Value-based pricing

Value-based pricing (also value optimized pricing) is a pricing strategy which sets prices primarily, but not exclusively, on the value, perceived or estimated, to the customer rather than on the cost of the product or historical prices. Where it is successfully used, it will improve profitability due to the higher prices without impacting greatly on sales volumes.

The approach is most successful when products are sold based on emotions (fashion), in niche markets, in shortages (e.g. drinks at open air festival on a hot summer day) or for indispensable add-ons (e.g. printer cartridges, headsets for cell phones). Goods that are very intensely traded (e.g. oil and other commodities) or that are sold to highly sophisticated customers in large markets (e.g. automotive industry) usually are sold using cost-plus pricing.

Value-based pricing in its literal sense implies basing pricing on the product benefits perceived by the customer instead of on the exact cost of developing the product. For example, let’s consider the pricing of a painting. A painting is priced much more than the price of canvas and paints. The price in fact depends a lot on who the painter is. Painting prices also shoot up with variables like age, cultural significance, and, most importantly, how much benefit the buyer is deriving. Owning an original Dalí or Picasso painting elevates the self-esteem of the buyer and hence elevates the perceived benefits of ownership.

The value-based approach

Value-based pricing is predicated upon an understanding of customer value. In business-to-consumer markets, sellers should understand the impact their products or services have on end user utility. In the business-to-business environment, companies must know how their offering helps customers, that is other businesses, become more profitable. In many settings, gaining this understanding requires primary research. This may include evaluation of customer operations and interviews with customer personnel. Survey methods are sometimes used to determine the value a customer attributes to a product or a service. Purchase intent, win/loss analysis and financial value measurement are examples of basic research methods that can unearth customer insights during the pricing process. The results of such surveys often depict a customer's 'willingness to pay.'

The principal difficulty is that the willingness of the customer to pay a certain price differs between customers, between countries, even for the same customer in different settings (depending on his actual and present needs), so that a true value-based pricing at all times is impossible. Also, extreme focus on value-based pricing might leave customers with a feeling of being exploited which is not helpful for the companies in the long run.

Long term, by definition, prices based on value-based pricing are always higher or equal to the prices derived from cost-based pricing (if they were lower, it would mean that the actual value perceived by the customer is lower than the costs of producing the good plus a profit margin, meaning that companies would not be interested to produce and sell at that price in the long term).

Frameworks for value-based pricing include amongst others Economic Value Estimation, Relative Attribute Positioning, Van Westendorp Price Sensitivity Meter and Conjoint Analysis.

However, despite being difficult in implementation, any production and any market positioning should have a consideration of the value the product brings to the customer at the very early stages of product development and is, in fact, employed by many companies.

See also

• Value (marketing)
• Pricing strategies
• Price discrimination
• Variable pricing
• Relationship-based pricing