Value Based Pricing: 🖼️ The Power of Being Value Based If You’re a Cost Plus Business
I wanted to start today by sharing a personal story about the power of value-based pricing. This is based on an experience I had as a customer, not a practitioner or expert. I think understanding what a value-based pricing strategy is should be done from the customers perspective. To give you a deeper sense of how customers experience or deal with your cost-based pricing strategy (or even the lack of a value-based pricing model).
Table of contents for this article include:
Value Based Pricing: The Power of Being Value Based If You’re a Cost Plus Business
When I was twenty-one years old…
I went to the Tate Modern in London with my dad for the first time. It was 2000 and the very first year the gallery had opened the building to the public. It was also the first time I understood the value of valued based pricing. My dad and I had talked for many weeks before our visit to all the wonderful pieces of art we would see there. We were also aware of the high price of entry for private exhibitions. But we were still prepared to go.
Because for my dad and I, art, books, and films were our primary activity in London together. Art helped us explore and challenge what we valued and why (as opposed to what we thought we valued). I had my dad right beside me explaining why he valued a certain piece of art, but I was also free to discover the value of the same piece of art inside my mind and with him as well. And I had this idea that the Tate modern was going to be the best place to test our assumptions and share our views.
I had a vision in my head of people wandering through the rooms and debating great art. Sharing their knowledge, opinions, views, and feelings…
What I found, though, was that Tate modern was more like an abattoir without the rib eye steak. The very first moment we got there I noticed the stone-cold silence. No one was talking or sharing views or ideas. We went to the counter to buy tickets for a Damien Hirst exhibition. An extremely gaunt, Avant-Garde staff member gave us our tickets with a very serious expression. He set spiel on how Damien Hirst’s ‘Cow’ was the spirit of Tate Modern.
This made me wonder, how can dead animals (including a shark, a sheep as well as the cow) hanging, preserved and suspended —and sometimes dissected in a tank full of formaldehyde – capture the value of Tate Modern. By any standard, the Hirst exhibition pales in comparison to the space in which the cow floated (the old OXO building – a landmark in London).
I turned to my dad and said if that’s all the value they can offer us, we should skip the exhibition and just walk around the building. We didn’t do that though; we paid nearly 40 dollars each to see Damien Hurst’s Cow exhibition, and zero dollars to explore the building.
As I was walking around the exhibition, looking at all the dead animals floating in harsh chemicals, I couldn’t figure out for the life of me why we were supposed to be so impressed by this? What the value of it was, or why the ticket price was so much money?
I walked around the room in silence; feeling slightly queasy along with everybody else.
I did my best. I tried very hard to appreciate the ‘Cow’ as a valuable piece of art. But, I couldn’t see it. I just walked around the exhibition in a dissociative state. Waiting for the time that we could get out of the room and walk freely around the rest of the building in peace.
I did try to share my views with my dad as we walked around the abattoir – I mean gallery. But the first time I said something to him, an arty looking person overheard and glared at me with contempt, like “What do you know about art you philistine?” And then the second time I tried, I read a sign beneath the dead Cow’s head – on its tank – explaining that the true value of Damien Hirst was his ability to capture the spirit of our age. I looked up at the cow and back at the sign. Up at the cow and then around the room. Did this dead cow capture the spirit of our age?
Not to me, it didn’t. I thought this gallery is firmly set on telling me I’m wrong, and that their view on value was the definitive view. I suspected bashing my views and destabilising my value system was their way of making more money. They had a captive audience of uninformed visitors willing to pay a lot of money for something they didn’t even like or understand. Visitors were pretty much paying to be herded around like cattle in a relatively small room filled with a dead animal; being told, at every step, how to think, feel and react to their surroundings. Maybe Damien Hirst is onto something here after all…
Explore my views
And so, I didn’t explore my views with my dad as I would have done in the past; and I have never shared these thoughts with anyone until now. I sort of suppressed my true thoughts and reactions. I think I only returned to the gallery again once after that too. The second time was the same, but this time I skipped the exhibitions and just walked around the building for free.
I felt kind of guilty about stifling my views too. At the time, I felt as if my views were not important and not valued. I was angry with the gallery for silencing me and making me self-conscious. The whole experience seemed like a framing and anchoring exercise. Positioning the gallery as a font of all knowledge and visitors as ignorant. I thought it was very clever of Saatchi to use a magnificent building with lots of rich history and cultural significance to frame worthless pieces of art and then later sell them for millions of dollars to private collectors.
Why explain Value-Based Pricing?
I tell you this story about the Tate modern. I could have told you fifty business stories very similar to it. Executives bewildered about why their customers were asking for price reductions? Or even prepared to bear the switching costs to an alternative supplier when they, in their minds, were the top incumbent. At the same time, the same executives could not explain the value of their offer to their customers. Or why their customers were so unhappy to find out that someone else was charging substantially less for the same thing.
Sounds a bit like the Tate modern story again, a business:
- Telling customers they have no right to complain when they were getting a poor service
- That doesn’t care what their customers’ value
- That thinks incumbency is a safety net for everything
- Overcharges and under-delivers with a bad attitude to boot
- That doesn’t even realise that it’s their job to be trying to give customers a great experience
The Tate modern
But like the Tate modern, it is easier to shut down any dialogue with customers and expect them to cough up the money. Even when they’ve had a terrible experience with you! I suppose, when you shut out customers, you don’t have to face feedback like “your offer is of limited value, I want my money back or a discount to compensate for what you’ve just put me through…”
And, really, it’s not just a shame when price discussions turn into a verbal bashing about how useless and no good your business is. It actually a real loss. A loss for you, your team, your peers, your customers, and business. When it comes time to re-evaluating pricing, we need leaders and innovators challenging the status quo and proactively trying to understand customer viewpoints, pain- points and problems (even if it is a bit difficult to stomach sometimes).
Asking more questions
We need managers not just offering discounts at the first sign of trouble. We need more people asking questions to uncover how we can help customers: achieve their financial goals, make their lives easier and fix their problems.
This includes listening to staff and customer feedback and doing something about it. Not believing incumbency is enough – because it’s not. And it is building world-class teams with the right mix of skills, styles, and capabilities. They drive a value-based pricing strategy in a tough market and business culture of staunch cost plus values and beliefs.
To overcome the emotional bias for the status quo in your business, you need to understand what value-based pricing is. So, what’s the difference between cost-based pricing and value-based pricing? Cost-based pricing strategies and methods try to control customers and the market by simply denying that they exist.
Businesses that use cost-based pricing vs. value-based pricing tend to do overly complex cost allocation analysis. There’s an overly simplistic mark up to finish off to set unrealistic margin targets. They also seem to believe that it’s okay to have their sales teams bashed daily by procurement. They sit through the painful process of procurement, unpicking their finance or marketing team’s irrational cost plus logic line item by line item, with absolutely no defence or position.
So, what is a value-based pricing definition, then? Value-based pricing b2b is more than light and airy marketing surveys or jargon. It’s a way to empower your sales teams and your customers to have a meaningful and relevant discussion about the value of the commercial exchange (not just the invoice price).
The advantages of a value-based pricing b2b strategy
This is a strategy, approach, and tool kit all in one. Thus, helping salespeople defend themselves against a procurement team only interested in lowering their costs.
Value-based pricing b2b is a way sales teams can get the full price by helping explain to customers the economic value of the offer in simple terms.
Consumer value-based pricing is also critical and applicable to B2C businesses under margin pressure too. Why? Because consumers are human’s and human’s don’t understand the absolute value. Value needs to be explained in relative terms for us to understand it. Not shoved down throats using a cookie-cutter approach.
I find that B2C businesses that haven’t done a good job understanding what consumers value offer blanket promos and excessive discounts, hoping this will drive volume. Often it doesn’t. Because consumers don’t appreciate discounts on things, they weren’t going to buy anyway.
It’s your responsibility, as a leader, to help your teams educate your customers on the value they are receiving. This means clearly showing customers the trade-offs they’ll have to make if all they want is a rock bottom price – this is true for consumer value pricing and value-based pricing b2b.
Help your sales teams and customers understand the opportunity costs and risks of not using your products and services. Value-based pricing focuses on the gains they would get using your product versus the competitors.
Often, even saying this, puts executives off. Or, leads them to water down value-based pricing with their hunches, rules of thumb and assumptions about customers. Value-based pricing is an equal mix of customer psychology, economics, strategy, data analysis, promos and incentives, and mathematical modelling. Many choose to leave out the parts with which they don’t feel comfortable or competent (often the customers part). Doing this, however, will lead you straight back to the beginning. Unexplained value, angry customers, volume loss, revenue loss, tired and stressed out sales teams, segmentation models that don’t make sense or limited yield insights about customers – need I go on?
To sum it up then, I think what I’m saying is we need more of a balance in business. We need people in the business to count and protect our money for sure. But, we also need people in the business that can make money and find new growth opportunities. Yes, I know you have sales and finance teams already, but sales teams are busy selling and finance teams are P & L experts with a limited view on the market.
Your teams need help to drive profitable revenue growth. They need the support of a world-class pricing team to help them. A team dedicated to helping them make more profitable sales and deals. And you need a world-class pricing team on board. They help optimise prices across your products and customer segments. They drive consistent and safe EBIT gains in highly competitive and disrupted markets.
If you really want to improve your pricing in the best way possible, then, you need a diversity of thinking and people who know what they are doing when it comes to value discover and strategic price-setting and strategy.
Improving pricing is a process, not an event. Not everyone who puts their hand up to do pricing can do it, often they are the worst option.
You now need to be careful now how you hire and select people to do this and how you resource your organisation to get your business through some tough times ahead.
Value Pricing: Articulating Value, not Price and Why It Is Vital
“At the end of the day, it comes down to price”. I heard this today from a marketing manager (not a pricing professional) in an electrical supplies company.
I told him to pack his bags (jokingly) as he had just admitted his job was nonsensical. If it was just price all our adverts would be big billboards at $19.99 etc. written on them.
Value pricing – what is the service worth to the customer?
It is all about price – but only when the product and service on offer are exactly equivalent i.e. when a perfect commodity exists at a precise equal quantity and in a precise place and state. In that non- existent instance – the lowest price option would win the deal. Of course, even this super, simplified example ignores instances such as seller reputation, counter-party risk, payment terms, account management, service guarantees, money back offers etc.
Articulating the value (value pricing) begins by understanding this and actually explaining it to people both inside (sometimes more difficult) and outside your company.
We’ll try to compare value pricing comes to low-cost pricing strategy. How these different approaches can affect product pricing.
Low-Cost Pricing Strategy: Why Free Services Can Be A Bad Idea
Have you ever tried to teach or mentor someone and found them to be disinterested and not engaged in the process? This can be a very frustrating process for the teacher or mentor as their work becomes fruitless. It can also negatively impact on remuneration – for example, if your remuneration is performance-related – bonuses etc may be payable if your client is successful or passes some hurdle. Also – having a record of achieving positive success with clients is very important for futures sales. This can be the case in businesses from personal trainers to career coaches or of course; pricing consultants.
The US based marketing expert Joe Polish has a saying ” if you do not pay, you do not pay attention” meaning that if there is no monetary exchange for value or information transferred, then people tend to undervalue it. I ask you to think back to when clients did not pay attention – were they paying you a sum that would be regarded as considerable or not pocket change?
Differences between Value and Low-cost pricing
Low-cost pricing can be established by larger competitors, with lower operating costs, to out-compete a small or new business on price alone. More established competitors could force you to take further price reductions that reduce your profits in trying to compete with your larger competitor’s low ball pricing to force you out of the market. Your pricing strategy can ultimately determine your business fate in a small business. By managing your pricing strategy, small business owners can extend business longevity and produce healthy profits.
But with value-based pricing; a company considers the value of its product or service, as against to the cost the company made to create and produce it. To do this, the company determines how much money or value its product or service will generate for the customer. This value could originate from factors such as increased efficiency, happiness or stability.
Potential implications of a low-cost pricing strategy for consultants
This insight carries a number of important insights for anyone involved in consultancy or any pricing environment as regards low-cost pricing strategy decisions:
- Charging too low a price can attract too many customers: evidence shows that even charging a nominal fee greatly reduces people using free services. i.e. they put very little financial value on the service. Are unwilling to pay even a nominal fee.
Note: in this context, arranging payment can be difficult and put people off also – hence Amazon invented the one-click shopping approach as a way to increase sales.
- Charging too low make people undervalue your product or service: This argument used in favour of some form of vouchers to give people “free” schooling. Thus, they believe (particularly in the USA) is that putting a monetary value on the schooling children and families receive will greatly increase their focus and attention. Interesting, there is a counter-argument to this one as in US University courses, despite huge fees, only 18% of students graduate within 4 years.
- You may attract the wrong kind of customer: as a consultant or advisor – if you provide advice for a low cost, you may attract customers who do not “invest” enough financially, to also invest mentally – i.e. you can bring a horse to water but you can not make it drink. As we have covered in our blogs on psychological pricing and luxury pricing strategy – sometimes a high relative price tag can make people place more value on the service being offered.
Comparing the value pricing and low-cost pricing strategy, both created to attract the costumers in buying their products.
The disadvantage of low-cost pricing undervalues your products; whereas value pricing focused on how much the customer believes a product is worth which companies base their pricing on.
The low-cost strategy can attract the wrong kind of customers who wants free service or product whereas in the value pricing the customer will pay the product/service he believes its worth.
In running a business – there is a huge difference between cheap and free. Hence, very few companies have built profitable or sustainable businesses with a solid financial performance by always offering free services.
The low-cost pricing strategy is no longer viable and current with today’s market. More retailers should instead switch to value pricing.
More retailers are preferring the value pricing strategy as it accurately determines what the customers view the product’s worth.
A Quick Guide to Value-Based Pricing
Here’s a quick guide to value-based pricing for teams embarking on a price rise, improvement or transformation project. Customer value-based pricing is considered to be the best pricing strategy for both B2B and B2C businesses, at least from a pricer’s point of view. Why?
The fact is, most businesses approach value-based pricing in a way which is not entirely right; and this, in many ways is a great opportunity for learning and development. And, in our view, the problem still comes down to a vague value-based pricing definition and surface-level understanding.
So, in this article, we will provide you with a quick guide to value-based pricing, including an overview of the problem, some insights, tips and a reading list on value-based pricing.
We strongly believe profitable pricing decisions are based on learning good habits but also unlearning bad habits too. So, let’s start now.
Why is it still so misunderstood? Here’s a quick guide to value-based pricing
We are now in 2020, and value-based pricing definition should by now be a well worn and understood concept to implement, but it is not. There are still a fair few staunch disbelievers out there dismissing value-based logic because they believe pricing should be cost-based rather than value-based.
These ardent supporters of cost-plus are in both B2B and B2C markets and large and small businesses. What’s more, they strongly believe that using simplistic multipliers on aggregate costs is a more tangible and reliable way to set prices than understanding how customers perceive and value their products.
As a result of these latent assumptions and blindspots, cost-plus is still the dominant method of setting and positioning customer prices for new products and price reviews. Which in turn indicates that most organisational strategies and approaches are the opposite of a value-based pricing definition.
And to be honest, I don’t blame them. Pricing is both an art and a science, and it can take a lot of time to master. Again, this is why you need an expert pricing team to help you – or at the very list a quick guide to value-based pricing and reading list.
So here it is.
Did you know that there are entire books that just talk about pricing? Books like:
1.Negotiating with Backbone: Eight Sales Strategies to Defend Your Price and Value by Reed K. Holden
2. Confessions of the Pricing Man: How Price Affects Everything by Hermann Simon.
3. The Ultimate Guide To Retail Pricing
4. How to Develop a Powerful Pricing Strategy for Your Business by Peter Hill.
5. Pricing: The Third Business Skill: Principles of Price Management by Ernst-Jan Bouter.
6. The Psychology of Price: How to Use Price to Increase Demand, Profit and Customer Satisfaction by Leigh Caldwell.
7. Brilliant Selling: What the Best Salespeople Know, Do and Say by Tom Bird and Jeremy Cassell.
8. Pricing Strategy: How to Price a Product by Bill McFarlane.
Reading the books (listed above) and this quick guide to value-based pricing will dispel some of the myths surrounding customer value-based pricing. What’s more, learning to understand customer value-based pricing with fresh, untinted lens will help to dispel the myths of it being a dark art.
Let’s get to a quick guide to value-based pricing basics
Value-based pricing is about figuring out how your customers value your product portfolio – every single product and every single customer group and eventually a customer.
Do your customers understand the benefits of value-based pricing on your products and services?
How would potential customers value your portfolio if only they knew about you?
How much do you think they’d be willing to pay for the stuff you sell them if you knew what and how much they valued them?
Difficult questions I know, but the essence of value-based pricing.
So how do you go about determining a customer’s willingness to pay for your products when you don’t know how they value and perceive your business or portfolio? Simple answer: You can’t. You’ve got to find out and do the research, ask the right questions and bring your assumptions and insights into a pricing framework which elicits an essential criteria and list of customers value drivers. And from here start to rank, sort and prioritise these unique value drivers on an ongoing basis and put economic values behind each.
These criteria may include:
1.Your ability to supply what customers want.
2. Network/convenience / i.e., not going too far to get it.
3. How they came about value-based pricing b2b in the first place.
4. What pressing problem is making them look for your products.
5. How easy it is to buy from you.
6. How well they understand their needs and relate the solution to your offer.
And finally, you also need to be realistic about how competent your teams are at pricing in this way. It takes a complete mindset change to do value-based pricing properly. Not everyone can do value-based pricing – the people that can are probably terrible at cost-plus pricing.
Value-based pricing requires people with a range of skills, capabilities and experiences – from maths, science, statistics, psychology, marketing and financial. They need to be logical but think laterally because essentially they are maximising margin and revenue by charging optimal prices for each customer based on the exact amount they are willing to pay.
No, it’s not simple by this is why businesses are now hiring expert pricing teams to do the heavy lifting.
Discussion on a quick guide to value-based pricing
Pricing is a vast and fast-evolving discipline. Cost-plus pricing is now a somewhat antiquated and risky approach to driving profitability. There are experts in this domain who have over 20 years of dedicated experience in the topic and are still learning new things every day.
Value-based pricing is a discipline in its own right now. Value is relative and deeply intertwined with the market. An expert pricing team knows this and is constantly learning and tracking the market to inform their pricing decisions and playbook. A set and forget attitude to pricing is risky and antiquated.
The market is always changing, and it is a perennial truth that customers will not always want or like the same stuff. But what is a constant is customer pursuit of benefits of value-based pricing when they buy. This does not mean value for money, which is occasionally the reason we buy; but rather, buying something that solves a problem or meets a real need (financial, emotional, physical or psychological) – this is value, and this is what customers are willing to pay for.
Knowing this then, your approach to pricing, value and learning should be adaptive and human too. Rest on your laurels with financial terms and cost-plus pricing knowledge based on what you learned 20 years ago, and face volume and revenue loss and eventually a profit downgrade.
- If you are not sure how to price properly, hire an expert pricing team that knows what they are doing.
- By prioritising the opinions of your customers, you are focusing on the people who will be making the buying decisions rather than just your own internal business needs and metrics.
- It takes time to find the right pricing strategy. You have to be dedicated to discovering your customers’ preferences before you set your prices.
- Pricing is a business-critical marketing decision. It shows what the product is worth, what the business is worth, and especially what the customer is worth.
- By finding out how much they are willing to pay for your product. What features they want to see you develop; you will be able to not only give customers what they want. But you’ll also be able to attract and retain these customers as well.
- People are different and value things differently. For your business, the important thing is to ask your customers what they would have bought; if not your product or service. Their answers tell you who your toughest competitors are.
Value-Based Pricing Steps: Separating Facts from Myths
With value-based pricing steps, we will dispel some the myths surrounding on value-based pricing. In an earlier article, we gave you a Quick Guide to Value-Based Pricing. Here are the top 5 myths about value-based pricing marketing. Followed by some tips and advice on what you can do to improve your approach to pricing.
» Myth 1: the price that creates the most sales is correct
Well, that’s not quite right. You have to think about the 3, 6, 9-month impact of each pricing decision you make. You’ve also got to think about how discounts, promotions and price rises impact your price and brand positioning in the market.
The problem with only using a volume pricing strategy and cost-plus logic to set prices is that it drives your prices down, and keeps them low as consumers get used to taking discounts from you and seeing low prices in front of your products.
Pure volume plays are a risky price action in any market because there’s no guarantee that customers will buy more simply because it’s cheap. And what if your costs change? Answer: You’ll probably end up either overcharging customers or underselling yourself. A nightmare for customer price perception and your bottom-line profitability.
Best Strategy on value-based pricing steps
So, what is the best strategy to create maximise margin and revenue in a safe and sustainable way? The correct price will always be the price which is good for you and good for the customer as well. The profit dollars you earn as a result of value-based pricing will keep investing back in the growth of your business.
» Myth 2: pricing is a financial decision
Again, you’ve got to look at the bigger picture as value and pricing is more than just a financial modelling exercise.
When you’re calculating the best invoice prices for your items, you don’t want to hike up your prices too much because your spreadsheet says you’ll make more money doing this. No, listening to uncommercial financial models alone will drive your customers to the competitors and leave a sour taste in their mouths about you…But you still have to make money and shouldn’t be shy of this – often making money is the perfect excuse to back out of anything scary in life. But pricing decisions shouldn’t be scary or risky.
For example, if you want to sell high, sell high but know you can do this based on data and evidence. If you want to increase your prices later, do so by enlightening your customers on the value they once valued and have received without delay or fault. There is no shame reminding your customers that you deserve to get paid for great products and services that they really value. Value is a two-way street.
A Marketing Decision
Pricing is, in fact, a marketing decision, the price you put on something, whether deliberate or not, sends a message to your customers about what the product is worth, what the business is worth, and especially what the customer is worth. The point of pricing is about capturing value and making stable profit margins, not just short-term spike in sales or revenue.
Research your market for value-based pricing steps
» Myth 3: it’s okay to give random discounts if it gets more customers
This is the kind of practice that can ruin a business.
Sometimes a prospective client would come in and say, “Hey, I really want to buy from you, but your prices are too high so I will have to go to X your competitor unless you give me a substantial discount?”
To please the customer or get the sales over the line, many sales teams give in and offer large discounts. Then they say to themselves, “what’s the big deal? We got a new client and the client got a discount. Isn’t that win-win?”
Big mistake. These are the kind of customers that arm wrestles you for a lower price and don’t make for good long-term clients. Interestingly, they are the people who complain most loudly about minor issues, and they try to suck up most of your time by looking for special treatment.
And worst of all, they tell the entire community that you’re a pushover and you don’t really know what your business is worth. Encouraging everyone else to get a discount
Part of the pricing decisions in value-based pricing steps
» Myth 4. Price erosion is an outside force that you can’t control. Wrong!
Price erosion only occurs when you are forced to lower your price—and thereby, the perceived value of your product—to compete with unauthorised sellers violating theirs and your pricing policy to gain market share quickly.
Price erosion is essentially the consistent loss of product pricing due to you and your competitors making a number of risky price actions over time. Playing the market like life is a zero-sum game doesn’t really work either. In fact, it’s repeat purchase from valuable customers that really maximises margin.
Penetrating the market with low ball prices is a short term revenue play – and not sticky at all. Customers tend to move on to the next cheap offer. You become yesterday’s news and find yourself viewed as a commodity.
Tips on How To Control Price in value-based pricing steps
It is you who controls your prices, and when you set them too low, or don’t build enough value to justify them. Thus, you have nobody to blame but yourself.
Dominate your market. Offer the best products or services, compare cost vs value-based pricing; excel on client expectations, and build a customer base which loves to be a part of your ecosystem.
The goal here is not to make the market think your prices are “fair ”. But to make the market feel awkward for not paying you more since you’re already giving them such incredible value.
The only way to get the right prices for your offers is to understand what problems you are good at solving. Hence, becoming the go-to expert in your community for that.
- The correct price will always be one which is good for your business and good for the customer. Do not let speculations dictate your price.
- Giving random discounts will give the impression that you don’t know your market value and consumers. They will always expect a discount.
- Pricing is all about capturing value: It shows what the product is worth; what the business is worth; and especially what the client is worth.
- Remind your customers that you deserve to get paid for products and services that they really value. Hence, value is a two-way street.
- Listening to abstract and often uncommercial financial models alone will drive your customers to the competitors. And, therefore, leave bad feedback about you
- Adhering to the myth that pricing is out of your control is essentially a load of crock. You control what your price should be with the help of the pricing team
- The advantages of value-based pricing will increase the profits and revenue of your business. In effect, following these myths will not bring you revenues.
- The goal to value-based pricing steps is not to make the market think your prices are “fair ”. But to make the market feel awkward for not paying you more.
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