Why value-based pricing works best

Why value-based pricing works best

Value-based pricing is about coming up with a price that your customers are willing to pay. Pricing strategist Mark Stiving of Pragmatic Pricing explains

Value-based pricing is the most highly recommended pricing technique by consultants and academics. The basic concept is setting a price to capture the majority of what your customers are willing to pay. Before I explain value-based pricing, though, I need to look at value-based buying. This is how your customers make their decisions when they deliberate about which product to purchase.

What's it worth?

Imagine you are at the supermarket and you want to buy a can of green beans. Two cans catch your eye, the store's own-label can and a branded product. The first costs £1.49 and the second costs £1.69. How do you choose? You ask yourself, is the brand name can worth 20 pence more?

Is it worth it? To answer this, you think of everything that is different between the two cans. You may have had better experiences with the branded variety. One may have less salt. One may be cut differently. One may have a prettier label. It's completely up to you as to what you think is important. After you've determined the important differences, you place a value on them and then decide if the branded can of beans is worth 20 pence more than the own-label can.

Of course you don't actually do these calculations. But that is how your mind makes the decision. You ask yourself and answer the question, is the brand name can worth 20 pence more than the own-label can?

Ask your customers

Notice there is no right or wrong answer. People are different and value things differently. For your business, the important thing is to ask your customers what they would have bought if not your product or service. Their answers tell you who your toughest competitors are.

Now, choose one of these competitors and do the value-based buying maths for yourself. How much is your product or service? How much is your competitor's? What are all of the differences? (Don't be biased. Be sure to list the areas where your competitor is better.) How would you value these differences? How do you think your customers value these differences?

Setting value-based prices

Value-based pricing is about setting a price to capture the value that a potential customer receives. Here are the steps:

  1. Identify your customer's second-best option. If your customer can't buy your product or service, then what would he or she choose?
  2. Determine the price of the second-best option.
  3. List all of the ways that your offering is better than the second-best option. Estimate how much you think these differences are worth to your customers.
  4. List all the ways that the second-best offering is better than yours. Be very honest here. How much do you think these are worth to your customers?
  5. To calculate the best price - take the price of the second-best option (step 2 above) plus the value of your advantages (step 3), minus the value of the second-best option's advantages (step 4).

Price = step 2 + step 3 - step 4

All customers are different, so which one do you think about when doing this analysis? First off, choose a customer that purchased from you and do the analysis. Then choose a customer who didn't buy from you (harder to find to talk with) and do it again. Customers who buy from you and those who don't value your offering differently. This is especially true for your advantages and disadvantages. As a marketer, your target market should be the customers who value your advantages. Hence, you should price for those customers.

However, this does not give you the "right" answer. This gets you close. This lets you see how your customers are making decisions and creates a calculated price so you can see if it makes sense. Eventually, you have to tweak this price up or down based on your judgment and experience. If you are trying to reach a broader market, you may want to reduce the price. However, a better strategy may be price segmentation.

Don't skip this step. Even if it gives you the same price range you are currently using, it forces you to think about your customers' decisions processes. This is valuable to you.

Written by Mark Stiving of Pragmatic Pricing.