The ABC of value based pricing

Value based pricing

Last week Casper Mønsted from Incentive gave a really interesting talk on pricing and offered 1:1 coaching on pricing issues for the participants in Danish Tech Challenge.

  

Here’s what I took with me from his talk:

You need to consider four aspects when pricing your product or service.

1.     The pricing strategy (which is the overall price model)

2.     Optimizing the price (basing the price on experienced value, price differentiation, price regulation and estimating the experienced value for customers)

3.     The pricing processes (control and monitoring, definition of roles and responsibilities)

4.     Realizing the price (mapping and optimization of discounts and discount policies)

There are three basic ways of determining your pricing:

	Cost based	Competition based	Value based
Pros	Easy to calculate Avoids loss on products	Easy to estimate Secures competitive prices	Maximizes profit
Cons	Doesn’t leverage knowledge about the customer Doesn’t leverage knowledge about competitors Doesn’t maximize profit	Doesn’t leverage knowledge about the customer Doesn’t maximize profit	Can be complex

According to Casper Mønsted value based pricing should always be preferred. Otherwise you risk cheating yourself. The value you provide might be much greater than the price you take and the cost of production.

To base your price on value you have to understand the value you are creating for your customers. And your customers might be diverse and experience different value from your product, which is why you should consider differentiating your pricing.

Compared to cost based pricing where the price is calculated on the basis of the cost of production value based pricing is calculated from the perspective of the experienced value of the customer.

Price differentiation: Can you put a price on water?

A simple example is the price of water which varies dramatically when comparing tab water, water bought at a super market (AquAdor) as opposed to 7-eleven (Kildevæld) or a five star restaurant (bling H2O).

Another illustrative example of price differentiation is Microsofts office package which are sold in three different packagings with different prices (home&student, home&office, professional) but with the same costs of production. The experienced value is different because many companies can’t do without the office package but private persons can.

A small feature change can mean a significant value leap that some customers are willing to pay for. A good example for this is the Weber charcoal grill which can be bought in two versions the budget model without ash tray and premium model with ash tray. This is a small difference in cost of production, which creates a value difference that makes tangible price differentiation possible ($100 vs. $150).

The ABC of value based pricing

1.     Identify the advantages of your product from the customers perspective.

2.     Estimate the value of the advantages.

3.     Set the price so that the value of the advanteges exceeds the price.

4.     Repeat 1-3 for different customer segments.

What you need to do to master value based pricing:

·         Map out what your customers are willing to pay

·         Ask your customers in surveys

·         Know the value drivers of your product and map the value creation

Are the value drivers of your product delivery time, quick service after purchase, warranty, service and support prior to purchase, high reliability, low noise level, product aesthetics (visual design), the possibility to buy add-on service, low energy consumption size and dimensions?

·         Calculate the cost reductions your product makes possible

·         Analyze sales data

·         Ask distributors or industry experts

As yourself the following questions:

·         What’s my product? (remember service), know the value drivers, remember the entire package (incl. service)

·         Who are my competitors? How’s your product different from theirs, how do they price their products? How will they respond to your pricing?

·         Who are my customers? Does your product deliver different value to different customer segments? Can this be used for price differentiation?

·         Will my price be experienced as fair? Can you explain your pricing? Which reference price do your customers have?

Price differentiation 

	Premium	Standard	Budget
Characteristics	All inclusive Few people buy this, but the package exists as an anchor and benchmark for the price you actually want people to pay.	The typical package The package you want people to buy Has to have the most important features	Low fidelity There are good reasons to choose the standard model
Price ratio	15	5	3

When differentiating price always create the reference for comparison yourself, otherwise your customers will find one themselves, and that one you can’t control. And make sure that the price your customers see first is the premium price, so that becomes the anchor and benchmark for your lower prices.

Pricing is important for any business. Give it the consideration it deserves and price it smart!