The single most profitable thing you can do as a company is to adopt value-based pricing (VBP). This is the foundation of everything that has to do with pricing.
The meaning of value-based pricing is clear: charge what your customers are willing to pay. In a future blog we will talk about value, but for now, know that value and willingness to pay (WTP) are highly correlated.
Once you adopt this attitude of VBP, the world of pricing opens up to you. Ideally, you would read the mind of each individual buyer, discover how much they are willing to pay, and charge them that price. OK, this is only possible in fantasy land. But accept that as your impossible goal. Although you will never achieve this ideal, every step closer is more profit in your pocket.
The nemesis of VBP is cost-plus pricing. Ugh. Too many companies, especially hardware companies, find themselves stuck simply calculating their cost of goods sold and adding a markup to get to a price. This is horrible. Sure, they’re certain they will make a margin on each unit sold, but this has nothing to do with the market. What if every buyer was the same and would pay a lot more? What if those buyers would buy, but only at a price slightly less? In both of these cases, it makes sense to adjust the price based on the buyer’s WTP (willingness to pay).
In reality, some buyers probably would pay a lot more and some buyers probably would buy, but only if the price were slightly lower. As you adopt and explore VBP, you will learn that there are ways to charge these different buyers different prices. This is called price segmentation. But it is only possible if you’re willing to use VBP.
Adopting VBP means thinking hard about how buyers value your product. It means measuring or at least estimating how much buyers are willing to pay. It means understanding how buyers use price when making a decision.
Over the years I’ve talked with many companies who say they use “value-based pricing”. They think they’re done. When I dig in, often it’s simply a set of words they use. They adopted those words when they implemented a new quoting system or pricing process. Granted the new system or process probably did capture more value. It was consistent with value-based pricing. But value-based pricing is an attitude of discovery and implementation. It’s a never-ending journey.
Lesson: adopt the attitude and goal of value-based pricing.