TL;DR
- Value-Based Pricing (VBP) focuses on setting prices based on the perceived value to the customer, rather than the cost of production.
- Value-based pricing ensures customer loyalty by aligning product prices with customer perceptions of value, leading to repeat business and referrals.
- Pros include improved profit margins, elevated brand value, better customer experience, and enhanced customer loyalty.
- Cons involve the significant time and effort required to understand customer value, difficulty in setting the right price, and potential for higher competition and production costs.
- It involves risk factors such as fluctuating perceived value and competition, which can significantly impact pricing and revenue.
- Businesses in niche markets or with unique, high-value offerings, like luxury goods or SaaS, may benefit most from VBP.
- While VBP can lead to increased sales and market penetration, it's not suitable for every business and requires careful consideration and research.
- Togai offers an end-to-end metering and pricing infrastructure to quickly launch any pricing model, demonstrating a practical solution for businesses considering VBP.
Discover the pros & cons of value-based pricing and determine whether it is the right pricing strategy for your business.
There are numerous ways to set pricing for your online business. However, some approaches can lead to lost revenue and harm your brand image. Inaccurate pricing can unintentionally damage your business because not all pricing strategies prioritize the customers' interests. Determining the ideal price points is critical.
Value-based pricing has the potential to be the most effective pricing strategy for your brand, customer relationships, and profitability. But like any other pricing strategy, it requires careful consideration. To help you take the step towards evaluating value-based pricing for your business, we have compiled a list of the advantages and disadvantages of this approach.
Understanding the Concept of Value-Based Pricing
This is an example I do not tire of citing. It’s the best example to understand value-based pricing. Any guesses?
It’s Apple (of course!). Despite their exorbitant prices, they hold loyal customers who prioritize the product’s value. The value is influenced by many factors like their tech ecosystem, sleek design, User-friendly macOS and iOS, and unmatched security features, to name a few. The product prices revolve entirely around the customer and their willingness to pay.
From this, what do we understand about value-based pricing?
It is a way to set prices for products or services based on what customers think the product or service is worth. The price is not based on how much it costs to make or provide the product or service. Rather, it is based on how much customers are willing to pay for it.
It is also known as "customer-based pricing" for obvious reasons. It is certainly a suitable option for software-as-a-service (SaaS) businesses.
Businesses That Can Benefit From Value-based Pricing
Value-based pricing can be adopted when the perceived value of the product is high. An example of this would be luxury items like a Rolex watch. The products tend to be completely unique or they are highly coveted.
Similarly, it may also be used when the purchasing decision is emotionally driven. Paintings at auction could be an example.
Also, when something is in scarcity and is being provided by a business, value-based pricing can be adopted. During the COVID-19 pandemic period, prices of hand sanitizer, face masks, and toilet paper have risen.
To summarize, value-based pricing can be applied to many types of businesses. However, it is mainly used in markets where:
- There is a big difference in quality and experience between the competition, for example, fancy restaurants vs. fast food chains.
- The value that the customer receives is much higher than the cost of making the product or providing the service, for example, software-as-a-service (SaaS)
- The demand for the product or service does not change when the price changes, for example, in the housing market in some areas.
Value-Based Pricing: The Positive Side
The advantages of using a value-based pricing strategy include the following:
Improves profit margins and helps penetrate the market easilyÂ
Value-based pricing can be a great way to increase profits, as you can charge a higher price for a product if customers are willing to pay that much for it. For example, a luxury handbag company can charge more for their bags because it is deemed "new" or "limited" and are priced at a value-based amount. The high sales can lead to higher profits for the company. It would also be an easy way to penetrate the market if the product is highly coveted or unique. This is especially true if your target market is not brand loyal, or if you’re relatively unchallenged in your market.
Elevates Brand Value
Value-based pricing helps increase the brand value of your product/service. Running your marketing campaigns that position your product as something of high quality and elite, you can justify a higher price point in the eyes of the customers. Also, by focusing more on the value your customer receives, your business is making sure that your customers are happy.
Gathers willingness-to-pay dataÂ
Value-based pricing involves collecting detailed information about how much your customer is willing to pay. While this may involve some serious effort, it’s all worth it. When you go about researching your customer’s perceived value, you understand your product’s worth and can come up with a suitable profit-making price for your product. Without this information, you will be merely guessing about the price of your product. But with well-researched willingness-to-pay data, you can create a more competitive pricing strategy.
Offers Better Customer Experience
When you use value-based pricing, you focus on the customer's needs and preferences. You gather information about what they want by talking to them, asking them questions, and listening to their feedback. By doing this, you can come up with new ideas on how to make your products better. Offering extra features can increase your profit while giving customers a better experience with your service. For example, if you sell a mobile phone, you might find out that customers want a better camera. So, you can add a better camera as an extra feature to your mobile phone, which can increase revenue and give customers a better experience.
Since value-based pricing means setting the price of a product or service based on how much customers think it is worth, customers are more likely to be happy with the price they pay and will want to buy from you again. Value-based pricing ensures customer loyalty.
Builds Customer Loyalty
Since value-based pricing means setting the price of a product or service based on how much customers think it is worth, customers are more likely to be happy with the price they pay and will want to buy from you again. They may even tell their friends and family about your company. For example, if a customer thinks a shirt is worth $20 and you sell it for $20, they will be more likely to buy it and come back to your store again in the future.
Helps Penetrate Markets Easily
It is easier to sell your product or service and get more customers if the people you are trying to sell to are not already loyal to a different brand. This is true if there are not many other companies offering the same thing. For example, if you are selling a new type of yoga mat, it might be easier to sell to people who don't already have loyalty to another yoga mat brand.
Improves Customer Focus
When you use value-based pricing, you focus on the customer's needs and preferences. You gather information about what they want by talking to them, asking them questions, and listening to their feedback. By doing this, you show them that you care about their needs. Hence they will be more likely to continue to buy from you. For example, if you are a phone service provider and you regularly ask customers about their experience and use their feedback to improve your service, they will be more likely to stay with you and recommend you to others.
Value-Based Pricing: The Negative Side
We all know that nothing is perfect, and value-based pricing is no different. There are some situations where value-based pricing might not be the best choice:
Demands More Time and Effort
It takes considerable effort to understand your customers and what they want. You need to thoroughly research the following: who your ideal customers are, their needs, and how much they are willing to pay for your product or service. For example, if you are selling software, you need to research what features the customer wants, how much they are willing to pay for it, and what are their pain points. These can help organizations rightly price their software.
Moreover, it also requires businesses to accurately assess the perceived value of their products and services by their customers.
Difficulty in Setting the Right Price
Businesses are challenged with striking a balance between the perceived value of the product and the price that customers are willing to pay. One needs to develop a deep understanding of how much customers think your product or service is worth, analyzing customer feedback and competitors' pricing. But the only way to know for sure if you have set the right price is to put your product on the market and see if people buy it.
Beneficial for Only Niche MarketsÂ
Selling expensive products can be very profitable if there are customers who are willing to buy them. However, the number of people who can afford to buy these items is usually much smaller. By pricing too high, businesses run the risk of alienating some customers. An example of this would be a business selling a product (say, a helpdesk) that is useful to both an enterprise and a start-up. But by pricing it too high, they stand to lose the chance of selling it to eh SMB market.
Involves Higher Competition
Since there are fewer customers in a niche market, competition is usually higher. This means that businesses in a niche market need to work harder to keep customers. For example, if you are selling a unique type of product, like organic handmade soap, there will be fewer customers in this niche market, but the competition will be high as well. If you lose a customer to another similar product, it will be a significant setback for your business.
Results in Higher Production Cost
When you want to sell a product at a high price, the product must be of very high quality. This means that you will have to spend more money to make the product because you can't cut corners.
Did you know that it takes about a year to make one Rolex watch? Every watch is painstakingly made by hand in Switzerland and almost everything is made from base materials in-house. No wonder these watches are exorbitantly priced.
Involves Riskier Factors
The perceived value of your product can fluctuate based on cultural, economic, and economical factors. All these are beyond your influence. Depending solely on value-based pricing to boost your contribution margins might lead to negative consequences. If customers suddenly deem your product to have a lower value, or if a competitor enters the market offering a product that is considered superior to yours, it could impact how you price your products. In turn, lowering prices can affect revenue.
Also Read: Exploring the Different Types of Value-Based Pricing
Does Value-Based Pricing Work for Your Business?
There is no definite answer to this question. Every business is unique, and so is its pricing. By comparing the pros and cons concerning the market in which you operate, you could decide if value-based pricing is right for your business. Value-based pricing can be helpful because it takes into account what customers want and need. However, it also takes a lot of work to do research and gather information about customers.
Though it may not be the best option for every business, it can be a good strategy for increasing sales, penetrating new markets, and building a good reputation with customers. Despite the effort it might require, value-based pricing is a powerful pricing model that can bring benefits.
Togai is an end-to-end metering and pricing infrastructure that businesses can leverage to launch any pricing model in the shortest time possible. If you are curious and would like to take a look, sign up here. Or you can schedule a demo!
