What’s it: Value-based pricing is a pricing strategy in which a company considers the product’s benefits to determine its price. From a company perspective, benefits are reflected in the value added to the product. Meanwhile, for consumers, benefits mean the value they feel (satisfaction).
The company can increase the perceived value through several attributes, such as quality and features.
The selling price must be in proportion to the added value. A high-quality product should have a high selling price.
Various premium and luxury brands take this approach. Companies in the fashion, luxury car, jewelry, and cosmetics industries are examples. They will usually highlight that their product can enhance the consumer’s social image.
Why do companies adopt value-based pricing
A value-based pricing strategy is customer-focused. Companies set the selling price according to consumers’ belief in the company’s products.
Maintaining consumer loyalty is getting harder. Competition continues to be dynamic, and consumer tastes are constantly changing. The success of past strategies does not guarantee future success.
Loyalty is positively correlated with satisfaction. When consumers are satisfied, they are more likely to be loyal to the company (unless there is a better alternative). Loyalty creates repeat purchases and supports future growth.
Satisfaction is created if the benefits of the product they feel are worth the money they pay.
The difference between value-based and cost-based pricing models
A value-based pricing strategy begins with analyzing customer satisfaction. Companies seek to measure their needs and wants. Also, their expectations of the product are taken into consideration. Companies then use such information to determine prices.
It is the reverse process of cost-based pricing. Under this approach, companies are more concerned with production costs in calculating selling prices and paying less attention to customer satisfaction. Therefore, the company will analyze the costs first and then determine the price.
Cost-plus pricing is usually for commoditized products. Products on the market are uniform, so it is difficult to determine their differences. Commodity products such as petroleum, coal, palm oil are the closest examples.
When did companies adopt value-based pricing
A value-based pricing approach is usually suitable for differentiated products. The market really appreciates the uniqueness of the product. By offering a unique feature, quality of service, the company strives to satisfy customers.
Satisfaction can take on dimensions such as luxury or exclusivity. That ultimately enhances the customer’s self-image in the eyes of those around him. Products may also facilitate an incomparable living experience.
High satisfaction makes consumers willing to pay a higher price. They are also less sensitive when prices change.
Value-based pricing mechanism
The value-based pricing process is more complex. Companies must measure the variables that determine satisfaction and other market data. And that is a difficult task.
Satisfaction is a subjective concept. Even though measuring the same target market, each marketer will probably produce different results. Also, satisfaction is dynamic, depending on factors such as consumer psychology, competitive conditions in the market, and social trends.
One way is by surveying customers. Companies can solicit customer feedback and ask them to quantify their satisfaction with the product. Surveys usually also capture information such as features or prices that consumers expect. The company can then use such information to calculate the future sale price.
In general terms, a value-based pricing model involves the following consideration:
- Market segmentation. Companies must decide which segments they will serve. Not all segments are appropriate and profitable. Some consumers tend to be price-sensitive, while others are not. Because of this, companies that adopt this strategy typically target wealthy individuals, billionaires, or artists.
- A unique selling point. It is not only to differentiate itself from competitors but also to represent the added value that the company gives to the product. Companies must find additional features that can satisfy customer wants and needs. One source of information is through a criteria survey for customer purchasing decisions.
- The right communication and distribution channels. Effective communication paves the way for strong relationships and obtaining feedback from customers. Not all communication channels are suitable for the product, so companies must choose one.
Value-based pricing advantages
The value-based pricing model is ideal for maximizing profits. The company only targets customers who are willing to pay high prices. Therefore, if successful, the company gets high-profit margins.
The profit will be higher if it can produce quality goods at an efficient cost.
The next benefit of value-based pricing is that customers tend to be loyal and less price sensitive. That gives the company the flexibility to raise prices without having a significant impact on sales volume.
Value-based pricing disadvantages
Value-based pricing can be challenging to implement because it is more complex. Companies must measure the dimensions of customer satisfaction.
Apart from being subjective, satisfaction is also relative. Apart from being influenced by product features, other factors also play a role, such as the availability of the closest substitute (competitor’s product), the customer’s social environment, and psychological conditions. Such factors are beyond the company’s control.
The next, value-based pricing is high resources-consuming. Companies must invest a lot of time with customers to build strong long-term relationships.
This pricing strategy is also costly. Adding unique features is often expensive because it requires more in-depth research and development. Companies may adopt a personal marketing strategy, which is often more costly than mass marketing.
The next weakness is the low economies of scale. The company must customize the product according to the preferences of several customers. Hence, firms bear relatively high unit costs because they cannot spread fixed costs over a larger number of outputs.