Value Based Pricing means charging what your customers are willing to pay (WTP).
The other day I was describing this to a successful, self-employed businesswoman and she kept asking, “How do I know what my customers are willing to pay?”.
I mentioned how she should put herself in her customers’ shoes, compare her offering to the competition. She said, “I don’t always know who else my customer is considering, and I certainly don’t know what he thinks about our offers.”
I told her she could use win/loss data to narrow down the possibilities. “I don’t have that many data points. Will this be significant?”
I described how she could use conjoint analysis to determine what types of customers are willing to pay for which features. “But that doesn’t tell me about the customer I’m talking to right now.”
I suggested she learn from her customers during the sales cycle. “Sure, but they aren’t going to tell me the most they are willing to pay, even if they know it.”
Finally, I conceded with an Aha! of my own. We will never know how much a specific customer is willing to pay in a specific situation. We can’t read his mind and he’s not going to volunteer that information. If we can’t know his true willingness to pay, what good is value based pricing?
Think of value based pricing as an attitude. We know we won’t always be right, but we are doing our best to estimate what our customers are willing to pay and charging as close to that as possible.
We can use experience (and statistics if possible) to guide our estimating methods. For example, if we continually lose, then we are estimating too high and need to lower our pricing. If we always win, we are pricing too low and need to estimate higher.
When you go to buy a car from a dealership, the salesman is looking you over, trying to determine how price sensitive you are. In other words, he is estimating your willingness to pay. He’s looking at the car you arrived in. He studies your clothes and your jewellery. Once you give him your address he will look up the value of your house. He can never know exactly what you will pay, but he can make estimates based on observable criteria.
This is what Value Based Pricing really is, estimating willingness to pay. If you know which competitor your customer is considering, that can help you know how much to charge. If you know which market segment your customer is in, you will price more appropriately. The more you know about this customer and this situation, the better.
This lack of precision is probably one reason companies like and use cost plus pricing. They know their costs (at least they think they do). If you always charge two times your cost, then there is no uncertainty. In fact, no thought is needed.
However, if you want to be more profitable, if you want to capture more of the value you create, then adopt value based pricing. Value based pricing enables more powerful pricing strategies, like price segmentation and product portfolio pricing. It has the power to focus the entire company on creating more value. Value Based Pricing may not be precise, but it is powerful.
Adopt the attitude.
Mark Stiving is a pricing strategist, runs Pragmatic Pricing, and is the author of Impact Pricing: Your Blueprint for Driving Profits.
Some people think that price is everything. My son currently works in my company, SellerDeck, sitting beside me in the home office. His job is account managing customers who use our ecommerce web hosting. It’s very instructive listening in. We’re not the cheapest offering, although we believe that we offer good value. Since you will start losing orders and customers the second your ecommerce web site goes down, and Google research suggests that marginally slow sites reduce orders by 20%, you would expect quality of service to be the major topic of conversation. Often it is, but for a minority, price is all that matters. In fact, there are relatively few products and services where price should be the sole criterion. These probably include electricity, where the same stuff always comes down the same wire anyway, and petrol, where rival brands across town often sell petrol from the same refinery. But some people always focus on price. The question is; do you even want to speak to customers who only care about price? Wouldn’t these customers be better hassling the competition? They not only pay less, they can also waste a lot of time. Competing on price requires the lowest possible cost base. So most businesses try to compete on overall value. My suggestion is if you aren’t losing a few customers on price, you probably aren’t charging enough. And those customers that you would lose from slightly higher prices, will probably be the very same ones that would be the least profitable and the most trouble.
Market research — the name alone brings moans and groans from customers and businesses alike. Somewhere deep down, we know that it’s worthwhile filling in those seemingly endless surveys to end up with a better, brighter, tastier product or service.
Market research plays a vital part in any business as it gives you insight into your market, your competitors, your products, your marketing and your customers. This way you can make informed decisions, such as which chocolate Easter eggs to stock. And believe me, this is hugely important.
Market research helps you to reduce risks by getting product, price and promotion right from the outset. It also helps you focus your resources where they will be most effective. Much information is available online and from industry organisations, and some of it is free. This information provides data on market size, sales trends, customer profiles and competitors. Your customer records also provide a wealth of information, such as purchasing trends.
So that’s the theory. With our experts like Kate Willis of KW Research and Steve Phillips of Spring Research Ltd offering their hands-on advice and tips, you can turn the theory into good business practice.
To make sure you know how to plan your market research so that you can find out which chocolate your customers prefer, check the Marketing Donut website — it goes live on 20 April.