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What is value based pricing?
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What Is Value Based Pricing
Value based pricing is a type of pricing strategy where a company sets the prices for its goods and services based on how much it’s worth to the customer.
In other words, the company will sell its products and services at a price point that reflects what it’s worth to the customer.
For example, a software developer will set the price for its software based on how much the client can save by automating its services.
This type of pricing strategy considers variables directly linked to the customer as opposed to considering internal costs or competitor pricing.
Companies that have a strong relationship with their clients or have unique products and services will be able to set value based pricing ensuring they maximize their profit margin.
The more clients perceive your product and services as valuable, the more they will be ready to pay a higher price tag for it.
When To Use Value Based Pricing
Value based pricing is a type of strategy that can work in certain situations, but not all.
Typically, value based pricing is effective in situations when a customer is making a purchase because it has a specific need or wants to satisfy a specific desire.
For example, companies selling luxury goods can set their price based on the value perceived by their clients as their clients are looking for a premium product, brand, and high quality.
The more a customer has a specific need it wants to satisfy, the more a company can take advantage of value based pricing.
Another factor that helps companies set their prices based on the perceived value is when the products and services are sufficiently differentiated from that of the competitors.
In other words, a customer cannot simply achieve the same level of utility by going to another product.
For example, some people are highly loyal to a brand.
As a result, if another company releases their latest and best, the customer will not necessarily be tempted to switch as they are loyal to the brand.
In this context, the company will have a significant advantage over its competitors as its customers will continue purchasing its products based on their perceived value.
Value based pricing is effective in the following situations:
- When customers decide to purchase based on emotions
- When there are shortages
- In scarce markets
- In niche markets
- When customers are buying an addon or complementary product to another
Value Based Pricing Advantages
There are several key benefits to using value based pricing.
The first advantage of setting your prices based on value is that you can potentially penetrate a certain market more easily.
If your target market is not brand loyal and the products and services are highly similar, provided you have a product that is sufficiently differentiated, customers will want to buy from you as you offer a unique product.
Since your product is unique, customers will be ready to pay more for your product than for a similar product.
Another key benefit in value based pricing is that you can potentially generate a much higher profit margin as you can markup your prices significantly.
Since the customer is willing to pay for what the product or service is worth to them, that can translate into a much higher profit margin for the company that is able to command a much higher price.
Also, companies that set their prices based on customer-perceived value are able to position themselves as premium providers or luxury brands.
With this type of positioning, you can achieve a higher brand loyalty over time, resulting in higher perceived value.
Value Based Pricing Disadvantages
Although value based pricing has many benefits, you should also be mindful of the disadvantages.
Since there’s a lot of competition in the market, it may be difficult to find a niche where customers have less brand loyalty and where your product is sufficiently differentiated.
If customers consider that your price is too high, they may deliberately choose an alternative that is more reasonably priced and gives them the utility they are looking for.
Another challenge that companies may face is that customer perceived value may change quickly.
If the company has quality issues or has other issues that affect its customers, the general sentiment about the perceived value may change quickly, resulting in a significant loss to the company.
Another important drawback in setting value based pricing is to determine the actual price corresponding to what a customer will be willing to pay for the product.
Perceived value is in the eye of the customer.
As a result, there’s no scientific way of measuring that unless you can ask your customer about how much value they are getting when using your products and services.
Companies that do not have a strong relationship with their clients to know what would be the right price point may have difficulty setting their prices.
How To Do Value Based Pricing
Setting your prices based on what the market is willing to bear requires a good level of business intelligence.
The first step is to conduct market research.
The objective here is to ask your potential target market how much they perceive value in your products and services.
You can segment your customers in different ways to assess the perceived value based on the type of customers you may serve.
The next step is to see how your competitors are positioning themselves in the market.
Do your competitors have brand loyalty?
Are they setting their prices below what customers perceive in value or at the same level?
Can you differentiate yourself in the market?
The next step is to see how fast competitors can produce a similar product.
A product that can easily be replicated may not be able to be priced based on a value based pricing strategy as complex products in niche markets.
Once you’ve gathered your business intelligence, the next step is to set the price based on the value perceived by the customers.
It’s important to keep track of your sales and market development to reassess if your price is adequately set.
Value Based Pricing vs Cost Plus Pricing
What is the difference between value based pricing and cost plus pricing?
Value based pricing is a type of pricing strategy where you set your price based on what your customer is willing to pay for it.
In other words, what matters is the perceived value for your product.
The more a customer is willing to pay a higher price, the more you can set higher prices.
On the other hand, cost plus pricing is a type of strategy that considers your production costs.
You set your price based on what it costs to produce your goods and services and add the desired markup.
This type of pricing strategy does not consider what customers are willing to pay or the prices set by your competitors.
Typically, value based pricing will result in much higher prices and higher profit margins than cost plus pricing.
Value Based Pricing Example
Let’s look at an example of value based pricing to illustrate the concept better.
There are many industries where companies can set their prices based on the value perceived by the clients.
The pharmaceutical industry is notorious for this type of pricing.
A pharmaceutical company selling drugs that can help save people’s lives, customers will practically pay any price the company commands.
This is the case because a patient who needs a specific type of drug to overcome an illness will have a much greater perceived value for the drugs.
Companies selling luxury goods are also highly known to use value based pricing.
For example, the fashion industry, the luxury automobile industry, cosmetics, and personal care products can be priced based on how much the customer believes the product is worth.
Software companies are also able to set their prices based on the value obtained by a client when using their software product.
So there you have it folks!
What is value-based pricing?
In a nutshell, value-based pricing is a type of pricing strategy where a company will sell its products and services based on how much a client is willing to pay for them.
The more a customer perceives value in a company’s products and services, the more they will be willing to pay for such products.
Although value based pricing can be combined with other pricing strategies, this type of pricing strategy is based on how much the market is willing to pay for your products and services rather than looking at the cost of producing the goods or competitor prices.
This type of pricing strategy works well when customers make purchasing decisions based on emotions, in niche markets, when there are shortages, or when purchasing complementary products to another.
Now that you know what value based pricing is and how it works, good luck with your research!
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