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Value-Based Pricing Definition
Value-based pricing refers to a method of setting prices of products or services based on the value the consumer attaches to said product or service rather than on the cost of production. This method is successful where a consumer needs certain products based on fashion or luxury. In most markets, the pricing is based on the cost of production, commonly known as cost-plus pricing.
This mode of pricing is mainly appropriate to a more sophisticated market. There are consumers who value a product based on emotions. Some products automatically fetch more value like fashions, products that are competitive in the market like cell phones or items that are in shortage in the market.
Cost-plus pricing as an approach takes into consideration all the cost involved in manufacturing an item, and then add another amount on top to allow the business to make a profit. For example, a manufacturer who uses approximately forty dollars to produce an item may need to sell the same item at sixty dollars. The producer may not make any profit if the product is sold below the production cost. In this approach the consumer’s willingness to pay for the product based on its value is limited.
In contrast, cost-plus pricing method largely emphasizes on recovering the cost while value-based pricing emphasizes maximizing profits by setting high prices while maintaining the client relationship.
A Little More on What is Value-Based Pricing
The value pricing approach is most successful where owning a certain item may increase the self- esteem of a consumer or the consumer may have an exciting experience. Value pricing method primarily is based on the value of an item as perceived by the consumer, however, there are other factors that may be considered during pricing such as labor and other cost incurred during the manufacturing of the said item.
Measuring the value of an item and coming up with a price is a challenging task but attainable. The company needs to know its objectives in the market and also identify its advantages and capabilities that are unique and those that stand out among competitors in the same field. This helps the company to conquer the market thus sustaining the segmented customers the company is targeting. A company whose objectives are not aligned are at risk of conflicts between objectives and profitability.
Perceived value in Pricing
When we talk about the perceived value of an item, it simply means the value of an item a consumer has in his/her mind. This is what affects the price a consumer is willing to pay. In this case, the value becomes the most important aspect and a driving force in every business as it affects the price and willingness to pay.
Markets dealing with luxurious items like vehicles mostly use the value-based pricing approach. Manufacturers gather feedback from the clients on experience and features, use this information to come up with a more innovative brand which increases the value and benefit as perceived by the customer.
There must be some benefits and values attached to the item for the customer to pay for a higher price willingly. For example, two companies could be selling the same type of an item, one on cost-plus pricing while the other on value-based pricing technique. The company selling on value-based pricing should come up with a more innovative way and exciting way of using that item which the other competitor doesn’t offer.
A product with unique benefit gets an advantage over competitor products, and therefore can be sold on value-based pricing. This is because prices are controlled by the value of the benefits the business offers to its customer. At the same time, the price that the competitors charge should also be considered. In order to maximize the profitability of the products and services, the business needs to quantify the benefits the products offer to their customers and also review customers buying decision principles and maximize on that.
Prices set on value-based pricing are always higher or equal to the prices set from cost-plus pricing. If by any case the prices are lower, the customer perceives the value of that product lower than the cost incurred plus the profit margin. A company setting prices based on value pricing attracts a certain segment of customers. The company may lose some potential customers who are motivated by prices and may also attract new customers from their competitors who are motivated by the value the product offers.
Advantages of a value-based pricing
- If done successfully, it can generate huge profit
- Help you develop high-quality products
- Helps to retain the customer base and acquire new potential clients
- Helps the company to develop good customer service
- Improves innovation and rapid business growth
Examples of value-based pricing
One of the business sectors where value-based pricing is commonly used is in the fashion industry. There are popular brand names and designers that fetch high prices; this is typically based on the consumers’ views on how that brand affects their self-images.
In a case where a brand or designer can manage to persuade a high-end celebrity to use his products, especially on a red carpet occasion, the consumers’ perception of that particular product suddenly increases. Generally, a brand image may weaken for a reason, in such cases; the pricing approach should be based on cost-based technique.
Another industry dealing with value-based pricing is pharmaceutical. In this industry, the customers and the company agree on the pricing based on the value (actual performance) achieved rather than the volume. In this case, value is achieved from the highest possible health benefits for the patient, against the total health cost.
However, not all items in this category use value-based pricing. For instance, generic drugs may benefit from a cost-plus approach while medication from a renowned brand uses a value-based approach.
In automotive industries, value-based pricing strategy is also embraced. This encourages innovation and upgrading of features in the automotive industry. This is only applicable to luxurious cars. For non-luxury cars, cost-plus pricing is appropriate.
Other industries employing value-based pricing are cosmetics and personal care industries.
References for Value Based Pricing
Academic Research on Value Based Pricing
Towards value–based pricing—An integrative framework for decision making, Hinterhuber, A. (2004). Industrial Marketing Management, 33(8), 765-778.
Customer value–based pricing strategies: why companies resist, Hinterhuber, A. (2008). Journal of business strategy, 29(4), 41-50.
Supply chain cost management and value–based pricing, Christopher, M., & Gattorna, J. (2005). Industrial marketing management, 34(2), 115-121.
Operationalizing value–based pricing of medicines, Sussex, J., Towse, A., & Devlin, N. (2013). Pharmacoeconomics, 31(1), 1-10.
Retail value–based pricing strategies: New times, new technologies, new consumers, Grewal, D., Roggeveen, A. L., Compeau, L. D., & Levy, M. (2012). Journal of Retailing, 88(1), 1-6.
The conceptualization of value–based pricing in industrial firms, Liozu, S. M., Hinterhuber, A., Boland, R., & Perelli, S. (2012). Journal of Revenue and Pricing Management, 11(1), 12-34.
Value delivery and value–based pricing in industrial markets, Hinterhuber, A. (2008). In Creating and managing superior customer value (pp. 381-448). Emerald Group Publishing Limited.
Pricing strategies for information technology services: A value-based approach, Harmon, R., Demirkan, H., Hefley, B., & Auseklis, N. (2009, January). In 2009 42nd Hawaii International Conference on System Sciences (pp. 1-10). IEEE.
Mindful Pricing: Transforming Organizations Through Value Based Pricing, Liozu, S., Boland, D., Hinterbuber, A., & Perelli, S. (2015). In Marketing Dynamism & Sustainability: Things Change, Things Stay the Same… (pp. 412-421). Springer, Cham.
Value–based pricing, Hughes, D. A. (2011).
Organizational and institutional barriers to value–based pricing in industrial relationships, Töytäri, P., Rajala, R., & Alejandro, T. B. (2015). Industrial Marketing Management, 47, 53-64.