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Demystifying Value-Based Pricing

(976 words – 8 min)

Value-based pricing is an extremely simple concept: Charge what your customers are willing to pay. This is the perfect profit optimizing price. Charge more than that, and they won’t buy. Charge less, and you’re leaving money on the table. You can’t do better.

This concept is simple to understand but impossible to do perfectly — you can’t read the minds of your buyers. Besides, they probably don’t even know exactly how much they would pay. However, you can always get closer. There are many strategies and tactics you can implement to capture more of your customers’ willingness to pay.

The single approach I find most powerful is to put yourself in the mind of your buyer to understand the decisions they are making. There is one fundamental customer decision you need to understand that is bound to help you win some deals at higher prices. What is the decision your buyers are making just before purchase? Is it “Will I?” or “Which one?”

Buyers Make Two Decisions

Most buyers make both decisions. First, they answer “Yes” to “Will I buy something in this product category?” Then they go on to answer, “Which one will I buy?” Think about the last time you bought a new car. First, you decided you needed a new car. That was answering yes to the “will I” question. Then you shopped around to figure out which car was best for you and your budget. That was making the “which one” decision. In other words, you compared competitive alternatives.

Pricing Relative To Competition

If you have a product where buyers go through this process before making a purchase decision, then you should be pricing relative to your competition. Your buyer looks at the two alternatives, sees which one is most expensive and now answers the question, “Is it worth it?” They are comparing the differentiation to the additional money. To price these products, you need to estimate how your product is different from your competition (in the mind of your buyer) and how much that differentiation is worth. The price of your competitor’s product acts as a reference your buyers use.

The real magic happens, though, when buyers aren’t making a “which one” decision. Sometimes, buyers only say “Yes” to “Will I?” and then purchase. This is magical because, in these cases, buyers are not price-sensitive. Price didn’t drive their decision. Something else did. There is no competitive price comparison. If price isn’t driving their decision, then you could raise your prices 10%, and it may barely impact unit sales.

You probably have products and situations right now where buyers only make a “will I” decision. Your challenge is to recognize them. Let’s categorize these as “will I” products and “will I” situations.

A “Will I” Product

A “will I” product is one where most buyers only make the “will I” decision before purchasing. The Apple iPhone is a great example. If you currently use an iPhone, you are likely saying to yourself, “Should I buy the new iPhone or not?” You are probably not saying, “Should I buy the new iPhone or switch to Android?” In other words, most people who use iPhones are only making a “will I” decision for a new iPhone. However, most Android users get to choose between Samsung, Google, Motorola and more.

Other “will I” products include monopolies, like many utilities. Products with high network effects like LinkedIn are often included in this category. Highly innovative products and products well protected by patents can be included, too. You are looking for products where customers typically don’t consider competitive alternatives.

A “will I” situation is when a product that normally has competition is in a situation where no competitive alternative is considered. Gasoline is a great example. If any gas station in town is too expensive, customers go to the one across the street. However, when you’re in the middle of nowhere and see the sign that says, “last gas for 75 miles,” that gas is much more expensive. There is no competitive alternative. This is a product that normally has competition in a situation where there wasn’t. Popcorn at the movie theater is another fun example.

There are many “will I” situations. The gasoline and popcorn examples have to do with constraints on distribution. Selling options or upgrades to current customers are usually “will I” situations. Accessories sold as add-ons to high ticket items, like an HDMI cable with a TV, are sometimes “will I” decisions.

Subscriptions are a unique combination of the “will I” and “which one” decisions. Usually, buyers make a “which one” decision when first adopting a subscription. Once they have made that decision, month after month, the buyer only makes a “will I” decision. “Will I keep paying for this?” Subscribers also only consider their selected vendor for upgrades. Upselling and cross-selling current subscribers are almost always targeting buyers only making a “will I” decision.

My recommendation is to look for and create “will I” products and situations; those where your buyers do not consider a competitive alternative. These buyers are not price-sensitive. They are willing to pay more. You will be able to win those deals at higher prices. This is a powerful example of using value-based pricing to get closer to how much your customers are willing to pay.

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