Is your pricing strategy accurate? Do your price points delight customers? Or, are you losing out to competition due to flawed pricing? It’s not just you; all businesses face these questions when reviewing their sales and pricing strategies.
There’s no doubt that pricing is vital, as it drives profits and performance of any organization. Strategists have long held that return-on-investment (RoI) from pricing is substantially high, and that taking the right pricing decision at the right time helps in increasing profitability. A company’s marketing program is directed to creating value for its customers – putting a lot of emphasis on the perceived value of a product over the actual product’s cost.
On an average, a 5% price increase can lead to a 22% improvement in operating profits (source: Hinterhuber, 2003). However, traditional pricing strategies (markup pricing, competitive pricing, etc.) have several gaps, in terms of potential consumer connect. Value-based pricing, on the other hand, is turning out to be a promising alternative that can help you set prices by taking into consideration the “value” customers associate with your products.
Demystifying value-based pricing
As the name suggests, value-based pricing is a strategy in which the price of a product is set at the value perceived by the consumers rather than the product’s cost. Different people assign different value to products. Although value-based pricing may also be influenced by factors such as market competition and psychographics, it predominantly sets prices by considering the value consumers associate with a product or service. Factors such as the criticality of the product, existing competition (substitutes and cheaper products, differentiating features, etc.), manufacturing complexities and the end product’s features are used to ascertain customer value. The derived customer value provides clear insight into what the customer would be willing to pay for the product. This pricing approach results in more differentiated and acceptable costs, leading to customer delight. Moreover, as value-based pricing is tailored and customized for specific market segments, it may have an edge over classical competition-based pricing or markup-based pricing.
Determining brand or product value for customers
All smart businesses are highly focused on keeping a tab on the value that their customers associate with their brands and offerings. Given that organizations now have access to a lot of data on consumer behavior, spending, purchase, etc., they can surely leverage existing advanced analytical tools to deep dive into them. This will help organizations understand consumer purchase behavior better and further align their pricing on the basis of customer perception. Some analytical tools not only derive insights but are also robust enough to predict purchase behavior and willingness to pay. Data-substantiated and intelligently developed pricing strategies targeted at the desired segment can go a long way in driving a business to newer heights.
Though not as easy as it seems, it is important to have a clear understanding of the two-way relationship between a business and its customers. It is imperative that we have a clear view of the factors that drive this relationship and the extent of its impact on pricing. There are numerous ways in which businesses can evaluate this relationship.
One of the most promising approaches is to undertake market research around preferences, followed by the use of analytical methods to understand how consumers perceive an offering. The first step of such a process is to survey a sample of customers. Correct customer representation is crucial, as the sample will act as the base for the entire research.
The next step is to design a study (may be Conjoint) that identifies the factors consumers associate with a product, and brainstorm on the impact of those factors on product perception and price. The study can focus on uncovering the consumer perception of value vs. price of a product. Trade-off analysis is performed by showing customers multiple product profiles, which include price as one of the many factors.
Once you have the data, consider the inherent segments in your market. It would be good to derive these segments based on tradeoff data (you have acquired using Conjoint); if this is not possible, you can conduct psychographic/motivational segmentation, etc. As mentioned before, to make the most of the implemented pricing framework, it is important to have segment-specific customized pricing. Every step of your assessment process, from selection of the right factors for research to setting the right price, plays a critical role.
Once you have the segments and the preference data from your market research, you can easily understand the value of your offering and come closer to the optimal price that customers associate with your product/service.
These analytical tools are not new to the market. However, an integrated mind+machine approach should be taken to derive relevant insights from the data.
Advantages of value-based pricing
The biggest advantage of this synergistic approach is the benefit it holds for a business organization as well as its customers. On one hand, a business that uses this methodology moves closer to a price acceptable to its targeted segment, and on the other, the customer receives a product at an acceptable price point. Value-based pricing is becoming a trend and may be the best way forward for businesses.
The potential challenge in accepting and implementing value-based pricing is understanding what customers actually value. The key is to ensure that the product meets the wants of customers and provides information that conveys the value of the product to customers.
Furthermore, the process of establishing value-based pricing is considered to be somewhat expensive and time consuming. But this is a trade-off that a company needs to decide with respect to creating a robust value-based-pricing for their products that eventually leads to higher revenues.
As rightly put by Harry MacDivitt, a specialist in value-based pricing, “A poor selling process means that the correct decision makers never hear the value proposition. The people who do—usually the procurement team—may well claim not to care about value, only price.”
Overall, if value-based pricing is correctly implemented, it can surely have a positive impact on sales and profitability.
Do not forget these 5 pointers:
- Research well on what the customer values the most and why
- Bring in the competition perspective
- Pick suitable attributes
- Associate clear value
- Align sales support
- Hinterhuber A and Liozu S (2012) Is it time to Rethink Your Pricing Strategy? MIT Sloan Management Review 53(4): 69-77
- Hinterhuber A, (2008) “Customer value‐based pricing strategies: why companies resist”, Journal of Business Strategy, Vol. 29 Issue: 4, pp.41-50
- Dutta, S., Zbaracki, M. J. and Bergen, M. (2003) Pricing process as a capability: a resource-based perspective. Strat. Mgmt. J., 24: 615–630. doi:10.1002/smj.323
- Harmon, R; Demirkan H; Hefley, B & Auseklis, N (2009a) “Pricing Strategies for Information Technology Services: A Value-Based Approach” 2009 42nd Hawaii International Conference on System Sciences, pp. 1-10
- Nagle, T.T. and Hogan E.J. (2006) The Strategy and Tactics of pricing. Upper Saddle River, NJ: Pearson Education, Inc.