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As an individual contractor, freelancer, or independent entrepreneur, you may have run across the term value-based pricing (VBP) when formulating your business plan and pricing strategy.
So, just what is value-based pricing? And, when is it important to use?
According to Wikipedia, “Value-based price is a pricing strategy which sets prices primarily, but not exclusively, according to the perceived or estimated value of a product or service to the customer rather than according to the cost of the product or historical prices.”
But, what does that mean for you and your business? Read on to find out.
What is value-based pricing?
Literally, value-based pricing is pricing based on the customer’s perception of your product’s benefits to them. It is also referred to as customer-based pricing, value pricing, or value-optimized pricing.
A company would use this pricing strategy based on their estimated value of the product or service to their targeted customers rather than trending or historical prices. A great example of value-based pricing is the auction price of an original painting by Monet.
What’s the difference between value and price?
So, you may be asking, what is the difference between value and price? Price is what an individual pays for the goods or services they acquire. Value is what the goods or services pay them.
Price is in a dollar amount. Value can be measured financially, emotionally, or a number of other ways – it is what you get out of a purchase.
How to determine value-based pricing
When using value-based pricing, your price is based on the differences your product/service offers your customer versus your competitors’ products.
You then need to place a numerical value on those unique features (not every single one, but in general) based on what you think your target customer would pay.
The best way to know this is by doing some market research on your consumer base. What has the customer paid in the past, what are your past customers willing to pay, what did they pay for your competitors’ version?
The important thing to remember is that there is no right or wrong answer to what your price should be in this pricing model because people are different and value things differently.
How does value-based pricing work?
Market research was mentioned above to utilize when using a value-based pricing strategy. This can include customer surveys, customer interviews, and marketing intelligence.
Utilize sources you trust and look at what your competitor(s) are doing. If you are offering a product like a laundry detergent, where there are hundreds of alternatives, this pricing strategy may not be the right approach.
If you are offering specialized marketing consultation to small businesses in a specific niche, this strategy would be best for yours.
“The customer is always right”
You can utilize customer segmentation to identify your ideal customer and then find out what those customers value based on their experiences, packaging content, etc.
You’re probably saying, “But what about my competition and what they are charging?” Don’t be afraid to find out. Choose a competitor and compare their product/service to yours.
Compare the features offered and the success of their sales to your target market. Customers are a key part of value-based pricing and there are three great reasons to base the pricing on customer value: you get to know your customers so you can build the best product based on their willingness to pay the price that you are charging.
Value-based vs cost-based
A pricing strategy is an important component of business and can be used as a marketing message or a means of survival in your market area.
Value-based pricing and cost-based pricing are two common pricing methods but rely on different components. Below is a table comparing the two methods:
|Cost-Based Pricing||Value-Based Pricing|
|Uses manufacturing or production costs as a basis for pricing||Considers the value of the product/service as opposed to the cost incurred to create it|
|Price is set based at a percentage above the costs of manufacture to secure a profit||Considers the potential value the product/service brings to the customers|
|Most companies that produce in masses use this strategy||Company has to determine how much value or money product will generate for the customer(s)|
|Considers what cost to produce and how much customers willing to pay||Can originate from factors such as increased efficiency, happiness, or stability|
|Textiles, food products, building materials, household items||Pharmaceuticals, computer software, artwork, name brand cosmetics, luxury cars|
|Focuses on the company’s situation when determining the price||Focuses on customers when determining the price|
|Sets price at least can charge and still earn a living and the most the market can bear||Company sets pricing in a range determined by what customers willing to spend|
|Objective factors used to determine the price||Subjective factors of customers determine the price|
|Need to sell more products with a lower profit margin to net a profit||Enables you to earn an even higher net profit from fewer products|
When to use value-based pricing
Value-based pricing is more successful when you are selling products based on emotions, in niche markets, in short supply, or for complementary products such as print cartridges.
Successfully implemented, this method will improve profitability by generating higher prices without impacting substantially on sales volumes.
You want to use VBP when providing services rather than products if your services are unique or specialized and not mass produced.
It is useful to utilize VBP after building a solid relationship of trust and respect with your customer base or segment.
How to set and implement value-based pricing
Value-based pricing is pricing based on your product and the value your customer receives from it. In order to effectively set up and implement value-based pricing, you have to be dedicated to finding out more about your customers/prospective customers and your product. You will also need patience because the process takes time.
Here are some basic steps to follow when starting to price based on value:
1. Identify your customers and the segment you wish to serve
2. Compare your product or service with the next best option available to your customers
3. Make a list of all the ways your item is better and estimate how much you think these differences between your product and your competitors are worth to your customers
4. Make a list of how your competitor’s option is better than your product/service (remember to be honest with yourself here) and how much these differences are worth to your customers
5. Now, take the price of the competitor’s option (CP), add the value of your product’s advantages (PA), subtract the alternative’s advantages (CA) and you have your final price (FP).
CP + PA – CA = FP
As you learn more about your customer, you can start at a higher price point based on their willingness to pay it and as you add more to your offerings making it more valuable to your customers.
Misconceptions about value-based pricing
Now that you have read how great value-based pricing is and how to implement it in your business, here are some misconceptions you may run across in your pricing process.
- Value-based pricing requires the company to evaluate the customer’s willingness to pay for each and every product feature
- Not all customer segments are the same
- A dollar amount needs to be assigned to each unique difference in your product from the competitor’s product
- If your competitors are not smart with pricing using value-based pricing will still lead to success – this can create false expectations of your product’s triumph over other products
- The perceived value doesn’t equal delivered value
Why value-based pricing works
This pricing strategy works because it benefits both the company and the consumer. Your company will increase profits and customer loyalty and your customer is receiving premium services/products that they value.
It can also help to grow your business by creating a dedicated customer base for your products, maintaining sales levels, and can provide advertising through word of mouth when your customers are satisfied.
Now that you have the lowdown on value-based pricing, it is up to you whether you choose to use it in your business.
Ask yourself who your customer is, what niche are you catering to, and what values do your services/products provide to them.
If you can’t answer those questions, value-based pricing may not be for you or may not be the best choice for your company at this moment. Remember that VBP is just one pricing strategy to utilize—if it doesn’t work for you, there are other strategies out there.
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