When paying is cheaper than free
The power of value messaging
Often when you are in the position of having to sell something to another person — having to describe the product they could buy and how much it will cost them to do so — you find yourself doing so in an apologetic fashion. It’s a very natural human reaction. We do not want to feel like we are acting selfishly, and saying, “Please give me money for this product I am representing,” can often feel selfish at an intuitive level.
One of the advantages of value-based pricing as a mindset and a sales tool is that it helps to reframe that discussion from “please give me money for this product” to “you should invest in this product which will produce a return that makes you better off than you are now”.
Not only is this a better message to persuade the customer, it also is a better message for the salesperson’s confidence. You’re not taking something from the customer, you’re helping them become better off.
I’d like to illustrate this with an example I’ve dealt with from the steel industry.
In a steel mill, steel is refined and processed into a long rectangular bar called a billet. If the mill is making steel rebar, the long ribbed steel rods used in construction, the heated billet is then run through a series of paired rollers which gradually roll the heated steel into a thinner and thinner rod until it reaches the target diameter.
The first sets of rollers in the sequence are very large (and thus turn comparatively slowly) and are made of cast iron. As the steel moves down the line, it goes between smaller rollers, and since they are smaller in diameter they have to turn faster to keep up with the moving steel, and they also heat up more, being smaller in relation to the steel passing between them.
In an older steel mill, these later hot rolls would be high speed steel, but in a more modern one the hot rolls would be made from tungsten carbide. The reason is that the tungsten carbide will last roughly ten times longer before needing to be changed out.
To change out a hot roll, the entire steel rolling line has to stopped. The cost of downtime in a steel mill can run to tens of thousands of dollars per hour. If steel rolls have to be changed out ten times as often, and we value the cost of a stoppage at $20,000, then the difference in operating cost between a steel roll and a tungsten carbide roll is $200,000.
A tungsten carbide hot roll might sell for $12,000, while a steel roll might sell for only $1,000. However, since steel rolls only last 1/10th as long, you would need to buy $10,000 worth of steel rolls to provide the same operating lifetime as the single $12,000 carbide roll.
Then consider the cost of the downtime. With our assumptions above, that is $20,000 for the carbide roll versus $200,000 for the steel rolls.
So the total cost of operation for the steel rolls is $210,000 in product plus downtime, while the total cost for the tungsten carbide roll is $34,000.
Indeed, even if the steel rolls were free, it would still be $66,000 cheaper to buy carbide rolls than steel ones.
You might ask, if the carbide rolls are such a good deal, why anyone would ever buy steel ones. There are two answers:
The cost of investing in tungsten carbide rolls is an up-front cost, which might need to be financed. Whereas the higher operational cost of the steel rolls is incurred over time.
When steel mills are running far below capacity, the cost of downtime diminishes.
Still, it’s a staggering example of how looking at price in terms of total value is eye-opening. In this case, a product is cheaper than a competitive offering which initially appears to be less than 1/10th the price.
A different question you might ask is why tungsten carbide rolls don’t sell for a good deal more. If there is a $76,000 difference between the total operating cost when buying steel rolls and tungsten carbide rolls, couldn’t the tungsten carbide rolls sell for more?
They could. But unfortunately there are discount manufacturers of tungsten carbide who are eager to break into this market and they keep the price of carbide rolls low. Sometimes, sadly, we can’t have nice things.
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I always like to read good writing no matter what the subject is, so I'm enjoying reading your blog, although I have never worked in industry. I do self-publish books and I know you wrote a book yourself though it was published through Ignatius. I'd really be interested in an article about pricing in the book industry.