Pricing is the most powerful tool in your marketing mix.
Value-Based Pricing is the single most profitable pricing strategy your company can adopt. Almost all other pricing strategies depend on at least an attempt to implement Value-Based Pricing (VBP).
What is Value-Based Pricing?
Value-Based Pricing means simply charge what your customers are willing to pay. Yet, Value-Based Pricing is more of an attitude than a reality. You will never know exactly how much your customers are willing to pay (WTP). Even if you knew, you wouldn’t be able to implement the systems and controls to charge every buyer the exact right price for them. Although perfect VBP isn’t possible, it is the objective. Your job as a pricing person, as a product manager, or as an executive is to get closer and closer to that objective.
The antithesis of Value-Based Pricing is Cost-Plus Pricing. 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 is completely inside out and has nothing to do with the market.
Let’s play a thought experiment. A company makes a product that costs $50 to make. They want 50% margin, so they double their costs and charge a price of $100. So far so good. They sell into a unique market where every buyer has the exact same willingness to pay (WTP), which in our example is $200. Each buyers looks at the price of this product, thinks, “that’s a good deal,” and buys it for $100. The company just missed out on $100 per unit.
What if instead everyone in this market has the WTP of only $75? Each buyer looks at the price of this product and thinks, “$100 is too much,” and they don’t buy. The company sells 0 units.
Obviously markets do not have identical buyers, but if you think about each buyer as a market of one the same thing happens. Either you don’t sell because your price is too high or you miss out on profit because your price is too low.
Profit flows to companies who understand this and implement strategies to capture more of each buyers WTP.
How to Implement Value Based Pricing
You are ready. You believe in the power of Value-Based Pricing. But, you may be thinking, “Now what? How do we do it?” The first fundamental process is to think like a buyer. Put yourself in the mind of a buyer to determine how they use price when making a purchase decision. In other words, how much buyers value your product?
Understanding the Buyer’s Journey
When buyers make a purchase decision they almost always make two separate decisions:
- “Will I buy something in this product category?” Buyers are not price sensitive (WTP is higher) when making the ‘Will I’ decision.
- “Which one will I buy?” They become more price sensitive when making the ‘Which One’ decision.
Their Willingness to Pay and their perception of value are very different in these two decisions.
Imagine Debbie. She is the type of person who buys her cars new. The last two were new when she bought them. She bought them at the same dealership. But she’s not in the market for a new car right now. She’s not shopping. She gets a coupon for 10% off the price of a new car. Does she go to buy a new car? Probably not. I wouldn’t.
Now imagine Debbie is shopping for a new car. She likes her current car dealer, but she’s thinking about changing brands. She’s narrowed it down to two cars but still hasn’t made the decision. She gets a coupon for 10% off of one of the cars. Does that sway her decision? Probably.
Value-Based Pricing is not simply putting a number on product. Value-Based Pricing is a fundamental attitude that’s pervasive in great companies. Your company must create, communicate and capture value in order to grow. Value should become a driver inside your company.