Value-Based Pricing Definition
Value-based pricing is a type of pricing strategy in which the price of the product is based on perceived value delivered to the customer instead of the actual cost of the product or service and this type of pricing is most commonly used by niche industries and those that deliver customer-oriented customized products.
Price of product/service is fixed based on the estimated value of a product or the value to the customers but not exclusively from these criteria. Same cuisine food is priced differently in different restaurants. The normal restaurant will charge nominal price whereas the same dish is priced higher at a premium in a 5-star hotel. Even though the dish is same and irrelevant to the taste of the food, the customer will be ready to pay that premium amount just to avail the attached benefits like enjoying the hotel ambience.
A painting may cost a lot more than just the cost of raw materials involved, an art piece may be valued more than just the cost of the production. In other words, pricing a product as to how much the customers see the value in it. Designer apparels are priced at a premium compared to same apparel available in Amazon or Walmart by a local seller.
Types of Value-Based Pricing
There are two types each one is mentioned along with explanation below –
#1 – Good Value Pricing
In this type of pricing, the product is priced as per the quality of the product and service provided to the customers with respect to the product. The pricing depends mainly on the quality and service associated with the product
#2 – Value-Added Pricing
In this type of pricing, the product/service is priced as per the value-added in the products for the customer to make use of. From the customer’s perspective, how much ever the value of a particular feature in the product is worth is studied and accordingly the price is decided for the whole product.
- The products priced under this strategy are always customer focussed. Any improvement, changes, version and variations in the products are done only after consulting the customer and according to his/her needs.
- Companies manufacturing such products should have a niche market for such products and such products should be associated with a service which differentiates it from the rest of the players providing similar products.
- There should exist a strong communication channel in companies to collect effective feedback from the customers as the customer perception is the main driving force in deciding the price of the product/service.
- Firms willing to price product using such a strategy must spend a significant amount of time in understanding the needs of their customers. Only then satisfied customers will justify the price of the products.
How to Calculate Value-Based Pricing?
Consider a Brand ABC fashion designers who are into men’s fashion. Suppose they are launching new trousers and the pricing needs to be done as per value-based. Brand ABC being a premium fashion retailer has to price the product appropriately to target the correct audience. It will consider another premium fashion retailer brand XYZ to compare its price for a similar kind of trouser.
Suppose the brand XYZ has priced 125 USD then brand ABC being a similar brand and launching a similar product, the price should also be around 125 USD. Depending on the value addition happening in the new product to be launched, the brand ABC decides to launch the product at USD 130.
Another example of Software Company Value Tech providing an exclusive software service to client Romez using value-based pricing is explained in attached excel. The calculation to arrive at a price is also provided in the same.
The actual cost to the company is 525000 USD where the total billed amount is 600000 USD, thus there is no relation between incurred and actual price.
- The product should be focused on a particular segment and not deviate from the main and only segment. Customer perceived value is estimated in this step.
- Price of the nearest competitor’s products in the same segment is taken for reference to decide on the range of price to be fixed. Based on feedback from customers, the price range of the product is decided.
- To see the value of the product from a customer’s perspective and point out differentiated features in the product to be priced. To check how much customer values the product.
- Decide a price for this differentiated feature of the product and price the product collectively by adding competitor’s price and extra feature price.
Difference Between Value-Based and Cost-Based Pricing
- In value-based pricing, the price decided is irrelevant to the cost incurred whereas in cost based the price is decided mainly depending on the cost incurred for production and other tangible overheads.
- Value-based pricing is done using intangible parameters as perceived by the customer whereas, in cost-based pricingCost-based PricingCost-based pricing is a pricing strategy in which a certain percentage of the total cost is added to the cost of the product to determine its selling price. Simply put, it is a pricing method in which the selling price is decided by adding a profit percentage to the cost of making the product., cost incurred is tangible.
- Cost-based pricing is always less expensive whereas the value-based pricing is priced at a premium depending on the value the product is carrying.
- Value-based pricing has a bigger range of prices for products whereas cost-based pricing doesn’t have a price range depending on the product range and cost incurredCost IncurredIncurred Cost refers to an expense that a Company needs to pay in exchange for the usage of a service, product, or asset. This might include direct, indirect, production, operating, & distribution charges incurred for business operations. .
- The profit margin is higher in value-based but the number of products is less compared to cost-based which also has a lesser profit margin.
- Increased profits for the manufacturer.
- Customer loyalty is higher in these types of pricing.
- Customization of products is possible
- Better quality of product and service.
- Better understanding and rapport between customer and manufacturer.
- Products are priced very high.
- A manufacturer can target only a niche market.
- Difficult to scale up the production due to lack of market scope.
- The competitor can launch a similar product at a similar price range and the manufacturer will have to sacrifice the market share.
- Labour costsLabour CostsCost of labor is the remuneration paid in the form of wages and salaries to the employees. The allowances are sub-divided broadly into two categories- direct labor involved in the manufacturing process and indirect labor pertaining to all other processes. are also very high in this type as it involves more skilled labour to undertake production and service.
Value-based pricing is a type of pricing strategy to be used when targeting a Niche market. The product has to be customer-oriented and customizable according to the needs of the customer. No doubt the quality of the product and service associated with the product should be of high quality but the price of the product will also be very high. There will be a better understanding between customer and manufacturer. The profits for the manufacturer is also very high but it is not easy to scale up the production as the target will be niche.
This has been a guide to Value-Based Pricing and its definition. Here we discuss how does value-based pricing work along with examples, types, steps, advantages and disadvantages. You can learn more about from the following articles –