I don’t think there’s a capital equipment sales or marketing professional that hasn’t argued, “We need to discount to break into this account, and once we’re in, the gross margin will go up.”
This position is usually rebuffed by the general managers and finance people who argue, “If the product is as good as marketing says, then you need to convince the customer of its value. We need to get our price. The market share will follow.”
So, who’s right?
Market Share Usually Comes First
You’ve got your marching orders to penetrate that critical account. The competition has won every order for the last three years, but you’re not deterred. You hit your customer with your best presentation, touting your advantages and the higher profits they will realize due to your product’s technological breakthrough. Point by point, it’s clear that you’re better than the incumbent.
Your solution looks great on paper, and even the product demonstration went well. But the problem is that the only way the customer knows for sure your system will work is to buy it and use it. That’s a lot of risk for your customer, especially if his existing solution is acceptable.
You have to realize that your customers have already invested a lot in optimizing the competitor’s product. They’ve trained operators, optimized the process, and made a sizeable investment in spare parts. They even know your competitor’s weaknesses and have figured out how to work around them.
There will be a cost associated with switching to your system. Your customers will have to re-learn everything and rebuild their support infrastructure. They’ll assume you will also have weaknesses and expect that they’ll have to relive the painful discovery process all over again. Switching to your system will initially be more expensive and less efficient for your customer, even if your advantage claims hold up.
To overcome the customer’s switching costs and risks, compromises on standard pricing and terms may be necessary when penetrating a new account. These concessions can take the form of a:
- Longer-than-standard warranty
- Applications support to qualify your system
- Risk-free evaluation period
- Period with the right to return the system
- Discount off the system price
As a result, that penetration deal often doesn’t have a healthy gross margin. Thus, in the case of many capital equipment products, market share usually comes first.
However, making concessions to break into an account doesn’t automatically mean that higher gross margins will follow. Margins will only follow if your product provides a true value advantage.
Advantage Must Be Experienced for Margins to Follow
So, you’ve broken into that critical account, but you took it on the chin for that first order. That’s okay because better pricing is sure to follow, right? Not so fast. Your product must have a real, tangible value advantage over your competitor’s. Higher gross margins will not follow if the advantage isn’t clear.
Your product positioning, data, and demonstration got you this far, but now your product is parked right next to your competitor’s. It’s time for a real-world, head-to-head performance evaluation in your customer’s environment. At this point, there’s a significant change in how the customer evaluates your system. It’s no longer your data that matters; it’s theirs. It’s no longer your demonstration results; it’s their production results. Once your system lands on your customer’s production floor, there is no faking it. It’s here, in your customer’s environment, running your customer’s product, that your system must demonstrate its advantage over the incumbent.
But having an advantage is only half the battle. Remember, the competitor has already integrated their product into your customer’s process. They’ve already trained the customer’s staff and filled their stock room with spare parts. Your competitor’s support infrastructure advantage also needs to be overcome.
That means that your support during the head-to-head evaluation phase needs to be impeccable, and you need to get the customer up the experience curve fast by focusing on:
- Solving issues with lightning speed.
- Making the customer experts on your product.
- Establishing regular communication.
- Defining success criteria and tracking performance.
- Getting spare and consumable parts logistics up and running.
It would be a tragedy to have an actual advantage but fail to capitalize because the support wasn’t in place to ensure success for the customer. Once the customer experiences your value advantage and has invested in your product’s success, the door is open for margins to improve.
Structure Penetration Deals to Tee-Up Follow-On Pricing
When doing a penetration deal, you want to set the stage for follow-on orders but don’t negotiate them right away. Two big mistakes can doom you to a lifetime of penetration pricing.
The first mistake is trying to negotiate follow-on orders with the penetration deal. Before the customer has qualified you, you are in your worst negotiating position. The customer hasn’t experienced your value and hasn’t made a monetary, political, or emotional investment in you or your system. At this point, negotiating a volume deal almost assures the customer a fleet of systems at penetration pricing.
In addition, the terms will probably include an escape hatch for the customer since he hasn’t proven for himself that your system will work. So, in essence, you end up committed to multiple systems at compromised prices, while the customer only committed to giving your system a workout. Your position will improve once the customer has experienced success with your product. Wait until then to negotiate follow-on orders.
The second mistake is to fool yourself into thinking that you’ll penetrate a capable competitor’s account on standard pricing and terms. In this case, you stick to your guns on price and terms deep into the sales process because you cannot stand the thought of discounting or offering special terms until you absolutely must.
However, when the purchasing manager threatens to stick with the incumbent at the last minute, there’s a good chance panic will follow. Then it’s all hands on deck to save the order. There’s no time to think about preserving the concept of your system’s value to protect future orders. You’ve got to get this order, and there’s no time to recover, so you capitulate on price and terms. Now you’ve conditioned the customer to expect a last-minute cave-in and allowed him to anchor pricing to this penetration deal.
To help avoid this situation, create an official new customer package. Give it a name. This name doesn’t even need to be creative. “New Customer Start-up Package” will work just fine. This package contains special pricing, terms, and support designed to compensate the new customer for the costs and risks of qualifying your system.
Get this program on the table right at the beginning of the sales process. This program should include supporting marketing materials to communicate the value these special incentives have in helping new customers mitigate switching costs and risks. This special package will legitimize the offer as a one-time program for new customers rather than a heat of the moment capitulation.
Throughout the sales cycle, keep standard terms and pricing visible and separate from any concessions to help mitigate the customer’s switching costs and risks. New customer concessions should be explicitly called out as just that and always discussed in the context of your special start-up program. While not a panacea, this will help prevent future negotiations from anchoring to the original penetration deal.
Four Keys to Ensuring That Gross Margin Follows Market Share
Market share often precedes target gross margin performance because the supplier must share in the customer’s switching costs and risks. The four keys to ensuring that gross margins follow after a penetration deal are:
- Do not bundle follow-on orders with penetration deals.
- Outline a penetration sales process and contract that sets expectations for follow-on pricing and terms.
- Develop a robust support plan to get your customer up the experience curve.
- Provide a real value advantage that your customer experiences in their environment.