Value-based pricing

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Value-based price, also called value-optimized pricing or charging what the market will bear, is a market-driven pricing strategy which sets the price of a good or service according to its perceived or estimated value. [1] The value that a consumer gives to a good or service, can then be defined as their willingness to pay for it (in monetary terms) or the amount of time and resources they would be willing to give up for it. [2] For example, a painting may be priced at a higher cost than the price of a canvas and paints. If set using the value-based approach, its price will reflect factors such as age, cultural significance, and, most importantly, how much benefit the buyer is deriving. Owning an original Dalí or Picasso painting elevates the self-esteem of the buyer and hence elevates the perceived benefits of ownership. [3]

Contents

How it works

Within the strategy of value-based pricing, the price is not dependent on its cost of production, but instead, it is set with consideration upon the consumers perceived value and willingness to pay for the good or service. [4] This pricing strategy should have an even power balance between the seller and the buyer, maintain a long-term and service-based exchange and prioritise a strong relationship with consumers. [5] When adopting the value-based pricing strategy, the price is set to reflect the product or services benefit, meet the company's marketing and financial goals and additionally, consider any competitors' pricing that could influence a consumers preference. [6]

Within this method, value is considered a crucial driving force for every business decision, as ultimately, value determines the price the potential customers are willing to pay for the added benefits received. [7] Profitability of this method stems from its ability to eliminate potential customers who are driven only by price and attract new value-oriented customers from competitors. For example, Starbucks raised prices to maximize profits from price insensitive customers who value gourmet coffee, while losing consumers who seek cheaper prices. [8]

Characteristics of value-based pricing

A business looking to adopt the value-based pricing strategy must ensure that its product or service offering is of certain qualities. Furthermore, that it must possess:

  1. A distinct uniqueness, able to differentiate itself from competitors.
  2. A product that is consumer-oriented (that any-to-all adjustments to the product is based solely on consumers wants and needs).
  3. A high quality standard (associated with high value to a consumer).

Additionally, the business must prioritise having open communication channels with its customers, to ensure feedback is frequently taken into consideration and the business can further identify the attributes consumers want and their respective willingness to pay. [3]

When is value-based pricing most successful?

Businesses using this strategy are most successful when a product or service:

Types of value-based pricing

There are two types of value-based pricing, which are:

  1. Good Value Pricing
  2. Value-Added Pricing

Good value pricing describes that the product or service is priced in relation to its quality. While value-added pricing refers to the price given to a product or service in relation to the perceived value it adds for the consumer. [9]

Versus cost-based pricing

To completely grasp the concept of value-based pricing, it can be compared against an alternative pricing method of cost-based pricing.

Cost-based pricing

Cost-based pricing is applied through setting the price of a product or good based on its production and delivery cost with a certain target margin. This method shows an emphasis for cost recovery and profit maximisation which tends to result in lower prices in commodities and/or lower quality of goods. [3]

This method can be utilized successfully by a business when the following circumstances exist: [6]

If the above circumstances do exist a firm can profit very heavily off of cost-based pricing due to the high profit margin created. This can be considered more short term as many of the factors above can change such as customer purchasing power. [10]

Comparison to cost-based pricing

Choosing a pricing approach to assist a business in achieving a profit is a difficult decision, however, can be made easier when considering their goals and objectives. The cost-based approach is useful as it is easy to calculate and can guarantee that the firm will cover costs of production. [11] Conversely, this method fails to recognise consumer and competition perspectives, the overall business environment and positioning of product. [6] Businesses using this approach simply define their price in relation to internal costs and abilities, thus, potentially missing profit making opportunities or building customer retention. [4] However, value-based pricing takes these factors into consideration and assists businesses in understanding what consumers value and what they are willing to pay. [11]

Disadvantages

Value-based pricing presents many challenges regarding its implementation into a businesses marketing environment. [12] The main obstacles identified for successful implementation of value-based pricing is:

  1. Difficulties in understanding the specifics of what consumers value and how these values can change over time.
  2. Challenges in influencing what consumers value.
  3. Trouble communicating and quantifying value within a buyer-seller relationship.
  4. Difficulties in gaining a margin of the value formulated in industrial exchange. [13]
  5. Requires substantial resources and time to receive customer feedback and analytical data.

Implementation

Resolving competing objectives

The conceptualization of sales strategy (Panagopoulos and Avlonitis, 2010) [14] is an essential for companies to sell in a more strategic way rather than operationally selling their products. However, the focus of B2B (business-to-business) pricing method has transformed into the concept of appreciating and raising the value of a product in a market, such as value creation and value capture (Aspara and Tikkanen, 2013). [15] One of the reasons for some companies not applying value-based pricing is that they do not know their own advantages and capabilities. Next, the objectives of the company are not aligned. It is a typical conflict of objectives in companies is market share versus profitability, because in a business tradition, the higher your market share, the more profitable the company is. Hence, to implement value-based pricing into a company, the company has to understand its objective and the advantages that stand out among the competitors in the same field. Thus, this will provide a benefit of dominating the targeted market for the company, hence, sustaining the segmented customers that the company is targeting.

Understanding customer segmentation

There are many ways of approaching value-based pricing. However, segmentation between companies decides and affects which market segment the company is attracting or aiming for. Generally driving segments, there are customers who just go for the lowest price product, or value buyers who are willing to pay more to purchase products that are worth the price. Thus, value–based pricing companies are aiming for types of segmentation like value buyers. In reality, each and every product in the market is sold at different prices, for more or less similar products. However, selling the same product at different prices is often illegal, because it is regarded as price discrimination or treated as unfair. For example, if customer A and customer B purchased the same item but charged at different prices, this is perceived as unfair. Hence, two of the strategies to go around the market and still to charge more from one segment than another are price fencing and versioning. Price fences are criteria which customers must meet if they are to qualify for a lower price [16] e.g. fencing price buyers from convenience buyers by offering a lower price to shoppers who use coupons found in local newspapers. A convenience buyer only goes to a store and purchase the product they want to get in full price. However, price buyer wants a low price, so they would clip out the coupon they got from the newspaper and redeem the coupon in the department store for a discount. Thus, fencing and versioning are just the ways of how we can address different segments with the willingness to pay at different price point. By capturing the willingness to pay from price buyers with a low-end offering, and at the same also segmenting convenience buyer. Thus, companies are able to charge a much higher price in convenience buyer segment, so profit increases by serving different segments in different price points.

Using pricing as pain management

However, coupons cannot be given out blindly before understanding which customers are willing to pay more when buying in large quantities. Periodically, some marketers have eliminated their competitors by driving down cost or developing upsetting technologies (Paranikas, Whiteford, Tevelson and Belz, 2015). [17] Thus, market has been segmented out to set up different levels of discounts. Although market has a list price but no one ever pays the full list price, in fact, price negotiation turns into discount negotiation. For instance, the biggest challenge faced by market nowadays is giving too many discounts without getting anything in return. This proven that pricing is often a pain management, where when customer ask for discount or to purchase a product in lower price, customers have to give something back in return to get lower price or discounts. Hence, every discount should have a pain associated with it, because if customers do not suffer from the pain for asking to get a discount, they will just ask for more discounts.

Understanding price negotiation and fear

Price management and price psychology are related to each other. [18] Companies often transform from a sole entrepreneur into a large company with multibillion-dollar contracts at stake, subject to both price anxiety and on the other hand price confidence. For example, when the buyer knows that the seller will win a deal at any cost, the seller will get it at any cost, meaning that the price will go down. Thus, in another way, the moment when the seller fears a price negotiation and on the other side there is an experienced buyer, the price will go down. It is often said that fear is the most expensive feeling in a company. Additionally, it is often seen that companies, salespersons, entrepreneurs, or freelancers are anxious to lose a deal when customer just takes the price down. Pricing confidence is an essential organizational characteristic which allows teams to sell the product confidently and believe in the price-worthy value of the product (Liozu et al., 2011). [19] Therefore, it is important that companies build up pricing confidence in a team, showing the team a better insight, creating more value from the product. Furthermore, this leads to price confidence that leads from the confidence a seller has in the product they are selling. However, when the seller is not confident about the price or product they are selling, help from others to access your product that has the value for the price is possible as well, and this leads to commodization. Commodization happens when the product a seller offer is as good or as bad as the competitor is offering. In these scenarios, the seller will find it difficult to sell the product at a higher price. Customers often use commodization to drive down the price of a product during a negotiation. Thus, it is valuable to the seller to convince the buyer that the product is not a commodity when you understand the value and that the price of the product is justified. [20]

Addressing the mindset change

Value-based Pricing is as much about a change in mindset, as it is about the underlying mechanics of establishing a price and the sales skills needed to achieve the price in the market. The most important first step in Value-based pricing is to address the mindset change, so that the entire commercial organization starts to think about selling value instead of just selling a product.

Companies with most successful VBP initiatives invest the time upfront to build a unified view across their commercial functions on some fundamental questions like 'What is Value?' and 'How do we quantify Value?' Answers to such questions are very specific and unique to each B2B company depending on what it sells, where it sells, who it sells to and how does it sell. A proven approach [21] is for companies to conduct a cross-functional workshop that involves not just the Product and the Marketing teams but also the Sales and Customer Service teams to build a company specific view on Value-based Pricing. Once this common definition is established, companies can then go about quantifying value and establishing the value-based price

See also

Related Research Articles

A monopoly, as described by Irving Fisher, is a market with the "absence of competition", creating a situation where a specific person or enterprise is the only supplier of a particular thing. This contrasts with a monopsony which relates to a single entity's control of a market to purchase a good or service, and with oligopoly and duopoly which consists of a few sellers dominating a market. Monopolies are thus characterised by a lack of economic competition to produce the good or service, a lack of viable substitute goods, and the possibility of a high monopoly price well above the seller's marginal cost that leads to a high monopoly profit. The verb monopolise or monopolize refers to the process by which a company gains the ability to raise prices or exclude competitors. In economics, a monopoly is a single seller. In law, a monopoly is a business entity that has significant market power, that is, the power to charge overly high prices, which is associated with unfair price raises. Although monopolies may be big businesses, size is not a characteristic of a monopoly. A small business may still have the power to raise prices in a small industry.

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<span class="mw-page-title-main">Sales</span> Activities related to the exchange of goods

Sales are activities related to selling or the number of goods sold in a given targeted time period. The delivery of a service for a cost is also considered a sale. A period during which goods are sold for a reduced price may also be referred to as a "sale".

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<span class="mw-page-title-main">Pricing</span> Process of determining what a company will receive in exchange for its products

Pricing is the process whereby a business sets the price at which it will sell its products and services and may be part of the business's marketing plan. In setting prices, the business will take into account the price at which it could acquire the goods, the manufacturing cost, the marketplace, competition, market condition, brand, and quality of the product.

Database marketing is a form of direct marketing that uses databases of customers or potential customers to generate personalized communications in order to promote a product or service for marketing purposes. The method of communication can be any addressable medium, as in direct marketing.

Yield management is a variable pricing strategy, based on understanding, anticipating and influencing consumer behavior in order to maximize revenue or profits from a fixed, time-limited resource. As a specific, inventory-focused branch of revenue management, yield management involves strategic control of inventory to sell the right product to the right customer at the right time for the right price. This process can result in price discrimination, in which customers consuming identical goods or services are charged different prices. Yield management is a large revenue generator for several major industries; Robert Crandall, former Chairman and CEO of American Airlines, gave yield management its name and has called it "the single most important technical development in transportation management since we entered deregulation."

In marketing, a rebate is a form of buying discount and is an amount paid by way of reduction, return, or refund that is paid retrospectively. It is a type of sales promotion that marketers use primarily as incentives or supplements to product sales. Rebates are also used as a means of enticing price-sensitive consumers into purchasing a product. The mail-in rebate (MIR) is the most common. A MIR entitles the buyer to mail in a coupon, receipt, and barcode in order to receive a check for a particular amount, depending on the particular product, time, and often place of purchase. Rebates are offered by either the retailer or the product manufacturer. Large stores often work in conjunction with manufacturers, usually requiring two or sometimes three separate rebates for each item, and sometimes are valid only at a single store. Rebate forms and special receipts are sometimes printed by the cash register at time of purchase on a separate receipt or available online for download. In some cases, the rebate may be available immediately, in which case it is referred to as an instant rebate. Some rebate programs offer several payout options to consumers, including a paper check, a prepaid card that can be spent immediately without a trip to the bank, or even as a PayPal payout.

<span class="mw-page-title-main">Pricing strategies</span> Approach to selling a product or service

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Business marketing is a marketing practice of individuals or organizations. It allows them to sell products or services to other companies or organizations, who either resell them, use them in their products or services, or use them to support their work.

<span class="mw-page-title-main">Retail marketing</span> Economic concept

Once the strategic plan is in place, retail managers turn to the more managerial aspects of planning. A retail mix is devised for the purpose of coordinating day-to-day tactical decisions. The retail marketing mix typically consists of six broad decision layers including product decisions, place decisions, promotion, price, personnel and presentation. The retail mix is loosely based on the marketing mix, but has been expanded and modified in line with the unique needs of the retail context. A number of scholars have argued for an expanded marketing, mix with the inclusion of two new Ps, namely, Personnel and Presentation since these contribute to the customer's unique retail experience and are the principal basis for retail differentiation. Yet other scholars argue that the Retail Format should be included. The modified retail marketing mix that is most commonly cited in textbooks is often called the 6 Ps of retailing.

The following outline is provided as an overview of and topical guide to marketing:

Price optimization is the use of mathematical analysis by a company to determine how customers will respond to different prices for its products and services through different channels. It is also used to determine the prices that the company determines will best meet its objectives such as maximizing operating profit. The data used in price optimization can include survey data, operating costs, inventories, and historic prices and sales. Price optimization practice has been implemented in industries including retail, banking, airlines, casinos, hotels, car rental, cruise lines and insurance industries.

A marketing channel consists of the people, organizations, and activities necessary to transfer the ownership of goods from the point of production to the point of consumption. It is the way products get to the end-user, the consumer; and is also known as a distribution channel. A marketing channel is a useful tool for management, and is crucial to creating an effective and well-planned marketing strategy.

Premium pricing is the practice of keeping the price of one of the products or service artificially high in order to encourage favorable perceptions among buyers, based solely on the price. Premium refers to a segment of a company's brands, products, or services that carry tangible or imaginary surplus value in the upper mid- to high price range. The practice is intended to exploit the tendency for buyers to assume that expensive items enjoy an exceptional reputation or represent exceptional quality and distinction. A premium pricing strategy involves setting the price of a product higher than similar products. This strategy is sometimes also called skim pricing because it is an attempt to “skim the cream” off the top of the market. It is used to maximize profit in areas where customers are happy to pay more, where there are no substitutes for the product, where there are barriers to entering the market or when the seller cannot save on costs by producing at a high volume.

In marketing, a company’s value proposition is the full mix of benefits or economic value which it promises to deliver to the current and future customers who will buy their products and/or services. It is part of a company's overall marketing strategy which differentiates its brand and fully positions it in the market. A value proposition can apply to an entire organization, parts thereof, customer accounts, or products and services.

Customer to customer markets provide a way to allow customers to interact with each other. Traditional markets require business to customer relationships, in which a customer goes to the business in order to purchase a product or service. In customer to customer markets, the business facilitates an environment where customers can sell goods or services to each other. Other types of markets include business to business (B2B) and business to customer (B2C).

Pay what you want is a pricing strategy where buyers pay their desired amount for a given commodity. This amount can sometimes include zero. A minimum (floor) price may be set, and/or a suggested price may be indicated as guidance for the buyer. The buyer can select an amount higher or lower than the standard price for the commodity. Many common PWYW models set the price prior to a purchase, but some defer price-setting until after the experience of consumption. PWYW is a buyer-centered form of participative pricing, also referred to as co-pricing.

There are many types of e-commerce models, based on market segmentation, that can be used to conducted business online. The 6 types of business models that can be used in e-commerce include: Business-to-Consumer (B2C), Consumer-to-Business (C2B), Business-to-Business (B2B), Consumer-to-Consumer (C2C), Business-to-Administration (B2A), and Consumer-to-Administration

References

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  2. ↑ Garrison Jr, Louis P.; Towse, Adrian (4 September 2017). "Value-Based Pricing and Reimbursement in Personalised Healthcare: Introduction to the Basic Health Economics". Journal of Personalized Medicine. 7 (3): 10. doi: 10.3390/jpm7030010 . PMC   5618156 . PMID   28869571.
  3. 1 2 3 4 5 6 7 Helmond, Marc (2022-09-06). Performance Excellence in Marketing, Sales and Pricing: Leveraging Change, Lean and Innovation Management. Management for Professionals. Berlin, Germany: Springer International Publishing. pp. 75–81. doi:10.1007/978-3-031-10097-0. eISSN   2192-810X. ISBN   978-3-031-10097-0. ISSN   2192-8096.
  4. 1 2 Moretti, Livio (2018-11-02). Distribution Strategy: The BESTX Method for Sustainably Managing Networks and Channels. New York City: Springer International Publishing. pp. 156–157. ISBN   978-3-319-91958-4.
  5. ↑ Töytäri, Pekka; Keränen, Joona; Rajala, Risto (July 2017). "Barriers to implementing value-based pricing in industrial markets: A micro-foundations perspective". Journal of Business Research. 76: 237–246. doi:10.1016/j.jbusres.2016.04.183 – via Elsevier Science Direct.
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  9. ↑ Boomenthal, Andrew (2023-12-05). Anderson, Somer; Munichiello, Katrina (eds.). "Value-Based Pricing". Investopedia. Retrieved 2024-01-10.
  10. ↑ Doyle, Peter, ed. (2012-01-02). "Value-Based Marketing Strategy". Value-Based Marketing: Marketing Strategies for Corporate Growth and Shareholder Value. Wiley (published 2015-09-18). pp. 189–223. doi:10.1002/9781119207177.ch6. ISBN   978-1-119-20717-7.
  11. 1 2 "The Difference Between Cost-Based Pricing and Value-Based Pricing | Melbado". melbado.com. 2022. Archived from the original on 2022-12-05. Retrieved 2023-04-22.
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  13. ↑ Guerreiro, Reinaldo; Amaral, Juliana Ventura (2018). "Cost-based price and value-based price: are they conflicting approaches?". Journal of Business & Industrial Marketing. 33 (3): 390–404. doi:10.1108/JBIM-04-2016-0085 – via Emerald Insight.
  14. ↑ Panagopoulos, Nikolaos G.; Avlonitis, George J. (March 2010). "Performance implications of sales strategy: The moderating effects of leadership and environment" . International Journal of Research in Marketing. 27 (1): 46–57. doi:10.1016/j.ijresmar.2009.11.001 . Retrieved 2024-01-10– via Science Direct.
  15. ↑ Aspara, Jaakko; Tikkanen, Henrikki (May 2013). "Creating novel consumer value vs. capturing value: Strategic emphases and financial performance implications" . Journal of Business Research. 66 (5): 593–602. doi:10.1016/j.jbusres.2012.04.004 . Retrieved 2024-01-10– via Science Direct.
  16. ↑ Hogan, John; Nagle, Tom (Spring 2006). "Segmented pricing: using price fences to segment markets and capture value" (PDF). SPG Insights. Strategic Pricing Group. Archived from the original (PDF) on 2017-03-29. Retrieved 2024-01-10– via Wayback Machine.
  17. ↑ Paranikas, Petros; Whiteford, Grace Puma; Tevelson, Bob; Belz, Dan (July–August 2015). "How to Negotiate with Powerful Suppliers: A framework for assessing your strategic options". Harvard Business Review : 90–96. Retrieved 2024-01-10.
  18. ↑ Ciotti, Gregory (2012-06-26). "5 Psychological Studies on Pricing That You Absolutely MUST Read". KISSMetrics. Archived from the original on 2012-06-29. Retrieved 2024-01-10.
  19. ↑ Liozu, Stephan M.; Boland, Richard J.; Hinterhuber, Andreas; Perelli, Sheri (2011-06-02). "Industrial Pricing Orientation: The Organizational Transformation to Value-Based Pricing". First International Conference on Engaged Management Scholarship. doi:10.2139/ssrn.1839838. SSRN   1839838 – via Social Sciences Research Network.
  20. ↑ Michel, Stefan (2019-08-28). "Pricing Strategy: Value-Based Pricing". Lynda.com - LinkedIn Learning as of January 2024. Archived from the original on 2023-04-25. Retrieved 2024-01-10.
  21. ↑ Gharpure, Kedar; Ranade, Vidya (2019-10-07). "The 6Ws of Value-based Pricing for B2B". B2B Growth Consulting. Archived from the original on 2019-10-07. Retrieved 2024-01-10.
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