Value Base Pricing

“The cynic,” Oscar Wilde once wrote, “knows the price of everything and the value of nothing.” If Wilde was right, then many of today's companies must be highly cynical, as most overwhelmingly fail to link customer value to pricing in their day-to-day business.

Most companies either employ cost based pricing , or price their goods and services based on the prevailing prices of their competitors . Both these approaches, however, have their flaws.

Cost-based pricing is difficult to manage as costs change, since fixed costs per unit depend on how many units are sold, which in turn depends on unit pricing, which is driven by fixed cost allocation, etc. Clearly, this approach can be a bit circular in nature.

The dangers of market-based pricing are also real, as this approach encourages the notion that products and services are commodities that can be easily compared against one another. Most marketing approaches, however, preach the virtues of differentiating oneself from one's competitors and avoiding commoditization at all costs.

One key reason why these approaches fail is that they overlook the concept of customer value in the pricing equation. Indeed, neither approach takes into account the value that a new product or service offers to the customers from the customer perspective. Equally important, these approaches don't help generate insights into new ways of structuring or delivering a product or service in order to make it more valuable to customers.

Our experience has shown that taking a value-based approach to pricing can be highly insightful for companies that have always operated under traditional pricing schemes. Through adoption of value-based pricing, many companies have built better pricing schemes while developing a deeper understanding of what matters to customers, and what they will be willing to pay for. In the end, the real difference that value-based pricing can make lies in its ability to provide superior, differentiated products and services which stand apart from those of competitors.

“This all sounds too easy”, you might correctly say. On the surface, the merits of a value-based approach are hard to dispute. However in practice, the concept can be much more difficult to apply. To prove the point, try asking three people to agree on the value of anything simple like a mobile phone…it's not easy! Try it for a more complex service offering, and the divergence in opinion only grows.

Indeed, getting agreement on value for a given product or service is hard enough within a company's Marketing or Sales Divisions. Trying to convince all potential customers of a common value equation is even more tricky, since each customers' perception of value differs based on their own values and needs. Additionally, customers can only estimate value before buying through company information and the experience of others…the information they have is far from perfect.

There are other inherent obstacles to pricing based on value. Some of these obstacles are clearly illustrated by the request for proposal (RFP) process for selecting and purchasing high value goods and services. Anyone who has completed an RFP or evaluated RFP responses has probably noticed that the process favors easily quantifiable aspects of an offering over those which are more difficult to quantify. The process often ends with a somewhat blurred image of the offering that undervalues certain benefits simply because they are not easy to objectively evaluate.

Despite the challenges, there is a way to overcome these pricing obstacles. It requires companies to focus on three key areas:

Focus on Customer Value: Many companies make the mistake of over-emphasizing the features of their offerings, when in fact they should focus on the hard and soft benefits that the customer perceives. For example, a vacuum cleaner with an extended hose feature is not what matters to customers. It's what they can do with this appliance, such as cleaning hard-to-reach places, that drives their perception of value.

Strive For Product & Service Differentiation: The value of a company's products and services must be clearly superior to that of alternatives, otherwise, the price will end up being set either by your least sophisticated competitor or your most priced aggressive competitor. Either way, a competitor that does not focus its pricing on customer value will likely under-price the offering, and effectively destroy your ability to command a premium. The implication here is that if a company cannot meaningfully differentiate its offerings, it will find great difficulty putting a price on its value.

Understand and Communicate All Potential Sources of Value: In order for value-based pricing to work, customers must understand the value they can get from a particular offering. In a business-to-business context, this requires an explicit understanding of customers' business models, strategic goals, and internal economics. Without such insight, it will be difficult to assess the value for a given customer or communicate the value to them effectively.

In summary, value-based pricing is an emerging approach for making product offerings and pricing more suitable for the customers that will benefit from them. While setting pricing based on value may not be easy in the short-term, thinking about offerings and pricing from a value perspective can go a long way toward better understanding what customers truly value, and therefore, are willing to buy.

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