What Is Value Based Pricing? 💰 Episode 5
In this episode of Pricing College – we start discussing the big issues. What is value-based pricing? This is a basic introduction by Aidan and Joanna discussing the topic. Rest assured, we will revisit this topic in detail in the future.
TIME-STAMPED SHOW NOTES:
[00:40] Joanna explains that value-based pricing is becoming more accepted.
[01:00] Many companies have a reluctance to move to value-based pricing for some reason.
[01:20] So, what is value-based pricing?
[03:00] This pricing approach can sometimes seem very difficult on first impression.
[03:50] Aidan raises the concept of rebadging cars.
[04:25] It is vital to work out customer segmentation.
[04:55] We are not saying you should overcharge.
[05:20] Did Aidan just mention handbags?
We want to cover something slightly more, maybe exciting or interesting. We want to cover, what is value-based pricing?
Value-based pricing – it’s a method that people are starting to use a bit more but there’s still quite an element of confusion about what it is.
To some extent, I almost say it’s a bit of a holy grail in the pricing community. A lot of people want to move towards it, but they’re still certainly looking in the vast majority of companies. There’s a reluctance or a misunderstanding which is something that’s holding people back.
Also, value-based pricing is something that seems to be in the hands of consultants more than the business community. But we’ll get on to that maybe at a later date.
So Joanna, what is value-based pricing?
I suppose, in theory, it’s a processing method whereby you set your prices based on what your customers perceive as valuable about your products. While other people say it’s setting prices based on your customer’s willingness to pay.
You could think of it as a customer purchasing a product or service at a price that they’re happy with. It’s a price that they think is a fair reflection on the “value.” This is the value in relation to whatever they may be receiving, so they don’t feel like paying too much. They don’t care about paying too little but they’re paying too much for the value that they are receiving.
That’s the tricky part knowing where that best price, that sweet spot of pricing is for different customers. It’s because everybody knows we’re all different and we’re all willing to pay different amounts.
Now, I think this is where people and businesses get a little bit confused or reluctant to use it. It’s very difficult to know how because there are thousands and millions of people out there prepared to pay different prices. So what’s the best way to control value-based pricing in a business?
In the last episode, we touched on cost-plus pricing. We discussed one of the big pluses of it is that it makes sense to many people. And certainly, from a finance background, it’s easy to understand, use, and apply.
Yes, and I think that a value-based approach is almost the polar opposite. It sounds… I’ll be honest, it sounds hard.
In many ways, it’s not easy but it’s applying rigour and discipline to the price-setting process. You need a set of rules and you can’t just dive into it. There’s a science behind it, there’s mathematics, economics, and psychology all involved in that. Now, I think I’m making it sound even harder but I suppose you know to say if it’s easy and if it’s not.
I think for people who haven’t listened to the podcast and those who don’t know much about value-based pricing, I think we’d like to give two examples. This will make it clear to you in terms of how it works in the real world.
For example, the first one I’ll give is the concept of rebadging cars. In the auto industry, certain factories manufactured cars and they come out of the production line. Then there’s a different badge stuck on them at the end. What we see is fundamentally the exact same car, except that a badge can be sold in the same markets at different prices.
Now, we’re not trying to trick the customer. But the customer is actually putting a value on very different things. In fact, it’s not just the car itself but items such as brand prestige, perhaps financing packages, and lots of different things.
I suppose here, it’s the job of the business to work out segmentation. Value-based pricing becomes much simpler when you understand your market and you break it up into manageable sort of groups. Basically, you group your customers and it’s from that example you got the same product. It’s pretty much the same, but it’s just how your customer perceived that product which adds that additional price premium.
But just because you can add a price premium doesn’t mean you overcharge the customers. I think, very often value-based pricing is seen as an overcharging method. But I think that’s incorrect. Value-based pricing is about adjusting prices to the market. Actually, it’s more about creating fairer prices.
Another example I will give is when I saw Joanna comment when she had a new handbag. I don’t know about handbags but it appears to be an expensive one. And I suppose in that context, the cost of manufacturing the bag, does it even have anything to do with the price of selling?
Well, again we’re going into psychology here. Why do people, or why do women buy handbags? Just look at how the fashion industry is resetting value creation. I suppose it comes down to things like prestige or status. These are things called value drivers. And it’s a job of a pricer to find out what the unique value drivers are. From here, he or she sets prices based on those types of qualities.
Interestingly, they’re not always tangible qualities. In fact, they’re intangible, psychological value drivers. It can be emotional value drivers and things like that. They’re not just simply financial.
We’ll finish up whereby we’ll say those items that there’s more know on financial reasons. That’s something that makes a lot of people certain in the finance profession feel a bit scared. As I think of value-based pricing, I’d also like to finish by saying I’m very glad that the value drivers motivating expensive handbags and luxury products don’t apply to me. So, I don’t purchase them.
Well, I think this also comes down to having a diverse team. You do need different disciplines to get involved in the price-setting process. This way, you can ensure that you’re charging the right price for the product. You’re also using a range of different methodologies that ensure the price is the correct one.
LINKS MENTIONED IN TODAY’S EPISODE:
Did you miss the previous episode about cost-plus pricing?
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