Episode #0005 - What Is Value Based Pricing?

We know what you came for - it is a chat about value based pricing and what it really means.

Lots of people (from outside the pricing profession) have doubts about value based pricing - and whether it can be implemented in your business.

We give some simple examples that hopefully make it clear what it is all about.

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We want to cover something slightly more, maybe exciting or interesting. We want to cover, what is value-based pricing?

Value-based pricing, it’s a method that people are starting to use a bit more but there’s still quite an element of confusion about what it is.

To some extent, I almost say it’s a bit of a holy grail in the pricing community. A lot of people want to move towards it but they’re still certainly looking in the vast majority of companies there’s a reluctance or a misunderstanding or something holding people back.

Also, something that seems to be in the hands of consultants more than the business community but we’ll get on to that may be a later date.

So Joanna, what is value-based pricing? 

I supposed in theory, it’s a processing method whereby you set your prices based on what your customers perceive as valuable about your products and other people say setting prices based on your customer’s willingness to pay.

You could think of it as a customer purchasing a product or service at a price that they’re happy with. A price that they think is a fair reflection on the “ value “; the value whatever that may be that they are receiving so they don’t feel like paying too much. They don’t care about paying too little but they’re paying too much for the value that they are receiving. 

That’s the tricky part knowing where that best price, that sweet spot of pricing is for different customers because everybody knows we’re all different and we’re all willing to pay different amounts and I think this is where people may be businesses get a little bit sort of maybe confused or a bit reluctant to use it. Because it’s very difficult to know how many because there are thousands and millions of people out there prepared to pay different prices. So what’s the best way to control value-based pricing in a business?

In the last episode we touched on cost-plus pricing and we discussed one of the big pluses of that is it makes sense to many people certainly from a finance background it’s easy to understand.

Easy to use and apply.

Yes and I think this value-based approach it’s almost the polar opposite it sounds, I’ll be honest it sounds hard.

 In many ways, it’s not easy but it’s applying rigour and discipline to the price-setting process.  You need a set of rules, you can’t just dive into it. There’s a science, there’s mathematics, there’s economics, and psychology all involved in that which I think I’m making it sound even harder but I supposed you know to say it’s easy it’s not. 

I think for people who haven’t listened to the podcast you don’t know much about value-based pricing I think we’d like to give two examples that make it clear to you, how it works in the real world. For example, the first one I’ll give is the concept of rebadging cars. In the auto industry, certain factories manufactured cars and they come out of the production line and there’s a different badge stuck on them at the end. What we see is fundamentally the exact same car except a badge can be sold in the same markets at different prices. And, we’re not trying to trick the customer but the customer is actually putting a value on very different things, not just the car itself but items such as brand prestige perhaps financing packages; lots of different things.

I suppose here it’s the job of the business to work out segmentation. Value-based pricing becomes much simpler when you understand your market and you break it up into manageable sort of groups. You group your customers it was from that example you got the same product, it’s pretty much the same it’s just how your customer perceived that product which adds that additional price premium but just because you can add a price premium doesn’t mean you overcharge the customers. I think, very often value-based pricing is seen as an overcharging method but I think that’s incorrect.  Value-based pricing is adjusting prices to the market it’s actually creating fairer prices.

Another example I will give and I saw Joanna commented there she had a new handbag I don’t know about handbags but it appears to be an expensive one and I suppose in that context the cost of manufacturing the bag I don’t know does it even have anything to do with the price of selling. 

Well, again we’re going into psychology here why do people, why do women buy handbags? I suppose it comes down to things like prestige, which could be status, these are things called value drivers. And it’s a job of a pricer to find out what the unique value drivers are and from here set prices based on those types of qualities they’re not always tangible qualities, they’re intangible, psychological value drivers, it can be emotional value drivers and things like that they’re not just financial. 

We’ll finish up whereby we’ll say those items there’s more know on financial reasons that’s something that makes a lot of people certain in the finance profession you know a bit scared I think of value-based pricing but I’d also like to finish by saying I’m very glad that the value drivers driving expensive handbags luxury products don’t apply to me so I don’t purchase them.

Well, I think this also comes down to having a diverse team you do need different disciplines to get involved in the price-setting process so that you can ensure that you’re charging the right price for the product and using a range of different methodologies to ensure that the price is the correct one.