Imagine a sales conversation unfolding as follows:
Salesperson: "So, you’re interested?"
Potential Buyer: "Yeah, I might buy this. How much will it cost me?"
Salesperson: "That depends — how much are you willing to pay for it?"
With prices readily available online and in-store, it’s likely transactions are moving this way. However, companies employing the value-based pricing model need to think about what the answer to that final question would be, if they want to employ the strategy successfully.
In this post, we’ll explain the value-based pricing model, outline its pros and cons, and highlight a few ways to incorporate this pricing strategy in your business wisely.
Discover how much revenue you’ll get by employing a value-based pricing model in your business with our sales pricing strategy calculator, and compare revenue to nine other pricing models like cost-plus, competition-based, and prestige pricing.
What is Value-Based Pricing?
Value-based pricing is a pricing strategy used by businesses to charge products and services at a rate that they believe consumers will be willing to pay. As opposed to calculating production costs and applying a standard markup, businesses instead gauge the perceived value to the customer and charge accordingly.
Value-based pricing is commonly used in a few different scenarios:
Recognizing inelastic demand, where the need for the product is so high that a lower price would have little-to-no impact on unit sales.
Highly competitive and price-sensitive markets, since the level of competition usually settles at the price where consumers are willing to pay, and charging more could turn away interested buyers looking for a good deal.
Promoting prestige, where markups will be higher-than-usual to denote the exclusivity and grandeur of the product.
Selling companions and add-ons to other products that enhance their functionality, like a new charger for your cell phone or laptop if your old one breaks.
Value-based pricing requires a few extra steps to set a final selling price. While some pricing strategies, like cost-plus, are relatively straightforward, there are considerations to take into account when arriving at your ultimate price tag.
1. Analyze your customers
Because your price point will be exclusively based on what your customers are willing to pay, you’ll need to confidently know what that price point is.
One step towards reaching this number is to contact existing customers familiar with your products and/or services to learn what they would spend on your product now that they see its value. Remember — this pricing approach should be based almost entirely on the perceived value of your customers.
Use these to reach out to customers to gauge the price they would value your product at.
2. Analyze your total addressable market
While customer data is crucial to setting a price point, it’s a biased sample, because existing customers have proven they’re already willing to purchase your product.
To reach an accurate price point for acquiring new customers, conduct market research in your total addressable market to understand how everyone you’re attempting to sell to values your product, and what they would be willing to pay for it.
Use this kit to better understand your competition and market positioning to uncover your ideal selling price.
3. Conduct a competitive analysis
If your product is new to the market and you don’t have the resources for professional market research, look to your competition to see what they charge and how similar your product is to what they’re selling.
Setting your product a similar price point to competition is a good gauge of how much your target market values the product. If sales are lower than projected, perhaps your competitors have stronger brand loyalty associated with their products, which may force you to adopt a competition-based pricing model.
Use this guide to uncover crucial learnings from your competitors without breaking the budget.
The Pros of Value-Based Pricing
1. It could be easy to penetrate the market
If your target market is not brand loyal, or if you’re relatively unchallenged in your market, you’ll have an easier time acquiring market share compared to a diluted or brand-loyal market.
This is especially true if your product or service is differentiated in a notable way. For example, luxury items tend to see strong sales when they come across as "new" or "limited" and are priced at a value-based amount.
2. Higher markups are possible
The value-based pricing model works in the seller’s favor when an item is seen as prestigious or culturally important. For these situations, the buyers don’t care how much it cost you to produce a product — only how much value they see in it.
Consider art, high fashion, or luxury cars; the markups on these items are incredibly high because there is added value to owning something in this category. Consumers will pay more for the privilege of a famous painter’s work or a rare sports car because of the intangible benefits that come with the product itself.
In other words, given enough perceived value, your markups can be massive.
3. You perceived value can increase
While value is ultimately a concept that lies in your customers’ eyes, you can work to shift your perceived value in a more profitable direction. Running branding and advertising campaigns that position your product as prestigious or elite can justify a higher price point in the eyes of your customers.
If adding intangible benefit doesn’t work, you can also highlight more of the actual value created by the product. For example, a hammer is just metal and wood, yet, without it, carpenters and handymen would have a tough time doing their jobs, making the value created by this simple tool immeasurable.
The Cons of Value-Based Pricing
1. Your markups may not be high
Businesses selling commodities will face a tough time implementing a high markup with a value-based pricing model. This is because industries like these tend to have an abundance of options for the buyer. Unless there’s something special about your product compared to others, it’s tough to justify added value in the eyes of the customer.
This means markups can be lower than needed to scale and grow your business to the desired level — so it’s best not to rely on value-based pricing in these situations.
2. It’s not always stable
For better or worse, perceived value changes due to cultural, economic, and technological factors that are often out of your control.
Relying on value-based pricing to boost your contribution margins might backfire if the market becomes accustomed to your product and starts to see less value in it, or if a competitor comes in with a better offering with higher perceived value than your product. At that point, value-based pricing dictates you must lower your prices, which can severely hinder revenue.
3. Your price is harder to set
As we’ve touched upon, there’s less of an exact science when it comes to reaching your value-based price point. As opposed to a set markup you may find in cost-plus pricing, it’s hard to know for certain which price point works for every customer and how a product’s value is perceived across an entire market.
While market research, customer feedback, and competitor analysis can help you achieve some confidence in your price point, you won’t know the perceived value of your product until you put it on shelves and compare your sales forecasts to your actual revenue.
Is Value-Based Pricing Right for Your Business?
One way to decide if value-based pricing is right for your business is to run your sales forecasts based on various price points for projected revenue totals. You can use HubSpot’s Free Sales Pricing Calculator to see how much revenue you can expect to see when utilizing this and other pricing strategies.
Originally published Nov 6, 2019 7:30:00 AM, updated May 14 2020