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Value-Based Pricing

What is a value-based pricing strategy?

Value-based pricing strategy is a method to determine the selling price of a product using the customer’s perceived value of the product. In other words, the selling price of a product is determined by evaluating how much a customer is willing to pay for it. Since this pricing method is based on the priorities of a potential customer, it is also known as a customer-focused pricing strategy.

Unlike the cost-plus pricing strategy, this pricing approach does not consider the production costs of goods in the pricing calculation. Businesses that offer unique or valuable features and functionalities via their products and services generally utilize this pricing strategy. Businesses that primarily sell commoditized products do not tend to use this value-based pricing model.

How to frame a value-based pricing strategy?

Before learning how to set prices using the value-based pricing strategy, you should know some basic principles about this pricing method. They are:

  1. The market influences the customer’s willingness to pay for a specific product.

  2. The competitor pricing of a product can also influence its perceived value.

  3. The product’s advantage (features, uniqueness, functionality, etc.) to the customers helps in assessing its value.

Keeping these principles in mind, companies employ value-based pricing strategies depending on their industry's state and business goals.

  • Promoting luxury: For luxury products, markups (or profit margins) are significantly higher to indicate the high quality, luxury, and exclusivity of the product.

  • Price-sensitive and competitive markets: If a product has a higher price point than what the customer is willing to pay, the customer will try to buy other similar products that offer the same value at a lower price.

  • Recognizing high demand: When the demand for a particular product is so inflated that a lower price tag would have minimal impact on product sales.

  • Vending add-ons and extensions of other products: These extensions aim to enhance the functionality of a product. For instance: if you are selling a mobile case for a new model of mobile phone.

When a company deals in low-priced products, the value-based pricing approach shares a lot in common with the competition-based pricing strategy. Whereas if a company is dealing in high-priced products, the value-based pricing method resembles prestige pricing.

Advantages of value-based pricing strategy

The advantages of a value-based pricing strategy are as follows:

  • Ease in penetration of markets: It is relatively easier to penetrate markets that are not brand-loyal and are relatively concentrated, especially if your brand can create a loyal customer base.
  • Liberty to set higher price points: Luxury and prestigious products generally have higher perceived value than other products. For instance: paintings, cars, fashion, etc. The customers are paying for the brand name, skills of the manufacturer, value appreciation over time, etc.
  • Improves brand value: The value-based pricing model improves your brand value by demonstrating that your company cares about its clients and ensuring that the sold products are the best in terms of quality.
  • Promotes customer loyalty: If a company offers great customer satisfaction, good consumer service, and a unique user experience, you are bound to have a loyal customer base.
  • Development of higher quality products: Customer feedback can help you to identify the required product developments that can improve the perceived value of the product.

Disadvantages of value-based pricing strategy

The disadvantages of a value-based pricing strategy are as follows:

  • Instability in the perceived value: The customer's perceived value of a product is subjective and can change depending on cultural, economic, social, and technological factors that are not in your control. Your competitors can easily launch a similar product with a higher perceived value.
  • No justification for the perceived value of commodities: The abundance of buying options and market competitors makes it difficult to employ value-based pricing in the commodity market.
  • Difficult to set prices: If you have set a particular price using the value-based pricing strategy, you will get to know about its success only after comparing the sales forecast to the actual sales.
  • Scalability is difficult: This pricing approach is ideal for small businesses that sell unique and highly specialized products. It might be difficult to employ this pricing model to a bigger audience, making it difficult to scale the business.
  • Requires a lot of time, market research, and resources: Companies need to carry out extensive market research,  competitor analysis, and customer surveys to fixate on the perceived value of the product.

Value-based vs. Cost-plus vs. Competition-based: Which one is right for you?

It depends on a multitude of factors to determine which pricing strategy is suitable for your business. For eg: Type of product, market demand, target market, etc.

A cost-plus pricing strategy can be used as a starting point for your pricing strategy. But do not try to build your whole pricing strategy of all your products around this model because the chances that you will end up with the optimal price of the product using this strategy are minimal.

If you have noticed that your target market compares the price of your product with the competitor’s product, then you should employ the competition-based pricing strategy.

In an ideal scenario, all products should be priced based on the value they offer to the customers. But in reality, the value-based pricing model is best suited when your company is selling a unique or innovative product. It makes even more sense when your target customers do not have a reference point to compare your product with.

Key takeaways

  1. Value-based pricing strategy takes the customer’s perceived value of a product into account while setting the price of a product.
  2. Unlike the markup pricing strategy, this pricing method is not dependent on the production costs of goods.
  3. Businesses that sell unique or valuable products and services can make use of this price-setting strategy.
  4. Businesses that sell commoditized products make use of the cost-based pricing strategy. This pricing strategy is not suitable for these types of businesses.