How effective is your pricing model?
Are you looking to try a value-based pricing model?
While this pricing model works so well for brands that are specialized in a particular product or service, you might want to learn more about the benefits of value-based pricing as well as its demerits.
For example, Starbucks raised their net income by 25% in the 3Q of 2015 – from $333.1 Million to $4,177.8 million by leveraging value-based pricing.
Wondered why Starbucks beverage prices are relatively higher than their competitors and they still record huge sales?
Well, the truth is when customers feel they are getting a deal for their money they are more likely to buy from your brand even if your price is higher than your competitors.
Starbucks spends more time and energy differentiating itself from other brands. By consistently producing high-quality beverages and positioning itself as an authority in the coffee business.
So, people are more comfortable with Starbucks products and services even if they increase their prices just like they did in 2015 when coffee beans price was even low.
Starbucks is an ardent believer in value-based pricing and has been doing it for years successfully.
What is Value-Based Pricing?
Pricing has a great impact on consumers’ purchasing behaviors. The price of your product can influence decisions, considerations, and loyalty of a customer. Yes, pricing is that powerful.
Several businesses use different techniques to set the price of their products and services.
However, the two most used methods are the cost-based pricing and the value-based pricing methods.
Cost-based pricing is a pricing method that allows companies to set the price of their products or services based on the cost incurred in the production process + some extra amount which is the profit.
So, basically, in the cost-based pricing method prices of products and services are been influenced by the cost of producing them.
In contrast, value-based pricing model allows companies to set the price for their products and services based on customers perception of the value of the product or service.
Here the cost of production is not considered — it might take you $20 to produce your product but if after your research, you found out that your customer’s perceived value for the product is $500 — it’s still okay to sell at $500.
The challenges of using a value-based Pricing model
1). How to measure value: If your product is in high demand, you might want to consider pricing it based on the value it provides. Although, measuring “value” is difficult — since there’s no set rule or metric for measuring value.
Most brands don’t have a strategy to measure the value of services provided apart from the time spent and energy exerted in rendering a service.
Creating the skills and systems to measure value beside hours spent is one of the biggest factors affecting clients and brands alike.
So, you have to find out how your products and services are highly desired by your customers.
2). Customer segmentation: This is another serious factor affecting value-based pricing, because even with the same customer the value may vary depending on time and place of use.
To beat this — brands should conduct thorough research on their customers regularly, and segment them accordingly.
3). It’s hard to know the customer’s perception: Different customers have different perceptions of your product/service. This makes pricing a product/service based on “value” difficult because it must not be adopted based on assumptions.
To scale through this hurdle and eliminate assumptions, conduct surveys on your customers. For example, I participated in a survey by Symantec and I was asked series of questions:
As you can see, this survey is geared towards knowing the value their customers place on services they provide.
In turn, this will help Symantec align their pricing model to suit customers and create a better experience for them.
With these challenges out of the way, let’s discuss the advantages:
Advantages of Value-based Pricing
1). Value-based pricing Increases profit: Value-based pricing can actually help you increase your profit. As an example, Crunch Accounting in 2015 was named England’s fastest growing firm by Accountancy Age.
This was as a result of their firm stand on the fact that pricing products based on value is the future of marketing.
Crunch Accounting’s fee income for the year was £5.14 million, which was a 50% increase from the previous year.
And this made them rise from the 13th position to the 84th position on the top 100 accountancy firms in Britain.
2). Enhances customer loyalty: If customers perceive your product to be of high quality — you can build a top notch customer loyalty for repeat business and even referrals.
3). Transparency: Customers become even more confident to pay for your services, why? Because they know the value they’re going to get from the price they’re making and they’re happy with it.
4). Predictable revenue from every new client: With a value-based pricing, you can always predict exactly what you are going to get from any of your new clients — so it’s easy for you to measure your success.
5). Trust: Clients know they can always consult and ask questions without an extra cost. They trust your opinion. After all, you’re known for delivering value.
6). Clients pay for value not time: Unlike cost-based pricing, clients pay for the value you provide rather than the time or cost of production.
Disadvantages of Value-based Pricing
1). Niche Market: Often times, the high price and high-value concept will be accepted by a tiny fraction of customers. This might cause some customers to feel isolated and left out.
2). Not Scalable: As your company grows it might become very difficult to scale your services — because it’s difficult to apply value-based pricing in larger businesses where the employee skill levels might not be very high.
3). It takes time and resources: You can make the method simple, but since there are no metrics you can’t easily pull out and determine your cost quickly.
It takes extra time for you to do the research, create your customer persona, and study it closely before you’re able to determine what your customers actually perceive to be of high value.
Inadvertently, most brands shy away from it, though it’s been found to be the best pricing model in today’s competitive market.
4). Competition: Companies that adopt the value-based pricing model might be losing a lot of their market shares by leaving rooms for their competitors to offer lower prices.
It works best when you’re specialized in a particular product or service — value-driven pricing works best when you brand yourself as a leader in your industry and differentiate yourself from the competition.
Value-based pricing model is deemed profitable and many attorneys and investment bankers have engaged in it for decades — could this be the reason why they command such a high pay rate? I think so.
I’m certain it’d work for you. But you’ve got to look through it, conduct your research, understand your customers, and only price your product to bring them the best experience.