What Is Value-Based Pricing? Definition, Examples and Benefits
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Value-based pricing is a technique a company can use to adjust the cost of its products based on the worth for clients. The success of this strategy depends upon the company's industry, implementation strategies and structure. If you're a pricing specialist or freelancer, you may want to learn more about what value-based pricing is and how it can increase your profits or earnings. In this article, we explain what value-based pricing is, the characteristics companies need to use it, its benefits and disadvantages, how it compares to cost-based pricing, how to implement it and value-based pricing examples.
What is value-based pricing?
Value-based pricing is a process for determining pricing in which you consider the worth that your product or service is presenting to the client. Value-based pricing is an alternative pricing method to time-based pricing or cost-plus pricing. This type of pricing focuses on the relationship between the client and the deliverables, correlating the payment to the results the client experiences.
Company characteristics for value-based pricing
These are some characteristics a company, business or professional may need to effectively implement a value-based pricing system for their products or services:
Unique product or service: To offer value-based pricing, it's important that the organization can differentiate its product from competitors. Having a unique product or service makes it easier to justify higher prices.
Client-focused product: Offering a client-focused product allows the perceived value of the product or service to increase from the client's viewpoint. Customizing your services or products based on the client's needs can allow you to charge more for them.
Healthy client relationships: Maintaining a healthy professional relationship with your customers is important. Customers are your primary source of income, but they can be important in marketing for gathering testimonies or organic growth through word-of-mouth.
Efficient feedback methods: Committing to constant improvement allows you to improve your services, and efficient feedback methods can help you ensure you can identify which areas to improve for client satisfaction.
Benefits of value-based pricing
These are some benefits of using value-based pricing:
Increases initial profits: Value-based pricing usually allows you to price your products and services higher, increasing your initial profits without spending more money, time or effort.
Allows for better products: When you are pricing your products to their perceived value, it places an emphasis on increasing that value, which can lead to constantly improving products and services.
Improves customer service: Implementing efficient feedback methods and focusing on your client's needs improves your customer service and can cause higher retention rates.
Boosts perceived value: By offering your products for a price adjusted based on value, you can boost your perceived value. For example, by charging $1,000 for a product or service, your customer views it as being worth $1,000.
Value-based pricing disadvantages
These are some potential disadvantages of using value-based pricing:
Challenging to implement: Value-based pricing can be challenging to implement, especially if you are transitioning from a different pricing method. Conducting ample research and making a plan for change can make it easier to move to value-based pricing.
Lack of guidelines: Unlike other methods of pricing, like cost-plus, there are no formulas or exact answers, which can make it complicated to determine the best prices. Working with experts and starting small can help to provide a structure for the process.
Inconsistent profits: Though value-based pricing usually raises overall profits, it can make it more difficult to project profits when you charge differently for products or services based on the client. Developing a system for averages and working with accounting experts can help you create more accurate forecasts.
Risk current clients: If you are currently using a different pricing system, your clients may not want to change to a new method, especially if it costs more. Implementing the new value-based pricing system with new clients and slowly expanding it throughout your operation can help you minimize the risk of losing certain clients.
Value-based pricing vs. cost-based pricing
These are some differences between value-based pricing and cost-based pricing:
Cost-based pricing consists of various pricing strategies that focus on cost, including cost-plus, markup, target profit and break-even. Each of these forms of cost-based pricing uses the costs of production to determine how a company or business should price its goods. Value-based pricing focuses on the perceived value for the client rather than the cost of producing a good or service.
Cost-based pricing can strategize for profit by ensuring the product or service costs at least as much as it did to create. Most cost-based pricing methods include formulas in which you can input variables like materials and labor. Value-based pricing systems strategize for increased profits by operating upon perceived value, assuming that clients may pay more for a product than it costs to make. Because of this, it is not as easy to apply formulas to the value-based pricing method.
Cost-based pricing methods are more successful in industries where the perceived value of a product is not very important. For example, rice and gains on a grocery store shelf do not change in price depending on the customer's perceived value. Value-based pricing is best for industries that offer services or products with a high reliance on perceived value. The fashion and beauty industries, for example, depend upon perceived value, and a clothing designer may change their price for each client depending on where they may wear the piece and how high-profile they are.
The products or services offered by a company that uses value-based pricing often differ from those offered by a company that uses cost-based pricing. Companies that use value-based pricing are more likely to offer specialized and customized products. Those that use cost-based may be more successful by producing commonly used goods that people may pay a standard price for. For example, a company that offers a customizable profile of vitamins and supplements may charge their clients on a value-based system, while a company that produces vitamins and supplements for drug stores may charge using cost-based pricing.
Another aspect in which the two pricing strategies differ is their reliability for profits. Cost-based pricing may be more reliable than value-based pricing because the methods follow formulas for determining how much to charge, and they charge the same amount for each person who purchases them. This makes it easier to create accurate sales projections. Value-based is less reliable because it can be more difficult to achieve the correct pricing to optimize sales but avoid losing customers to your competition.
How to implement a value-based pricing strategy
You can follow these steps to implement a value-based pricing strategy:
1. Understand your business
The first step to implementing a value-based pricing strategy is understanding if it is a viable system for your business. By evaluating your business, you can determine if you have the characteristics for a value-based system to be lucrative. For a value-based pricing system to work, a company must have unique products or services, be client-focused, maintain healthy client relationships and implement efficient feedback methods. If your organization does these things, value-based pricing may be a good choice.
2. Research your competition
After you've determined that your company has the characteristics for value-based pricing, you can research your competition. Understanding how your competition prices their goods and services can help you determine if it may interfere with your own pricing plans. You can evaluate them to determine if your customers may turn to your competitors when you implement value-based pricing, and develop strategies for avoiding that. One way to retain your customers is to ensure that your product is substantially different or better than your competition's, which may require bundling or combining products and services.
3. Invest in market analytics
Depending on the size of your organization, you can hire dedicated professionals to help you monitor the market in your industry. To accurately determine your pricing, you may want data about how clients are spending and what their priorities are. If your organization is smaller, you can invest in market monitoring software or services from other companies.
4. Gather data from consumers
Consider reaching out to your clients and introducing the idea of value-based pricing to them. Inform them of how the value of their service may increase if you implement this new pricing system, and address any concerns they may have. Learning about your client's opinions and showing that you value their feedback is an important part of the process, as value-based pricing is very client-centered.
5. Begin with new customers
Rather than immediately switching all of your current clients over to a new pricing plan, consider testing value-based pricing with your new clients. This can give you an opportunity to refine your pricing process. It can also allow you to develop a base of higher-paying clients to minimize the risk of losing other clients that don't want the value-based pricing system.
6. Fully adopt value-based pricing
The eventual goal is to fully adopt the value-based pricing system by integrating it into all of your transactions. When informing your clients of this change, be sure to re-address the benefits they can gain from the switch and manage any concerns or questions you receive. It's likely that you may lose a few clients who preferred to pay less for your services, but by implementing this pricing system, you can raise your overall profits and keep clients who value your time and worth.
Examples of value-based pricing
Here are two examples of when value-based pricing may work better than other pricing methods:
A web designer charges $30 per hour to create a new home page for their clients. They accept two new projects, one for a small window company and one for a large fashion design business. Each project takes about nine hours and the web designer charges both the window company and the fashion business $270, although the window company sees only a small increase in customers while the fashion business doubles their profits that quarter. In this situation, it might make more sense for the web designer to charge according to value rather than time.
A new coffee shop opens downtown featuring trendy photo opportunities, unique drinks and sweets and customizable coffee flavor profiles roasted in-house for you to take home. This coffee shop charges $11 minimum per item, which is more than double their competition. They can use this value-based pricing because the products, services and experiences they offer differ from their competitors'. Their customers spend the extra money on the coffee to get cute pictures and customized roasts. As their marketing campaign reaches a wider audience, people recognize the brand and the perceived value of merchandise from the store rises as well.
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