will help you determine where the PEO’s price point should be to meet revenue and profit goals in the most effective manner.
There are other pricing strategies available and often a company may utilize a hybrid strategy approach (Costco uses low cost leadership and value). Whatever strategy your PEO uses, the point is to use something. Don’t simply let the market dictate your price. All PEOs are not created equal and therefore their price shouldn’t be equal either. It is essential that the PEO leadership be honest when evaluating the value it drives to the market before it demands a higher price.
A PEO should also be cognizant that as it realizes economies of scale not to diminish the talent to a level that negatively affects the ability to command a future premium price . A PEO with a clear value differentiation should spend time training its sales force on how to illustrate this value and thus justify the PEO’s price point.
If a PEO uses a channel strategy with referral partners, an internal PEO member should be the one illustrating the PEO’s value to the prospective clientele. This element of the sales process should not be left to the referral partner. Your internal team knows your value and they should illustrate this value commensurate with an appropriate price point to perspective clientele.
Author: Rob Comeau is the CEO of Business Resource Center, Inc. a management consulting and M&A advisory firm to the PEO and Private Equity industries. To learn more about BRC’s offering, please visit www.biz-rc.com.