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.
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.
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 they believe consumers are 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.
Artwork, cars, amusement parks, and even social media influencers use value-based pricing to sell their products and services. All three of these industries take into account a few standard truths about value-based pricing:
The market influences how much a consumer will be willing to pay for a product.
The benefit that the product provides to the customer influences the value of that product.
Competitors’ pricing can influence how valuable consumers perceive a product to be.
After taking into account these universal truths, companies then apply value-based pricing depending on their goals or the state of their industry. It's 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 andprice-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 productsthat enhance their functionality, like a new charger for your cell phone or laptop if your old one breaks.
Because value-based pricing thrives in the grey area of sales, one major factor that consumers must consider is negotiation. Consumers and sales reps should have a conversation to determine the benefits and value that a product has in order for the consumer to pay a price that reflects the value they’ve placed on the product and for the seller to make a reasonable profit on the deal.
Value-Based Pricing Examples
Value-based pricing is commonly used in a few different scenarios. Below are some common value-based products and the economic principles that guide the pricing for them.
Inelastic demand happens when the need for the product is so high that a lower price would have little-to-no impact on unit sales. One example of this can be found in the housing market. As of Q2 2021, the real estate market is considered a “seller’s market” where buyers are paying thousands of dollars above the home’s asking price. Although the housing market might flip between a buyer’s and seller’s market several times, the truth remains that even as the demand for housing soars, a lower price would have little-to-no impact on the sale of most houses. Therefore, buyers must consider the perceived value of the house they plan to purchase. Is it worth a few extra thousand dollars? The answer might be no, but there’s another buyer who’s excited to say yes to the address.
Highly competitive and price-sensitive markets usually settle at the price consumers are willing to pay. Charging any more could turn away interested buyers looking for a good deal. If you walk into any grocery store, you’ll see that milk falls squarely into this category. While you might see different brands of milk in the cooler, they’re all priced within a few cents of each other. In this case, the value of the milk is based on the third truth that we covered earlier – competitors’ pricing can influence how valuable consumers perceive a product to be.
Brands promote prestige with higher-than-usual markups that denote the exclusivity and grandeur of the product. Hermès, the popular artisanal luxury handbag producer, shows us just how exclusive its products are. The bags resale for tens of thousands of dollars online, but buying one directly from the manufacturer is nearly impossible. Due to the rigorous training, the artisans go through to make a Birkin bag, the demand far outpaces the supply which results in buyers placing an extremely high value on the bags which consignment shops like BagHunter take into account with their pricing.
Selling companions and add-ons to other products can enhance the functionality of products. In some cases, they’re simply a necessity for the original product to be usable. Swiffer sweeper mops are a prime example of value-based pricing simply based on the benefit that the products provide to the consumer.
The first time you purchase a Swiffer Sweeper, it comes with a handle and a few sweeper pads. But once you run out of sweeper pads, you’ll need to buy more. The value-based pricing comes into play when you arrive at the store and realize that other brands of sweeper pads don’t fit your Swiffer Sweeper. You then place a higher value on the add-on pads that keep your sweeper working. After all, you already committed to the Swiffer brand when you bought the handle.
Three Ways to Set Your Value-Based Price
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 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. Your 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 benefits 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?
Value-based pricing depends on several factors, three of which are critical to getting the strategy just right: analyzing how the market affects perceived value, determining how much value your consumers place on the products you sell, and understanding how your competitors play a role in your value-based pricing strategy. This type of pricing won’t work for every business, but it can be a smart way to penetrate a new market, increase profits, and develop better brand perception.
Another 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.
Editor's note: This post was originally published in November 2019 and has been updated for comprehensiveness.
Originally published Apr 14, 2021 2:00:00 PM, updated October 28 2021