What is value-based pricing?
Value-based pricing refers to setting prices for goods and services based on how much the buyer thinks they are worth. Businesses use value-based pricing to determine how much people are willing to pay for their goods based on how much they think they are worth.
The value-based method is more than just cost-plus pricing, which figures out how much something costs and adds a set profit margin.
Businesses must collect and quantify customer data to decide what to sell for and use value-based pricing. In addition to their production costs and desired profit margin, this lets them set prices based on what they think customers are willing to pay for their goods.
Companies that sell unique goods, features, and services are more likely to use the value-based model. On the other hand, companies that sell common goods and services tend to use more straightforward, cost-based pricing strategies.
Synonyms
- Customer value-based pricing
- Value-based pricing model
- Value-based pricing strategy
Examples of Value-Based Pricing
Prices that are based on value work best in places where people want one of these things:
- They wish to feel, look, or be seen as unique.
- They want to do something they can’t do anywhere else.
- They need things that an average offering doesn’t have.
- They can only get the services they need from a few hard-to-find businesses.
Still, most companies set their prices based on value in some way. They promote their “regular” goods in a way that makes people feel something, which gives the brand a sense of value.
There is no exact science behind value-based pricing, but here are some ways that businesses use it:
Luxury car companies
Luxury car buyers want their cars to look good, work well, and be high quality. They’re not just paying for a good car but also buying a brand name and social status.
Market research is a way for luxury automakers to get feedback from customers. They then use this information to set the prices of their cars, and most people expect them to be much more expensive than similar cars from popular brands.
People are ready to pay astronomical amounts for hyper-luxurious cars like Lamborghini and Ferrari, the fastest and fewest available on the market.
(SaaS) Software as a Service
A unique way that SaaS companies set their prices is by using value. The costs of making software are lower than those of making a car because it is only made once, then scaled up and kept up to date.
Software also usually has lower running costs, which is why SaaS companies sell rights for low monthly or yearly prices compared to the value they create for businesses.
Because of this, many software companies use tiered pricing to show customers different benefits and services based on their needs. This lets them set different prices for their goods based on how much value they add, which helps them meet the wants of various customers.
Standard Products That Cost a Lot
Several goods and stores use both cost-plus pricing and value-based marketing.
Apple usually charges more for its new products than most of its competitors. This isn’t because the products are technically advanced or cost more but because people think the products are worth the extra money.
A big part of Apple’s brand image strategy is marketing. Apple’s great copywriting, simple design, and well-planned product launches significantly impact how customers see the company’s brand.
Influencers on social media
Influencers can get paid to promote a product based on the number of followers, engagement, and relevance. These are all easy-to-link measures that can help another brand make more money.
Brands often pay a lot of money for just one post or comment, even though influencer marketing is usually done on the spot.
This kind of payment is usually based on how many people the influencer can reach and interact with, how valuable their following is seen to be, and how much exposure they can provide.
What are the pros and cons of value-based pricing?
The pros
Value-based pricing helps companies in several ways:
- Prices are going up. Businesses can charge higher prices with value-based pricing because it depends on how much the customer thinks the good or service is worth. If they can easily make high-quality goods, it helps them make the most money and be profitable.
- Possible markup. People are more likely to pay the total price (or more) for a good if they like it. In this way, companies can raise prices and still be successful in their market.
- Data on genuine desire to pay. Unlike cost-plus and competitor-based pricing models, a value-based pricing model tells businesses right now what people are ready to pay for their products.
- Product of higher quality. When companies set prices based on customer wants, they make better goods. It also pushes companies to add features that differentiate them from customers’ wants.
- More cash flow for making new products. Businesses have more money to reinvest in product growth (i.e., improving the product and finding the best parts) because value-based pricing models lead to higher prices.
- Loyalty from customers. A value-based price keeps customers coming back by giving them a price that meets their needs, not just one that makes the business money.
- How well sales go. Buyers are more likely to buy from a seller if they already know why their product is valuable from their point of view.
Pros and cons
Some problems with the value-based price method are:
- There is no promise of value as seen by others. People don’t want to pay much money for things they don’t understand or think are worth it. Companies must be extra careful when they market and sell their products, especially complicated ones.
- Problems with making money. One of the best things about cost-plus pricing is that it always makes money. Some or all of a company’s possible profits are lost if price optimization doesn’t match production and sales costs.
- Needs time and resources. Value-added pricing needs a lot of market study, customer data, and analysis to ensure that prices reflect fundamental value, which isn’t always simple or easy.
- Risks for how customers see things. Value-based pricing is often based on how much something is considered worth, which can sometimes make it hard (or even impossible) to get right. Some things, like new fashion styles or tech innovations, can significantly affect how much customers value a product.
- The ability of prices to change. They have to be careful not to charge too much if a customer wants to pay too much. Value-based pricing can often bring in more money, but you lose a lot of money if you push people past the tipping point.
Different Types of Value-Based Prices
Value-based pricing comes in two primary forms: reasonable and value-added.
Good Prices for Value
Value-based pricing comes in two primary forms: reasonable and value-added.
Good Prices for Value
The idea behind reasonable value pricing is that people will gladly pay a fair price for a product if it meets or exceeds their needs. A reasonable value price means that the seller creates value for the customer and gives the customer the best price for their money.
For instance, Amazon often has lower prices on its goods than many other stores. This is possible because it has a well-organized logistics and delivery network and is dedicated to making the customer experience better all the time.
A “fair price” could also be a mix of ease of use, high-quality items, and excellent customer service. Premiums are much more expensive than economy planes, but people are happy to pay more for a better trip.
Pricing with added value
Customers get more for their money when you bundle services or features with the main product. This is called value-added price. Businesses often use this with something unique to give and want to set themselves apart from competitors.
For example, companies that work with subscriptions often offer extra services or features to people who are willing to pay for them.
Customers may choose a more expensive plan even if they don’t need the extra features because of benefits that improve their experience, like special content access or faster customer service.
Other pricing models are not the same as value-based pricing.
Value-based models differ from other common ways of setting prices because they base prices on how much the customer thinks a product is worth, not just how much it costs or how much other products are selling for.
Value-based pricing vs. pricing based on competition
When businesses set their prices, they look at what their rivals charge. This is called competition-based pricing or competitive pricing. It’s often used when a few big companies control an industry and the prices of their products are pretty much the same.
When the following things happen, businesses would choose competitive pricing over value-based pricing:
- A new business doesn’t have enough information to set prices based on value.
- Information about competitors shows that the current pricing plans make the most money.
- There isn’t much difference between the goods of different companies (for example, they all have similar quality or features).
- There are already too many products on the market, and people know what they want to pay.
- The company wants to match or beat other businesses’ prices to stay in business.
Companies may use both value-based pricing and competition-based pricing tactics at times.
Airlines are a great example of this because they use dynamic pricing to give travelers a good deal, but they also keep their prices close to those of their main competitors and only charge more when they can offer more value.
Price based on value vs. price based on cost
Companies that use the cost-plus pricing strategy set their prices based on how much it costs to make and ship their goods, plus a profit margin. This pricing plan guarantees profits but doesn’t consider how customers see the product or how much they value it.
In the following situations, a business might choose cost-based pricing over value-based pricing:
- The business wants to make a profit, no matter what customers want or think.
- People in the market don’t care about price, so they’ll pay whatever the company charges.
- The high cost of making the product means that much money must be spent on cash.
- A company sells a commodity, like oil or wheat, whose price is set by supply and demand worldwide.
- The price of a company’s product changes a lot when the price of an essential product changes on the market.
Many businesses make and sell their goods quickly and then set prices that meet value-based and cost-plus standards.
This can be easier if you start cost-cutting and process automation projects inside your company.
How to Make a Pricing Strategy Based on Value
Find and study your current customers
To make a value-based pricing plan, you must first know who your customers are and what they want.
First, make a list of your perfect customers (ICP). You can use your ICP to determine what kind of people you want to attract and how to price your products to meet their needs.
Once you know your ideal customer, you should make buyer models for each group, including information about their age, gender, location, income level, and other factors that define them.
For business-to-business buyers, you should include firmographic information like the size and type of the company they work for, its internal structure, and industry vertical.
Poll your customers and look at the information.
The best way to learn about the wants and needs of your target market (and finally come up with valuable products and fair prices) is to talk to people in that market.
You can do this in several ways:
- Polls. You can ask people on your email list about product features, user experience, and price preferences in a poll.
- Talking to groups. Getting qualitative data from groups of people can tell you a lot about how they behave and what they like.
- Job interviews. Talk to pilot users or current customers one-on-one or in groups to get first-hand information on how your most important users interact with your product.
- Analysis of sentiment. Tools for social listening, like Hootsuite, can help you keep an eye on what people say about your brand in public.
Look at the information you gather to find out how much your customers are willing to pay for different services or features, how much value they think they are getting, and how much demand there is for each item overall.
Look at the whole market that you can reach.
Your total addressable market (TAM) includes all of your possible market share, not just what your competitors are doing and what your potential customers value.
By looking at your TAM, you can determine how many people you can expect and how much money you might make.
You can find out if there is a need for your product by looking into market trends like average customer lifetime value (CLV) and adoption rate.
Do study on the competition
Customers aren’t the only ones who can tell you something. It would be best to look at how much their products cost, what features they have (or don’t have), what other customers have said, and how well they market their goods.
You can also use competitive research to compare the success of your product to that of your competitors. This will help you determine what value you need to offer to stay ahead.
Drawing a Venn diagram of your business, its target market, and its products next to those of your competitors can help you learn more about them.
There is some overlap, but companies that offer solutions that seem to be similar still have the customers they want to reach. By knowing these things, you can figure out how well their pricing plan fits the needs of your business.
Check to see if a value-based method will work for you.
A price based on the customer’s worth doesn’t work for all businesses. After looking at your competitors and your overall marketable area, do the following:
- The ability to find perfect (or almost perfect) substitutes
- Costs of doing business
- Price of the item
- The cost of getting a new customer
- Needs in the market
- Budget for sales and marketing
value-based price only makes sense if you have a unique product that people want a lot of and the sales and marketing tools to let people know how valuable it is.
Set up levels of prices.
How you set your prices should depend on the kinds of people you have. You can offer a freemium or low-cost version for customers who want to save money, basic or mid-level services for customers who don’t need your product’s features, and a full version for customers who want to use all its features.
Think about what your product can do (its high-end functions). Set your premium features apart from the essential features that all tiers should have. Premium features should only be available to customers who pay the most.
One example is a business that sells automated invoicing software. Its basic version might include features like creating branded invoices and POs and reporting. In contrast, its premium version might include more advanced features like payment cus, Tomer analytics, and foreign processing.
Review and test
Ultimately, you can’t know how your target market will react to your prices until you start selling. This is why testing and reviewing your value-based pricing plan is the most essential part of making one.
As you make sales and run marketing efforts, keep track of customer information, showing how the market reacts to your prices.
Use this information to fine-tune the price based on how customers feel or what they want, and keep an eye on it often to see if customers’ behavior changes.
