Value-based pricing throws cost out of the window and focuses squarely on value and customer experience. Get the value/price balance right with these tips.
Without a shadow of a doubt, pricing is the topic I am asked most about within my business community. It’s a subject with a plethora of avenues; one of which is value-based pricing. This is one of the most widely discussed costing methods… But it’s also the one which raises the most questions.
So what is value-based pricing? Value-based pricing is the act of analysing the worth of a product or service for a target market, comparing it to the competition and setting a price accordingly. It’s pricing centred entirely on perceived value.
If you're looking to increase your prices or are determined to differentiate yourself from the competition, this could be a pricing strategy for you to adopt.
However, as with all elements of business design and strategy, there’s a huge deal to consider before making any decisions. Read on for my full guide on value-based pricing.
What is value based pricing?
A value-based pricing strategy considers prices primarily (but not exclusively) by pinpointing the perceived value of a product or service for the customer. This is markedly different from cost-plus pricing, which looks at the costs within a company when defining a price. It shines a light on the target market, and explores what they believe a product or service is worth.
It’s a popular approach, as it allows businesses to charge a higher price point, balance supply and demand and increase brand value. It gently pushes you into a profit generating state of mind, while giving you further data and insights into your target market that may spark future ideas for your offering.
Of course - because nothing in life is - this approach isn’t perfect. It can make scalability and the justification of added commodities tricky. In addition, it can feel like a ‘finger in the air’ approach, leaving it hard to draw a line under.
Value-based vs Cost plus pricing: which is best?
These are two very different pricing strategies - both bring their own positives to the table and have their place in a business plan and strategy.
Cost-plus pricing is arguably the easiest, most straightforward method; it’s consistent and relatively low risk. It keeps you on top of your profit margins and focuses inwards. All you need to do is figure out the costs per product and then add a predefined profit percentage on top. But, despite the benefit of simplicity, there is no real thought towards customers or the ideal customer. All you need to do is figure out the costs per product and then add a predefined profit percentage on top. This puts you at risk of over or underpricing your product or services, which could result in a loss of sales.
Value-based pricing, on the other hand, is entirely external. It’s based on the small amount of differentiation between yourself and your competitors on a single product or service. It’s more nuanced, and taps into the principles of supply and demand throughout the greater market and your target audience. Saying that, it comes with risk. If your competitors’ pricing is off, then yours will be too. It’s also a complex, time consuming approach that can take a huge deal of time to research and set up.
It’s worth noting that these are just two of the many pricing strategies available to businesses. You can read my guide ‘How should I charge my services?’ to discover some of the other routes, or use my FREE pricing calculator to try the tried and tested method I use for my clients (Innovate & Thrive Co. Service Pricing Strategy©)
How is value based pricing calculated?
There is no blueprint formula to work out your value-based pricing; it’s a process of research, analysis, trial and error.
Rather than a calculation, we must see it as a strategy. To kick start the process, you will need to consider the following steps:
Research your target audience
And I mean meticulously research them!
In order to implement a value-based pricing strategy, you need to know precisely who your consumers are and what they are prepared to pay. You need to understand:
How your product or service will impact their lives
What demographics they belong to (including income levels)
How much they care about the problem that you are trying to solve
I would recommend qualitative research for this step; have genuine conversations with your audience, and dig deep into what truly matters to them. This is the key to identifying their perception of your offering.
Research your competitors
Remember; the value of your product or service is only relative to the market you are in. It’s therefore important that you carry out a competitor pricing analysis before honing in on your final pricing structure.
Your aim is to identify the next best alternatives on the market and to have a clear (and provable) idea of why yours is better or different. Questions you may want to ask about a competitor’s product or service include:
Is it made of high end, quality materials?
Do they have extensive experience?
Does their product have more features?
How much roughly does it look like the product or service costs to make or deliver?
Are there any bonuses?
Do they have an enormous following and widespread network?
These questions barely cover the tip of the iceberg; and they will depend entirely on what it is you are offering.
Here it is fundamental to remember that if you are not creating enough value in your product or service, then your audience will simply opt for the cheaper alternative. So; what is it that makes you stand out among the crowd?
Determine the value of this differentiation
Okay - so you know what makes your product or service unique. Excellent. Now you need to put a numerical value on those features.
There is no exact science to this; and therein lies the difficulty. You need to assign value to the key features that you believe mark your service or product as better than everything else in the market. How much are those bonus modules worth on your course? What about the sustainable material you used to craft that bag? Or the fact you have spent the past twenty years leading teams of 500 on a journey towards business excellence?
It isn’t necessary to add a numerical value to every single element of your offering; just the ones that you believe put it above the competition.
Build marketing strategies and campaigns that speak to your target audience and do your pricing structure justice
You then need to market your offering in a way that encapsulates everything you have uncovered in the previous steps. Because you cannot expect your audience to immediately appreciate your added value; you need to tell them about it, you need to show them it in action.
This is a crucial step if you want your value-based pricing strategy to actually speak to your target audience and elicit the desired response.
A value based pricing example
Perhaps one of the most recent (and extraordinary!) examples of value-based pricing is one that I have personally succumbed to: that of the Dyson hairdryer.
The Dyson hairdryer is by no means cheap; it costs around £300. And when this product first came out, there was a lot of surprise from consumers - would your average Joe really pay that much for a hairdryer?
Yes, yes they would! The next comparable hair dryers cost at least £200 less, and yet the Dyson remains a bestseller. People see and understand its value of being better for your hair, easy to use and a great way to style your hair without extra products and heat. It’s consistently voted the best on the market; this not only keeps the sales rolling in, but also puts the company in a prime position every time they release a new product in their beauty range.
Increasing value for pricing
When you assess your services or products for those key differentiators, the bigger they are (or the more you have!) the easier it will be to use value based pricing. Because these differentiators? They are where YOUR UNIQUE VALUE lies 👏
This is why it is so beneficial to regularly unpick your offering and identify all of your differentiators. If you don’t have any, create some! Not just anything though… They need to hold real value for your clients. This is where your competitor research really comes to life.
Psst - This is a crucial practice whether you want to use the value based pricing approach or not!
Improving client experience for value-based pricing
If you’re service based, your client experience can be a prominent differentiator between you and your competition. Essentially, this comes down to how easy it is for people to work with you.
Have you made it simple and stress-free for your clients to communicate with you?
Is there a clear awareness of roles and responsibilities?
How do you address their questions and needs before they realise they even have them?
How do you ensure they always feel seen and heard?
Is your journey together a seamless one? How do you make sure of this?
Are there any ways in which you make your clients feel special along the way? Added treats and surprises?
Is your brand flawlessly woven into your client experience, further enhancing your position, identity and expertise?
Remember, it’s important to deliver this, not just through a value packed service (with differentiators interspersed along the way), but also through the ‘how’ of everything you do.
Steph Sanderson is a business design consultant who helps service-based businesses to accelerate their growth in a sustainable way through pricing, customer experience, process planning, systems and strategic planning. She has over 15 years experience in the field, working as a business manager, global Change Manager and Implementation Specialist. Find out more.