Value-Based Pricing: What Is It & How Does It Work?

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Every business must have a pricing strategy that allows it to maximize profits without turning away customers. When implementing a pricing strategy, it's important to consider your target audience, marketing objectives, revenue targets and other internal factors. The economic environment matters too. One option is value-based pricing.

TL;DR (Too Long; Didn't Read)

Value-based pricing is a business strategy that involves setting prices based on the perceived value of a product or service to the end customers.

What's Your Pricing Strategy?

Pricing isn't the first thing to come to mind when thinking about how to gain a competitive edge. As a small-business owner, you're probably more focused on how to deliver value, how to set your brand apart or how to keep customers engaged. Each of these aspects is important — and so is pricing. Choosing the right pricing model could give you a competitive advantage and help you expand your reach.

Several pricing strategies exist, including value-based pricing, premium pricing, high-low pricing, cost-plus pricing, competition-based pricing and more. When trying to decide on a pricing model, consider the factors that influence your business, such as customer demand, economic trends, brand positioning and marketing strategy, just to name a few.

Premium pricing, for example, is typically used for high-end products or services and involves establishing a price higher than what your competitors are charging. Economy pricing is used by companies like Target and Walmart, which appeal to the most price-conscious customers. With this strategy, it's essential to keep production and marketing expenses as low as possible.

Competition-based pricing involves setting your prices based on the average market rate. Companies that choose this option price their products slightly above or below their competition or charge the same price. Value-based pricing, on the other hand, relates to what your customers are willing to pay. Simply put, it requires setting a price based on customers' perceived value of your goods or services.

How Value-Based Pricing Works

Imagine you're at the grocery store trying to choose between two chocolate brands. One is organic and costs $6.55. The other contains all-natural ingredients and costs $5.45. How would you choose? Is the organic brand worth $1.10 more?

There is no right or wrong answer. As a customer, you'll choose the brand that brings you the most value. As a business owner, it's crucial to determine what your customers value most and how much they are willing to pay for it. That's what value pricing is all about.

This pricing model focuses on the customer rather than the costs of production or market prices. Companies that offer products or services with valuable features use this strategy to gain a competitive advantage. Prices can get as high as what people are willing to pay. When used properly, value-based pricing may result in higher profits and increased customer loyalty.

As Warren Buffet once said, pricing power is the single most important aspect to consider when evaluating a business. If you can increase prices without losing customers, you have a very good business. With value-based pricing, companies can maximize the amount that people are ready and willing to pay and deliver products that meet their expectations. This strategy is all about the value your customers get from your products or services.

What Do Customers Value Most?

People are different and place more or less value on a product or service depending on their interests. For example, Deloitte reports that one in five customers is willing to pay up to 20% more for personalized products and services. Modern technologies such as 3D printing, digital content, e-commerce and automation have the power to make personalized products more cost efficient while increasing their value to customers.

Some consumers prefer sustainable products. In 2015, more than half of buyers were willing to pay more for eco-friendly goods — that's more than double compared to 2011. A 2019 survey by Accenture found that customers value product quality and environmental impact as well as health and safety considerations. About half would pay a premium price for sustainable goods that could be recycled or reused.

Customer experience is another key factor that influences buying behavior. According to a PwC survey, buyers would pay up to 16% more for products and services with a better customer experience. If you're planning to implement value-based pricing, it's crucial to define your buyer personas and understand what your customers want.

How to Price Your Products

A higher price will only be acceptable to a small number of buyers. For this reason, you must narrow down your target market and even choose a different value-based price for each segment. If, say, you're selling beauty products, some of your customers may be willing to pay more for organic skin care products but not for organic makeup. Therefore, it's necessary to segment your audience and adjust prices accordingly.

Consider using customer surveys, polls and other research methods to determine what your target audience values most. Connect with potential customers on social media channels and ask for their opinions on whatever products or services you offer. Try to find out what features they value and would be willing to pay for, how often they expect to use your products or what other products they are currently using. Value-based pricing is unlikely to work for your business if you're selling products that are similar to your competitors' products.

Customer feedback can provide valuable insights on your audience's needs and wants. Engage with different customers, create buyer personas and set a price range for each segment. Remember that this pricing strategy should be based almost entirely on your customers' perceived value of a product or service.

Check your competitors too. See what they are offering and at what price and then list all the ways your product is better. Decide how much you want to charge for the perceived value of your advantages. Also, make sure your products meet customers' expectations because the perceived value should match the delivered value.

Value Pricing Pros and Cons

When applied correctly, value-based pricing can drive profits and sales. If you're a startup, this strategy could make it easier to penetrate the market and reach more customers. This is especially true if your products or services have sought-after features. Furthermore, you may offer different product versions to maximize the amount that buyers are willing to pay.

This pricing model also drives customer loyalty and satisfaction. It's a win-win situation for both parties: You offer what your customers want most, and they pay a price that allows you to grow your business and deliver greater value. Starbucks, for example, raised its prices by 1% across the U.S. for small-sized brews, which led to a 25% increase in its net income for the quarter.

Despite these perks, value-based pricing has its drawbacks. First of all, customers may perceive the increase in price as unfair. Second, it can be expensive and time consuming to conduct market research, determine the real value of a product and implement this strategy. Customer research is an ongoing process, so the costs can add up.

The perceived value of your product may change due to cultural, technological or economic factors. Over time, customers may start to see less value in your products as new technologies emerge or better products become available. In these circumstances, you have no other choice than to lower your prices, which can result in revenue losses.