What is value based pricing?
Value based pricing is a strategy where a business will decide the value their product or service will offer to the consumers. The value can be in terms of being time efficient, stability and durability etc. Value based pricing strategies are created around consumers and how much they are willing to pay extra for a product that comes with more value.
Value based pricing vs cost based pricing:
While value based pricing works according to the value a product offers to a consumer, cost based pricing focuses on its own internal reasons. For instance the cost of production along with other factors will come into play when cost based pricing is used to price a product.
Where is it used most often?
Value based pricing is usually found when products or services are priced based on
- Emotions (latest fashion or watches)
- Shortages in the market.
- Their niche in the market
- Whether it’s a necessary item ( cigarettes for instance)
- It is an add-on like charging cables or ink for fountain pens.
Value based pricing is also used if the economy is in recession or if the competitors are also bringing products and services with the similar value. Consider the fact that almost all phone manufacturers are competing at similar prices. An iPhone 8 will be priced similar to Samsung 8 smartphone. And the price that a consumer is paying for a product makes them feel like they are getting more value from their money.
How does it work
To fully understand how value based pricing is executed we need an example.
Consider Acme Laptops which is about to launch a new laptop with latest core i9 chip processor. The nearest alternative to Acme is Red Laptops’ core i7 laptop. Both are offering the same specs and same capabilities otherwise. However Red Laptop has priced their laptop at $999.
Now how would value based pricing work with Acme?
Focus on a single segment
First thing you have to realize is that value based pricing isn’t for the whole market. Since the computer has core i9 chip, its more powerful and faster computer compared to any other in the market. So Acme needs to focus on businesses, universities and other places where such a computer can be used. And if there are going to target different segments, each should have its own value based pricing strategy.
Compare your product with the next best thing
Your product needs to have value. If there is another product that is offering exactly the same thing or even better, then you are only over pricing your customers. Find out the next best alternative and compare meticulously with it. It is imperative that you calculate your value against your competitor and then add a price tag to it.
What makes your product different
The product that you want to price based on its value should have something that is different from your competitors. In our example, Acme’s laptop comes with a core i9 whereas Red’s laptop has a core i7 chip, meaning the former has a better processor. This is what makes Acme laptop better and the company will price it according to the value the processor brings in.
Evaluate the differentiation
Now that you know how you differ from your competitor, all you need to do is calculate the value based price. How much will consumers pay extra for a powerful core i9? The amount you figure out needs to be added to the price of your competitor’s product, in this case red’s laptop which is charged at $999.
If the value you considered is $200, then you can charge your customers $1,199 ($999+ $200)
Value based pricing is incredible if you can pull it off because not only it allows you to charge more but you do it without alienating your customers and can continue in attracting new customers. But it all trickles down to knowing the costs and knowing the value your product is offering.
One mistake businesses make is that they over simplify the process of creating value based pricing and rely purely on the costs. It’s very important that you focus on creating a cost that reflects the value you are offering your customers.
Another thing that you need to keep in mind is that when you create a price based on value, there is no harm in advertising the value you are leveraging. Let the consumers know that they are paying extra because your product has a unique value. This helps consumers in making a decision and accepting the higher price. Marketing plays a role here and the best example here would be of Apple Inc. that creates product demos narrated by Jony Ive, Chief Design Officer at the company. He tells customers directly what Apple is offering in the new MacBook, iPhone or the iPad so that consumers know that they are going to pay more but it’s going to be worth it.
How to use value based pricing
To use value based pricing, you will first have to compare your product or service with the next best alternative. This will show you how much value you are offering. Based on this, evaluate how much you can charge extra and add the extra amount to your competitor’s price.
Value Based Pricing is used to earn a profit on the unique value a product or service is offering.
Consumers are going to choose something that is offering them more value which means you can charge them more for it without losing them.
Value based pricing works really well in e-commerce arena since consumers make impulsive decisions and will prefer something that is little more expensive – thinking it offers them more value.
It also works well if you are in a niche market, emotions are high for your product or in case of shortages.