Guide to Value-Based Pricing
Determining a price for your product or a service is among the most important business decisions you need to make. Without the right price, you can make or break a business. It can impact your sales figures, your profit margins and your ability to pay the bills, among other things.
While there are different ways of optimizing your pricing strategy, this guide will explore one of your options: value-based pricing.
We’ll explain what value-based pricing means and the benefits, as well as the downsides to using this strategy. We’ll then provide you a simple four-step guide to determining a value-based price for your product or service.
WHAT IS VALUE-BASED PRICING?
Value-based pricing means determining the price of a product or a service based on the benefits it provides for the consumer. You are essentially attaching a price to your product or service based on what the consumers think the product is worth.
When you are using value-based pricing you are trying to reach equilibrium where you are maximizing your revenue, yet charging the customers an amount, which they are also willing to pay.
As an example, value-based pricing is different from cost-plus pricing. Cost-plus pricing determines the price of a product or service based on the costs of making it. Therefore, if a sock costs $3 to make – including labor, materials and so on – and the company wants a 50% profit, the price it charges would be $4.5.
On the other hand, value-based pricing would focus on determining what value consumers put on the product and therefore would be willing to pay. It might be that the socks are sold in harsh conditions and they are extra good at keeping your feet warm. This could mean the consumer would pay $8 for the socks.
The above example highlights the situations where value-based pricing is most commonly used. It works the best when the company offers something unique or high-value features for the customer. A company offering an almost indistinguishable product or service from its competitors, such as basic socks, is unlikely to benefit from value-based pricing. For common and largely available products, the value customers attach to the product is likely low.
Furthermore, value-based pricing is often used in service industry, where the product or service doesn’t require many tangible costs. For example, copy writing or image editing are services, which generally use value-based pricing. These don’t have many running costs, like materials, and the results are typically based on the valuation of the customer.
THE PROS AND CONS OF VALUE-BASED PRICING MODEL
Like any pricing strategy, value-based pricing has its pros and cons. Before you decide to use the model for your business, it’s essential to consider how the benefits and downsides relate to your business.
Due to value-based pricing’s focus on customer research and understanding, the pricing model is a valuable method for understanding and serving your customers better. In order to determine the price, you’ll need to survey customers and improve your understanding of the things they are looking for with the product or service. This enhanced understanding won’t just help you determine the price; it’ll also help you provide better service.
In addition, your extensive research can help develop better quality products or services. You’ll be required to research your competition and analyze their pricing strategies and the value customers put on those products or services. This can help understand what aspects in the product or service matter the most. You can use this information to improve your product or service focusing on the things that provide the most value for your customer and therefore, help you increase the price.
Overall, you need to understand the demand and the value of the product or service on offer in more detail, which can eventually lead to improvements in profit margins. In many cases, a product’s value to the customer is higher when the product has a positive and beneficial impact on the customer. With a high-quality service like this, the demand can further drive up the price. If your business only focuses on the costs of production or the hourly rate of creating the service, it might be missing revenue. The true value of the product can be much higher than the hourly labor costs, if the impact of the product for the customer is high.
Furthermore, since you are developing high-quality focus, with the emphasis on the qualities the customer is actually looking for, the overall costs of creating the product or service can go down. You’re not focusing on aspects customers don’t like or don’t value and you can enhance your abilities regarding the features they are looking for. This can help develop and train employees; a process, which can in time drive down the production or servicing costs.
Furthermore, listen to the tips from Chris Lema on value based pricing.
Perhaps the major issue with value-based pricing is how difficult it can be to get it right. The model requires more time and resources than some of the other pricing models, where you can calculate the figure from existing numbers. Figuring out the value of your product will force you to research your product, your customer-base and your market. Unlike with cost-plus pricing, you can’t view production costs and just determine profit margins, but you have to understand the worth of your product and service to your customer.
In addition, value-based pricing is not a precise method. You’re going to have to tweak your figures, which might add some pressure on your business’ finances. Testing out the different prices can also be difficult when you are handling customer relations, as you can’t change your pricing model dramatically without it impacting your existing partnerships.
Since the model won’t provide 100% accuracy, you’ll need to regularly assess and adjust the pricing, even after you’ve found the ‘sweet spot’. The value customers place on your product or service can change, forcing you to look ahead to stay on top of trends on the market.
STEPS TO DETERMINE A VALUE-BASED PRICE
As mentioned above, value-based pricing is a pricing method that requires meticulous research. Therefore, the process can seem a little daunting. But you can determine value-based pricing for your products or services by following these four steps.
Step 1: Do your research on your product and service
The first step is about conducting research on your product and service. You need to examine the different elements of your business, what it takes to get each of them done and the unique value each element provides to the customer.
Start examining your product or service by answering the following questions:
- What are the different elements you are offering? Each product and service consists of different elements. For example, accounting software might include the actual physical software, a cloud-based service, servicing for later and the installation.
- Do you offer these elements separately or are they always included in the final product? You might choose to offer different types of packages, such as only the software or the software and installation together.
- What materials and other such costs might be included in the price? It’s naturally always a good idea to consider certain costs your product or service entails, even though you are using the value-based pricing as a model.
- What is the typical timeline for delivering the different elements? Examine how quickly you are able to deliver the service or product from the moment the customer orders it. You should consider the fastest delivery, as well as delivery for times when you have plenty of other projects on-going.
- What are the different elements and qualities you are offering, which your competitors aren’t? Explore your competitors’ products as well and outline the ways your service differs from theirs.
When you are answering the above questions, keep in mind any previous work you’ve done. For example, in terms of determining timelines for delivery, you can base your schedule on the previous work you’ve done.
Good places to start researching your competition include industry analyst reports from analyst firms like Gartner and Alexa. You should also visit the company’s website, blog and social media platform and see what they are doing there in terms of product or service value.
After you’ve done your research, you can estimate prices for each element. You can use previous pricing strategies and information based on competition. For example, you might have previously charged $200 for a company brand design, but your research might indicate your competitors are charging anything between $100 and $600. Keep tab of these different price alternatives for later.
Step 2: Identify and analyze your customers
Your second step involves the identification and analysis of your customer. You must understand who your potential customer is, in order to fully appreciate what they are looking for and how much they are willing to pay for it. The step is essentially about understanding what you can offer to these customers in terms of value.
First, you need to understand what the target group looks like for your business. You’ll want to develop buyer personas, which are buyer profiles, for your product or service, as it allows you to better understand the value the customers are looking for and the prices they are able and willing to pay.
You can see how you should identify buying personas from the below box:
|Corporate buyers||Private buyers|
|What is the size of the company? Small business, start-up, large corporation and so on.||What groups are you targeting? Families, students, women, men and so on.|
|Who in the company are you selling to? The buyer might be the human resources department, the accounting department, the CEO and so on.|
Gain more insights into creating and analyzing buyer persona from the following webinar.
The buyer profiling doesn’t mean your business has a single target group. For example, if you are selling your product or service to corporations, you might well have to work with a number of different profiles. The key is just to identify the most common groups to make it easier to understand what the person is looking for.
Once you’ve identified the buyer, you need to analyze their behavior in terms of buying the product or service. You want to focus on two key aspects:
- What are the elements of this product or service the buyer profile values the most?
- What is the realistic price range the buyer profile is willing to pay? For example, a student’s realistic buying power is lower than a corporate buyer’s ability to pay for products.
The best way to find answers to the above questions is by surveying your target market. You can use online survey sites such as SurveyGizmo or SurveyMonkey and share your quiz on social media and the forums your target market is on. If you are attracting corporate clients, you can even send them these questionnaires directly.
In the surveys, you should focus on two aspects mentioned above:
- In terms of value: Find out what are the elements the customer feels add quality to a product or service. You can even present them with options like “Would you appreciate the speed of delivery over help with installation?”
- In terms of price: Ask directly what sort of price the customer would be willing to pay for the product or service. Focus on both the price point when the customer would no longer buy the product or service, as well as the price point in which they would consider paying, but might think it’s expensive.
In addition to the actual price, compare also different payment mechanisms. For example, would the customer rather pay per month, per project, per use, etc.?
Step 3: Combine and evaluate the different data
By now, you should have collected price data on:
- What you used to charge for the product or service (if applicable)
- What competitors charge for their similar product or service
- What customers are willing to pay for your proposed product or service
You should input this data on Excel and create charts to see what type of patterns emerge. You might notice there’s a price point after which customer interest drops and find the sweet spot for what customers are willing to pay and which is a little below what competitors are charging.
If you are selling to a number of different buyer groups, you’ll most likely notice wide variety in prices. You shouldn’t be afraid of using value-based pricing as a method of creating different pricing layers. Not only would you offer slightly different products to different buyers (remember that some might be only interested in certain elements), but you’d also find the product or service you offer provides different value to different customers.
Step 4: Test and review your price
Finally, you need to remember that value-based pricing is just a concept. As we’ve mentioned before, you will likely see shifts in the value customers attach to the service as their needs change. The value is also affected by what the market has to offer, not to mention how your experience and expertise is likely only going to increase as time goes by.
Therefore, the final step is about testing and reviewing your price. As you implement your new pricing method, you need to keep an eye on what it does to your sales. Furthermore, if you are just starting out and the business doesn’t seem to pick up, it’s worth considering that your value proposition might be wrong.
Consider conducting more customer surveys or simply offering the product for a discount price to see if the sales pick up. If you are still not generating enough sales, you need to look beyond price and see whether there’s something wrong with the product or service, or your business model.
In addition, if you are constantly busy and you have to say no to clients, you might want to consider adjusting the price upwards. It seems customers are enjoying your product or service and you might be able to generate a bit more profit with what you offer.
Overall, don’t think value-based pricing is just a one-off process. You should regularly keep an eye on your prices and test what the market and the customers are saying about the value of your product or service.
Learn more about how your company can transition from cost-based pricing to value-based pricing in the following slides.
Considering that a simple 1% price increase can boost your profits by 11% on average, finding the right price for your products is crucial. Value-based pricing is a great strategy for products and services that offer that extra bit of something. When you aren’t just providing a generic service and when customers attach their own value to the product or service, this strategy works exceptionally well.
Nonetheless, it is a time-consuming strategy and you need to research your product and the customer carefully. You must be aware of the things your potential customer is looking for and at what price would the customer turn his or her back on you.