Imagine, you own a Plumbing company, and your sales rep has a conversation with a prospective customer that goes like this:
Rep: Hi, I’m here to talk to you about our hot water tanks.
Homeowner: Yeah, we’ve been thinking about getting our hot water tank replaced. How much do you charge?
Rep: That depends. How much are you willing to pay?
In the value-based pricing approach, you charge the customer the value they perceive they would receive from the service. In this case, your Plumbing company would first need to think about what the answer would be to the price question.
What value does your company bring to the customer? This could be in the form of lower energy bills, increased control, or improved quality. Once you know what value you’re bringing to the customer, you can price your solutions accordingly.
Not sure if value-based pricing is right for you? This comprehensive guide will tell you everything you need to know about value-based pricing, including how to set value-based prices and what factors to consider.
What is Value-Based Pricing?
Harvard Business defines value-based pricing as a means to set a price that is calculated and based on the worth or value of its product for a particular market segment, especially in comparison with the company’s competitor. It’s sought to increase revenue and increase prices all without affecting the production of said product.
This pricing strategy is a good option when the perceived value of the product is high. You should use value-based pricing if your product holds a certain level of quality or worth. Another good time to use value-based pricing is when your product is scarce. If there are only a few left, the value naturally becomes greater as the demand cannot keep up with availability.
Are you considering this value-based pricing method, but not sure where to start? A strategy like this requires a unique value proposition. At Wizard of Sales®, we’ll help you put this into action. Book a demo with us today!
How To Set Your Value-Based Pricing
Value-based pricing requires some extra steps for setting a final price for your product or service. Unlike cost-based pricing, where you simply add a markup to your costs, or competitive, where you look at what others are charging and price accordingly, value-based pricing takes into account what your product or service is actually worth to the customer.
Here are three pivotal steps in setting value-based prices.
With value-based pricing being completely based on what your customers are willing to pay, you must take the time to analyze what they’re actually looking for.
What do they need? What do they want? What are they willing to pay? All of these factors play into your value-based pricing strategy, so you must understand as much about your customer base as possible.
To start, take a look at your target market and figure out who your ideal customer is. Once you know who you’re targeting, research what kind of needs and wants they have. Do they need the bare minimum, or are they looking for something more luxurious? Are they looking for convenience, or are they willing to sacrifice some time for a lower price? Once you understand what your customers are actually looking for, you can set your prices accordingly.
Contact your existing customers and ask them directly about their experience with your product or service. What did they think of the price? Was it too high, too low, or just right? What could you do to improve their experience? This feedback can be invaluable in setting your prices correctly.
As helpful as hypothetical data is in setting a price point, your existing customers have already proved they’re willing to pay a particular price. Many business owners are convinced they cannot possibly charge more. In most cases, market research will tell a different story.
To get a more objective perspective for acquiring new customers, you also need to set your value-based pricing using market research. This will give you a better idea of what the market is willing to pay for your product or service.
There are a few ways to go about conducting market research:
1. Look at what your competition is charging
This can be a helpful point of reference, but keep in mind that your competition may not have priced their product or service correctly. They could be overcharging or undercharging and this method should only be used as a general guide. If you can get a sense of how many they are selling, you will have a better understanding if they are priced too high or too low. If they are a higher price than you and selling more, it’s time to raise your prices.
2. Use online tools
There are several online tools available that can help you determine what people are willing to pay for a product or service similar to yours. Google Consumer Surveys is one option that allows you to create surveys and collect data from consumers all over the world.
3. Speak to your target market
This is perhaps the most important method of all when it comes to setting your value-based pricing. After all, if you don’t know what your target market is willing to pay, then you could be pricing yourself out of the market altogether.
The best way to speak to your target market is through focus groups or one-on-one interviews. This will give you the chance to hear directly from consumers about what they would be willing to pay for a product or service like yours and what they value within the proposed offering.
If your product has just entered the market and you don’t have the proper resources to conduct enough market research, you may feel like you’re in the dark about what to charge for your product. This is where a competitive analysis can be very helpful!
A competitive analysis will help you understand what other companies are charging for products similar to yours, and how your pricing compares. This information can give you a good starting point for setting your own prices.
To conduct a competitive analysis, start by searching for your product online and taking note of the prices you see. Then, research the companies selling these products to learn more about their business model and pricing strategy. Finally, compare your findings to decide on a price for your own product.
By conducting a competitive analysis, you can get a better understanding of the market landscape and make sure you are setting a fair price for your product.
Advantages and Disadvantages of Value-Based Pricing
Of course, just like any other business model or pricing strategy, value-based pricing has its own set of advantages and disadvantages that need to be considered before making the switch.
Getting Market Share is Considerably Easier
To attract buyers, businesses need to first get their foot in the door. With value-based pricing, this is considerably easy to do. By aligning your prices with the perceived value of your product or service, you’re more likely to convince buyers to take a chance on your business.
For instance, if you have an HVAC company with homeowners as your target market, you may want to add special perks or benefits to your club membership that’ll make it easier for homeowners to justify the price.
Markups May Be Significantly Higher
Value-based pricing allows businesses to charge whatever they feel is appropriate for their product or service. This could lead to markups that are significantly higher than the competition.
Now, this may sound like something that would deter customers, but not when you can showcase the value of your goods or services. If customers feel that they are getting their money’s worth, they may not be as price-sensitive as you think.
For example, if you offer home renovation services, you could charge a higher price than the average contractor because you either have a higher demand, offer a more personalized service, use better quality materials, or some combination of the three.
Can Raise the Perceived Value
Value-based pricing will also raise the perceived value of your goods or services. This is because value-based pricing is often associated with high-end brands. As a result, customers may be willing to pay more for your goods or services if they believe that they are getting good value for their money. This could lead to increased sales and profits, even if your costs stay the same.
If you’re a pool contractor, for instance, you might charge a premium for your services if you’re known for using only the best materials and providing the highest level of customer service.
Markups May Be Less Than Desirable
To make a profit, you’ll need to add a markup to your goods or services. This markup is often a percentage of the cost value of the good or service, which means that it may be less than what you would like to charge.
For instance, if you’re a roofing company selling shingles for $100 per square, you may only be able to mark up the shingles by 10 or 20 percent. This means that your company will only make $10 or $20 in profit for each square of shingles sold, which may not be enough to cover your overhead costs.
Perceived Value Isn’t Always Consistent
Just as beauty is in the eyes of the beholder, value is in the eyes of the customer. You could offer what you believe is an excellent value, only to have customers see it differently.
They may not place the same importance on the features or benefits that you do, and as a result, they may not be willing to pay your asking price. This can make it difficult to find the right balance between what your goods or services are worth to you and what they’re worth to your customers.
The Exact Price Is Virtually Uncertain
Value-based pricing can also be difficult because it’s hard to know exactly how much your customers are willing to pay. If you charge too little, you leave money on the table. But if you charge too much, you risk losing the sale. This can make it tough, especially for those who work in the residential home service industry, because people are notoriously price-sensitive when all things are otherwise perceived as equal.
At the end of the day, you aren’t going to be able to pin down an exact price until you’ve experimented a bit and gotten a feel for what your target market is willing to pay.
What Are The Types Of Value-Based Pricing?
Everything great comes with a price, it’s up to us to decide what price is right! Value-based pricing comes with a couple of variations, and you should know what each of them is to best decide which pricing strategy is the best one to use per product or situation.
Good-value pricing is a type of value-based pricing that takes into account what the customer perceives as being comparable. It’s not just about finding the lowest possible price, but rather offering a consistent price to the competition for a product or service. This strategy can be used when there is similar competitors in the market, or when you are confident in your solution’s superior value.
When using this strategy, it’s important to keep in mind what the customer is looking for. They want something that is fairly priced and will meet their true felt needs. If you can offer this, then you’re likely to win their business. Remember, it’s not just about finding the lowest possible price — it’s about offering a good value for your product or service.
Next is value-added pricing, which takes into account the added value that a product or service has for the customer. For example, if you’re selling custom closets, you might charge a higher price for the closets that come with additional features like built-in lighting or extra shelving.
This method helps to make sure that the features you’re adding are actually valued by your target customer. If they’re not, then you’re just charging a higher price for no reason, at least that’s what your customers will think.
Value-added pricing can be a great way to increase your profits without having to raise your prices across the board. By carefully selecting the features you add and targeting them to your ideal customer, you can charge a premium price that your customers will be happy to pay.
The key here is to find things that you can add to your value stack that have a low cost of time and money, but a disproportionately high perceived value.
When Should You Use Value-Based Pricing?
Value-based pricing is not a suitable pricing strategy for every business venture. But it can be a good way to penetrate a new market, develop a better brand presence, and even increase profitability. But because it depends on certain factors like the market or how your customers perceive the value of your product or solution, its suitability can vary.
You can also consider conducting tests to forecast how various price points affect revenue. Value-based pricing tends to be the pricing strategy when the product or service has a certain level of prestige or uniqueness to it. When the value is expected to be perceived as higher, it’s more likely this method will enable more lucrative results.
Example of Value-Based Pricing
Company A charges twice the price of Company B. The customer is aware of this price difference and still chooses to buy at Company A. How come?
Although Company A charges more, they have a well-regarded brand identity, a consistently great relationship with its customers, and strong peer-to-peer word of mouth marketing. This makes their use of value-based pricing a reliable pricing strategy for their market. We value the quality of their service and know that we’ll be getting our money’s worth — plus some. And on the off chance that something goes wrong, we know they have our back with a strong warranty.
Company B might be just as good, but the perceived value isn’t as high. They’re the new kids on the block, so we’re not sure what to expect from them. They don’t have as many reviews and their social media isn’t very active. And even though they offer a warranty, it’s not as strong as Company A’s, who talks about their customer’s experiences on the radio.
In the end, value-based pricing is all about charging what your product or service is worth to the customer. It’s not about what it costs you to make or deliver it. It’s about what the customer is willing to pay for the results they get from using it.
What Pricing Strategy is the Best Option For Your Company?
As we’ve mentioned before, value-based pricing might not be the most suitable option for your company. Or at least, not the best option for some of the products and solutions your company is selling. So, let’s figure out if value-based marketing is right for you.
Value-based pricing is best suited for brands that have something distinguishable about them. What kind of value do your customers place on your products, is it high? Is there something about your solution that you can market at a higher value? If yes, this is likely a great option for you.
If you forecast that your perceived value will have a good return profit, then test it out! Attribute different price points in your market to see what price works best. However, if the higher projected price point isn’t as you hoped, try adjusting the price. There are also other options for pricing out there that may work better.
Just as you initiate anything new for your business, do your research first. Weigh out the benefits and downsides of each pricing strategy. Try your best to forecast how your customers will perceive the value of your solution. And now that you know the factors going into value-based pricing, you’ll be able to do just that.
Conduct your market research in your total addressable market. And because your price point is ultimately determined by your customers, do your analysis on them as well. And finally, see what your competitors are pricing their products at. How is the value of your competitor’s solution being perceived in the market?
Once you’ve determined these factors, it’s time to decide what type of value-based pricing is best. Is your product distinguishable, unique, or of high quality? Or is your solution something cheaper that you could use good-value pricing for? These are all questions to be asked when deciding on the right pricing strategy to use in your business.