Which Comes First – Market Share or Gross Margin?

Product Marketing

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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 is usually rebuffed by the general managers and finance people who argue, “If the product is as good as marketing says, then you just 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 key account. The competition has been entrenched 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 that they will realize as a result of 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.

What you have to realize is 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 have weaknesses too 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.

In order 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 the gross margin that you were looking for. 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 key 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 that of your competitor. If the advantage isn’t clear, higher gross margins will not necessarily follow.

Your product positioning, data, and demonstration got you this far, but now your product is parked right next to that of your competitor. It’s time for a real-world, head-to-head performance evaluation in your customer’s environment. At this point, there’s a big change in how your system will be evaluated. 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’s product is already integrated into your customer’s process. The customer’s staff is already trained, and their stock room is full of the competitor’s spare parts. Your competitor’s support infrastructure advantage also needs to be overcome. The deck is stacked against you.

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 a true advantage but fail to capitalize because the support wasn’t in place to make sure that the customer was successful. Once the customer experiences your value advantage and has made an investment 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. There are two big mistakes that can doom you to a lifetime of penetration pricing.

The first mistake is trying to negotiate follow-on orders with the penetration deal. Before you’ve been qualified by the customer, you are in your worst negotiating position. They haven’t experienced your value, and they haven’t made a monetary, political, or emotional investment in you or your system. Negotiating a volume deal at this point 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 she hasn’t proven for herself that your system will work. So, in essence, you end up committed to multiple systems at compromised prices, while the customer really only committed to give 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 how to preserve the concept of your system’s value in order 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. You’ve now trained the customer to expect a last-minute cave-in, and all sense of the real value of your system has dissolved. The baseline for follow-on orders is now the penetration deal and pricing.

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 Program” will work just fine. This program is a package of special pricing, terms, and support designed to compensate the new customer for the costs and risks associated with qualifying your system.

Get this program on the table right in the beginning of the sales process. This program should include supporting marketing materials to communicate the value that these special incentives have in helping new customers mitigate switching costs and risks. This will legitimize the offer as a one-time program for new customers rather than as 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 at least help keep the starting point for future negotiations from being pegged 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:

  1. Do not bundle follow-on orders with penetration deals.
  2. Outline a penetration sales process and contract that sets expectations for follow-on pricing and terms.
  3. Develop a robust support plan to get your customer up the experience curve.
  4. Provide a real value advantage that your customer experiences in their environment.

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