Getting your pricing right is not easy, but it can make the most significant impact on your profit if you do. Pricing is not something to rush into without some proper strategic thinking. It's important you make informed decisions based on intelligent assessment of all the options. With that in mind, we've created a series of guides for each of the core Pricing Strategies - Cost Plus Pricing, Competitive Based Pricing and Value Based Pricing.
You can also download The Definitive Guide to Pricing Strategy for even more guidance and advice on getting your pricing right.
In this article we are going to examine what is widely considered to be the most successful pricing strategy and, unfortunately, often the hardest to implement. So read on to learn more about Value Based Pricing…
What is Value Based Pricing?
Value Based Pricing is an approach where you set your prices based on the value of your product or service to your customer. Customer perceptions are the number one factor when setting pricing in this way and it therefore requires a detailed knowledge of your prospective customers and marketplace.
Value Based Pricing is more difficult to get right, but when you do, it’s extremely effective at driving up your profits. Value Based Pricing is all about what your customers really want, what they value and therefore what they are really willing to pay. This approach also requires you to get your positioning and messaging correct to support what you are trying to do. The two must work in tandem.
How do I set my pricing using Value Based Pricing?
When using Value Based Pricing the main objective is to understand what sort of value you offer your customers. Start with answering some key questions:
- What is going to attract customers to your product or service?
- Why is your product desirable to them?
- How does it reduce their problems and therefore look valuable?
To get some answers around your value follow these steps:
1. Research your customers
The biggest factor in this price strategy is the opinions and perception of your customers. What they are willing to pay for your product or service is vital in forming a competitive price point. Here are some steps you can take to enhance your understanding of your customers:
- Contact existing customers and find out what they value
- Research what problems you solve for customers
- Find the monetary benefits your product or service brings. So either how much money the problem is costing, or how much money your solution generates
Take a look at the Value Disciplines to understand where you generate value for customers. Is it based on your product or your customer intimacy?
2. Research the marketplace
Value Based Pricing is all about customer perception, but that doesn’t mean the marketplace isn’t important. The value of products can go up or down so it’s important to keep track of what is happening. Consider:
- Are there good substitutions to your product?
- How much choice is there for the user?
- Is it easy to move away from your product or service?
- How long does the value last?
Take a look at Five Forces to understand your marketplace in detail and the pressures that will be on your price points.
3. Understand the competition
Although not as much a factor as with Competitor Based Pricing, it’s important to evaluate and see what your direct competitors are doing with their customers and offering. How much value do they provide for what price point? To maintain a Value Based price point you must ensure you differentiate from competitors who are positioning themselves as Cost Plus or Competitively Based.
Take a look at Four Corner Analysis to evaluate a competitor strategy and understand how your own SWOT Analysis might look against it.
You’ve now got a lot of analysis and data. It’s time to calculate your pricing. Let’s take the example of a fictional safety product. Some of the aspects of the product that generate significant value are:
- Visibility of Risks
- Peace of Mind
- Cost Management
- Low Admin
All of the above reduce the cost for the customer and so have a value. You can attach monetary values to every item of value, be it money saved or money generated, to start to understand the value of your offering.
Those numbers may start to look great, but this is only the upside and unfortunately you also have to consider the downside of how a customer will also look at your product or service, and what risks may be involved. For example let’s say the safety product is made by a new start-up. In that case, these are the possible downsides that need to be considered…
- Small business
- Low credibility
- Unknown capability of business
- Customer staff need training on new product
- Cost to change from old system
As with the benefits, you need to attach some costs to these negative aspects of the product or service.
You’ve now got a good idea of the value of what you offer and the associated costs or risks. So, now you can begin to set a price point that the customer will accept.
An added bonus of all this work is that you’ll also have all the research required to do some excellent marketing, nailing the message to your potential customers. Because, Value Based Pricing is very much about both the price AND the packaging.
5. Test, Test, Test
Test your pricing out. You’re unlikely to get it right first time, so try it in the market, work with a few customers or prospects, and get feedback from your sales team. Test and refine until you have the best price point to attract customers, at the highest profitability for your company.
What are the advantages to Value Based Pricing?
Value Based Pricing has a lot of advantages to it, such as:
- Driving high profit
- Allows for higher initial price points
- Focuses on customers of your business
- Looks both internally and externally at data
- Over time the perceived value (and thus price) can increase
- The process means improved insight into the market and your customers
- Your marketing and messaging can be driven by this understanding of value
What are the disadvantages of Value Based Pricing?
Value Based Pricing does have some disadvantages, such as:
- It requires time and analysis to do correctly. It's not a quick win!
- It’s the hardest pricing strategy to adopt
- It’s not going to be exact as the percieved value per customer could be different
- The value of a product or service could decrease over time, impacting price
- It normally means you are limited in terms of the strategic positions you can take as a business. Strategic positions such as Lowest Cost (where you position yourselves as the lowest cost in the market) are unlikely to be possible with this approach, unless your competitors are all adopting the Risky High Margins position (you can find out more about these strategic positions in our Introduction to Bowman's Strategy Clock)
When is Value Based Pricing the right approach to take?
In most situations Value Based Pricing is the right approach to take for your pricing strategy. The drawbacks to it are mainly in the time it takes to perform the analysis and get the price right.
If we consider that it is always customers who pay your price - it is always a customer, or potential customer, who decides whether they accept your price and make a purchase - then it makes the most sense to use the only pricing strategy that focuses on them!
With a Cost Plus pricing strategy, for example, you are focused on what it costs you to produce the product or service, and customers don't care about that. You could be leaving money on the table if you're producing a product that can solve a huge problem for your customers but actually doesn't cost you that much to make. If you're helping people with a significant problem (or even just an annoying inconvenience) you'll find people are prepared to pay a decent amount to make their lives easier. With a Value Based Pricing approach you will work to understand that problem-solving/making-life-easier value and discover the price a customer is willing to pay based on that perceived value.
When is Value Based Pricing the wrong approach to take?
In situations where you need speed to market, or if the market is extremely crowded and you can feed off the “going rates”, Value Based Pricing may not be the best first approach you take.
What are the alternatives to Value Based Pricing?
The alternatives to Value Based Pricing include Cost Plus Pricing, with which you establish your price points based on a desired set margin on top of your cost, and Competitive Based Pricing, where you look at the existing market price points and set your prices in relation to those.
What tools will help when setting Value Based Pricing?
There are a number of strategic tools and frameworks that can help you when adopting Value Based Pricing:
- Five Forces Analysis to understand your marketplace
- Four Corner Analysis to understand your competitors
- Value Disciplines to establish where you focus to generate value
- VRIO Analysis to establish your competitive advantage and values
- Perceptual Maps to map out the key players in your market and the options for your potential customers
Each of these tools will help you with what can be a complicated but extremely effective process. Good luck in setting your prices!