Value-Based Pricing

A phenomenon where a company tries to price a product according to perceived benefits and its value received by the customers.

Manu Lakshmanan

Reviewed by

Manu Lakshmanan

Expertise: Management Consulting | Strategy & Operations


September 15, 2022

Value-Based Pricing is a phenomenon where a company tries to price a product according to perceived benefits and its value received by the customers. It is also in competition with the competitors' products rather than using historical Pricing.

It is a customer-focused pricing mechanism, where firms price their products on how much the customer believes the product is worth, how much they are willing to pay for it, the value the product provides the customers with, and finally, the competitors' pricing.

The pricing used for the products under this mechanism comes down to the added value given to the customer from your company plus the brand advantage any company gives (e.g., Designer Houses selling high-end clothing).

Brand Advantage refers to the value of the product your company provides the consumers.

The value of a product determines how the consumers enjoy the product. For example, if you sell advertising services, you could be making hundreds of thousands of dollars from a single campaign, changing how you would charge them for your service.

Types of Value-Based Pricing

There are two types of Value-Based Pricing- Good Value Pricing and Value Added Pricing.

  1. Reasonable Value Pricing: In good value pricing, the product or service is priced in a way that analyzes the quality of service it provides to the customers. Thus, Pricing depends on the quality and service. It's also known as the Cost plus pricing strategy.

  2. Value-Added Pricing: In this type of Pricing, the value-added for the customer is more important than the quality of service the company provides.

If the goods or services add more value for the customer, the more you can charge them for it. The company studies the value addition, and the pricing model is decided.

Characteristics Needed for Value-based Pricing

When pricing your product using the Value-based pricing model, you need to remember that it should bring another value into the user's mind so that the Pricing around the product serves the proper purpose.

Let us understand this further through the help of an example. If company A sells mobile phones with the necessities served in the market and does not offer something more, the consumer might not pay a premium for it.

Whereas a newer company in the market, company B comes in and gives much more features with its newer models, which provide the customer with a feeling of value, the customer propels into buying the more recent model and even agrees to pay a premium for the added weight.

These added features and a feeling of owning a better or a premium product is the value the business adds, and they might charge more for it. This may also happen due to the better research & development or marketing the company invested into.

A lot of factors may come into play while using the value-added approach. However, it is a common practice used in almost every industry, from cosmetics to groceries, to apparel.

Customers look out for product differentiation and how it serves their needs and wants. Your product may satisfy the customer's needs and wants, but you also need to price it at a point where they are comfortable spending that amounts on it.

Pricing higher than what the market considers acceptable might lead to negative feedback and lower sales. Thus, it would help if you also researched how the product price can vary from market to market.

Pricing lower than the acceptable price point might even devalue the company; consumers might think the product isn't how they want it to be, which might also lead to the risk of losing profit to competitors.

When is Value-Based Pricing Used

Pricing is one of the most critical aspects of your product. It directly correlates with the profits you earn. The business uses data to examine the best price point to provide maximum value for the consumers and profit maximization for the stakeholders in the company.

Customers end up paying more for a product when they think it is a better fit for their lifestyle, and the value they receive is more. This involves products with a certain prestige or a premium feel when owned.

Let's understand this better through an example. A designer shirt may cost the manufacturer more than a regular shirt made with the same fabric, fit, or design.

But the name of the manufacturer or the designer adds much more perceived value to it as soon as the customer sees that. Due to that, they are willing to pay more for it as it adds an element of prestige to their lifestyle.

Value-Based Pricing is also used in areas where the decisions are emotionally driven. For example, buyers usually pay much more than the painter's effort to make that painting while buying art and images. The Cost of materials might be insignificant in front of the selling price.

The name of the artist who made the piece of art holds a significant amount of value in the minds of the seller and the buyer. They might price it according to factors such as the legacy or reputation of the painter or how the buyer connects with the painting.

The scarcity of a product affects the price for a shorter duration of time, where it might get priced higher than usual until the product restores to its average quantity in the market.

Food and water prices might rise during a shortage or a particular event. E.g., water bottles at concerts may be priced at $5, whereas they may be available for $2 outside.

The only factor is that people attending the concert might get thirsty and have to buy water there only due to its shortage at the venue.

Examples of Value-Based Markets

Value-Based Pricing works… there's no doubt about that. So let's explain that using a few examples in industries where it is prevalent.

1. Apparel Industry

One of the most prominent examples is the apparel industry. Designers and Fashion Houses command prices in the industry and set standards of the prices at which specific pieces of clothing sell.

These designers and fashion houses also convince celebrities and fashion influencers with huge fan followings to wear their clothes to events and on the red carpet, increasing the brand's image in the eyes of the consumers.

Wearing that particular piece of cloth or that brand's clothing attaches a social image to the consumers and may also be a part of self-expression. Hence, companies can skyrocket their value and, in turn, increase the clothing price.

Lowering the prices in the clothing industry is sometimes considered counterproductive as it may diminish the brand's image in the minds of the consumers and result in decreased sales.

2. Technology Industry

The technology industry is flooded with giants that provide us with gadgets, services, and applications, without which our life wouldn't have been easy.

This conversation isn't complete without talking about Apple. The users are buying it for the brand's name as it is more valuable than the value-added product in this case.

The Apple Ecosystem, which consists of almost all the products that Apple offers, makes it easier for users to arrange and do their work better. In addition, the easy-to-use Operating System and sleek design make Apple a customer favorite.

Pricing the products at a higher premium than market norms also helps build Apple's image as the most premium technology brand, which has helped them grab an impressive consumer base.

Even though coming under criticism for using such an aggressive pricing strategy, the company still prices its products for the premium end-user market.

Ways to Set Your Value-Based Price

Value-based costing requires some extra steps over the cost-based pricing strategy (Cost-based Pricing is a pricing method that is based on the Cost of production, manufacturing and distribution of a product) while deciding the price point because of the calculations involved in working out the value incorporation brands offer to the customers.

This can determine how well the product performs in the market and the brand image. There are a few considerations that are kept in mind while deciding the price tag for the product.

1. Analyze your customers

The price point decided by your company for the specific product determines the consumer who will buy it.

So it would help if you were confident that customers would be willing to pay that amount for the product, and also, it doesn't diminish the value of your brand in the market.

Reaching out to existing and potential customers is a great way to analyze the market and get acquainted with the price points you might want to introduce your product.

2. Analyze your total addressable market

While reaching out to potential customers using the existing database is one way to go, it might give us some biases in the results.

These customers are the ones who are already using your products and not the ones seeing them again on the shelf for the first time. They have shown they are already willing to buy your product.

To tap into newer territories, you might have to research the total addressable market to reach that sweet price point to launch your product.

3. Conduct a competitive analysis

A competitive analysis might be the way for companies that do not have enough resources to conduct market research for the price points.

Looking into the competition, what prices they are selling, and launching the product in a competitive price range might tell you a lot.

If the sales do not go as forecasted, it might mean that the competitors have more considerable brand loyalty towards them, and you might have to change your tactics.

Pros and Cons

Value-Based Pricing can be a practical approach for launching your brand in the market and making a name for the company in front of consumers and other businesses. But, everything has its merits and demerits.

In this case, both sides present a good argument about whether we should go for this pricing system. Here are a few pros and cons to help us decide.

Pros of Value-Based Pricing

There are three main advantages to using a value-based pricing system. These competitive pricing advantages include:

1. Customer Loyalty

When you provide customers with high-quality goods, they are happy to pay a bit more for it. Therefore, the right product type is much more important for those customers than the lower price.

So, listening to feedback and improving the products for the customers' needs is essential. This increases brand value, and people refer your brand to others.

2. Increased Profits

Providing good quality products and valuing customer feedback makes customers feel valued and willing to buy your products at an even higher rate.

This enables the company to charge higher rates and increase its profit margin.

3. Balancing Supply and Demand

Pricing goods according to value and not cost gives you an idea of the company's customer base and the consumer base it can build in the future. You can study the demand for your products and can control the supply.

Cons of Value-Based Pricing

The main disadvantage of value-based Pricing is that it is a pricing strategy that only works in certain conditions. These disadvantages include:

1. Increased Competition in the Market

When you value the products much higher than anyone else in the market, it can open doors for competitors to come in.

This could lead to other companies selling products at a lower price than yours, leading to decreased business over time.

2. Niche Markets

When you price the products higher than competitors, it could leave many customers out of your customer base. But, again, it is because not everyone will be able to afford your product.

It could lead to a limited number of customers who can afford to buy your product. This way, the little market you supply to could get even smaller.

3. Higher Costs

You need to provide a higher quality product, meaning high-end production lines, raw materials, and labor, to have a competitive advantage. But, of course, this adds to the Cost.

Is Value-Based Pricing Right for Your Business?

The proper Pricing for your products depends on many factors. For example, the customers buying your products, the Cost of goods, the extra value of your product over anyone else in the market, competitors' Pricing, and the list goes on.

This type of Pricing doesn't work for every business. Still, it is undoubtedly a new strategy to penetrate a new market, develop a new sense of what stands in the consumers' eyes, increase profits for the entity and better understand the brand value from the consumer's perspective.

You can make a better in-depth decision by studying and comparing the sales reports and projections of different price points for the company's revenue and profit calculations. How the product is researched and marketed for the consumer also plays a part in decision-making.

The price level will be higher than the excellent value pricing strategy, and the product's perceived value should be substantial in the eyes of the consumer. So, extensive research is required to arrive at such Pricing.

Let's take an example to understand this better. Assume an individual has to arrive at a price-point for the merchandise of a football club for the upcoming season. 

The company producing the merchandise owns the rights over the club-branded merchandise. So, they are the only ones licensed to have the equipment and don't need to compete with other companies on price.

Besides, the football team being a fan favorite means high demand, so it can be the ideal contender for the value-based pricing model.

Other companies can't produce the items, so you don't need to lower the price because of no competition. But, over and above that, a fan favorite means that consumers won't worry about paying more because of their perceived value. 

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Researched and authored by Prabhav Gupta | LinkedIn

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