Understanding value-based pricing: advantages, benefits, and misconceptions
In one of our previous articles, we gave an overview of different pricing methods and shared tips from our long experience helping international companies set up their winning pricing strategies. To freshen up your memory, there are three key approaches: cost-plus pricing, competitive pricing, and lastly, value-based pricing, which we’ll talk about in more detail in this article.
It’s no secret that many business owners struggle to price their products or services. Determining the right price point can be challenging, especially when you have to consider factors like competition, production costs, and target consumers. In recent years, pricing experts (including our team) have been advocating for value-based pricing, and for a good reason, as it can help businesses become and remain both competitive and profitable.
Let’s first determine what value-based pricing is. Value-based pricing is based on a consumer’s perceived product or service value. Rather than focusing on the overall market price, competitor pricing, or the cost of raw materials, the value-based pricing method focuses on a customer’s willingness to pay. Companies operating on a value-based pricing model can effectively increase profits, improve brand loyalty, strengthen brand equity and attract new customers for quality products.
Understanding value-based pricing
Pricing can be a tricky game, especially when it comes to products that bring out customers’ inner diva, thrill-seeker, or adventurer. We’re talking about items that make people feel good about themselves or give them unforgettable experiences. That’s when perceived value comes into play, determining how much a customer places worth on a product and ultimately affecting its price tag.
Value-based pricing is all about standing out from the competition. Your product must be designed with the customer’s wants and needs in mind, offering improvements and added features they’ll love. And let’s not forget: quality is king when aiming for this pricing strategy. So if you’re looking to add value to your product, you need to keep an open dialogue with your customers. By actively seeking feedback from customers, companies can learn what features customers want in their products and how much they’re willing to pay for them.
Advantages and benefits value-based pricing brings
Value-based pricing isn’t just about charging the most you can for a product. It’s a strategic approach that not only maximises profits but also builds loyal customers and a strong brand. By understanding what customers truly value in a product, a business can design future innovations that better meet their needs. This approach doesn’t just lead to higher price points and increased customer satisfaction, and a willingness to pay more for products they genuinely love.
Let’s discuss in more detail the many benefits of value-based pricing:
- Increased profitability
Value-based pricing can be a game-changer for business owners looking to boost their profits. By valuing your product or service based on how your customers perceive its worth, you can often command a higher price and benefit from a larger profit margin than a cost-plus strategy. It’s all about cleverly pricing your product based on its value to the proverbial table while still keeping an eye on the competition. This way, you can enjoy the best of both worlds: increased profits and happy customers.
- Improved customer satisfaction
By adopting value-based pricing strategies, you can gain a deeper understanding of your customer’s unique tastes and interests. This invaluable insight enables companies to tailor their pricing plans to suit different customer segments better, ultimately leading to heightened satisfaction and loyalty. By emphasising the value they bring to the table, businesses can justify charging a higher price point to customers who appreciate their brand’s unique advantages. Ultimately, value-based pricing empowers businesses to understand better and meet the needs of their customers, leading to long-term success and profitability.
- Competitive advantage
Value-based pricing is not just about charging higher prices for your products or services. It’s about effectively communicating the value you bring and using that as a competitive advantage. When you differentiate yourself from your competitors in this way, your customers start to see you as a unique option in the marketplace. It’s not just about the price tag – it’s about the value that you offer. So if you’re looking to establish yourself as a top contender in your industry, value-based pricing could be the key to standing out in a crowded market.
- Flexible pricing
Value-based pricing is a smart move for businesses looking to adapt to the constantly shifting market landscape. With this approach, pricing isn’t set in stone but rather adjusts based on trends, customer preferences, and the unique selling situation. It’s more than just factoring in production costs, giving businesses the power to make informed decisions about pricing adjustments that keep profitability on track.
Misconceptions and disadvantages of value-based pricing
Value-based pricing is very widespread, but there are still misconceptions about this practice, such as:
- Myth nr.1: Value-based pricing guarantees sales success
Despite careful calculations and thoughtful considerations, value-based pricing is not always a guaranteed road to success. In fact, there are three reasons for this:
(1) competition: even if you offer more value than the competition, if they have a very aggressive pricing strategy, it could affect your strategy.
(2) the cost: even though value-based pricing is better than cost-plus, costs should always to be considered. If the value-based pricing is lower than cost-plus, then it shows a weak brand.
(3) retailers/distributors: the resellers might not follow your pricing guidelines, meaning their prices might not be aligned with what you recommend.
In short, value-based pricing is not a standalone method or view. It needs to go hand-in-hand with cost analysis, competitor intelligence and building strong retail/distributor relationships.
- Myth nr. 2: Value-based pricing means companies have to consider every single feature of a product
Value-based pricing is often considered a tedious process of evaluating every aspect of a product and assigning a price to each. However, that’s not the case. Instead, customers and consumers don’t necessarily evaluate pricing in such detail, as they usually pay attention to aspects that matter the most to them.
- Myth nr. 3: Value-based pricing is about linking the price to product benefits or quality
This statement is only partially true, as a brand is a big factor. Evaluating the worth of a brand can be quite a conundrum, especially when trying to compare it to competitors with distinguishable product features. Assigning a value to a faster, more durable, or longer-lasting product is a no-brainer. However, when it comes to brand recognition and reputation, it’s not as cut and dry. That’s why “branding” is so important and why value-based pricing is much more than paying for product benefits. You often value the brand and trust that its product or service comes with the right features. Differentiating based on brand alone can be tricky, leaving much room for subjectivity and debate.
Aside from the misconceptions mentioned above, it’s important to emphasise that every pricing method can be high-risk and costly. The same applies to a value-based method.
Here are the four most common challenges to consider before adopting the value-based model:
1. Positioning in a crowded market
Standing out with value-based pricing can be challenging in a sea of competitors. The more crowded the market, the harder it is to convince customers that your product is worth paying more for. Here’s where branding comes in again. The stronger your brand is, the more you can stand out. If you don’t have a strong brand to begin with, value-based pricing will be difficult.
2. The shifting sands of perceived value
The value your customers place on your product can be a moving target. Trends and tastes shift over time, so if you set your value-based pricing once, it doesn’t necessarily mean it will stay relevant forever. You should review your pricing strategy on a regular basis, especially if you know that customer values change fast.
3. The price is (not so) simple
Setting the right price for your product requires in-depth knowledge of your target market. To truly understand what your customers value, you’ll need to invest time and resources into gathering valuable data. But the payoff of an effective value-based pricing strategy can be well worth the effort.
4. Selling in markets where products are very cost-driven
Value-based pricing rarely works well in markets where people are looking for the lowest price, for example, when buying basic products. Often this strategy is designed to attract a specific segment of customers.
The bottom line
In conclusion, value-based pricing is an excellent strategy that allows businesses to maximise profitability while ensuring customer satisfaction. Value-based pricing incorporates information about the value customers perceive from a brand, product, its features, and related services. By implementing a value-based pricing strategy, you can differentiate your brand from your competition while ensuring greater customer satisfaction, thus driving profitability. However, the mandatory element to successful pricing lies in extensive customer understanding, suitable strategy, and alignment with all the stakeholders.
In the following weeks, we’ll continue to share more details on value-based pricing and the connection with customer understanding.
In the meantime, if you need help optimising your brand’s portfolio pricing, get in touch with us. Our team is here to assist you in developing your ideal pricing strategy.
