Do you struggle when you’re faced with setting prices for your products or services? An effective pricing strategy is critical for your business to be competitive in your market. There are several strategies to choose from, and value-based pricing is a customer-focused method.
With value-based pricing, the key is selecting a price that you think your customers will be willing to pay—keeping profit margins, brand perception, and competition in mind. Let’s talk about value-based pricing, why you should use it, how it compares to cost-based pricing, and how to apply it to your products and services.
Value-based pricing is a type of price optimization that is based on the customer’s perception of the value of your product or service. It doesn’t factor in production costs. It’s all about what the customer believes a product is worth.
Unique and luxury products are in the best positions to be priced with this method. Art, diamonds, technology, fashion, and cosmetics are just some of the industries that use value-based pricing. Think Apple, Starbucks, Balenciaga, Gucci, Louis Vuitton, or Chanel Beauty. Each of these companies bases their prices on what they believe is the perception of value customers have of their products.
Examples of value-based pricing
How much was that last coffee you bought from Starbucks? People could get their caffeine fixes from anywhere for much less, but instead, they head to the closest Starbucks. Why? The value associated with being welcome to sit, socialize, study, or people-watch is part of the Starbucks formula for providing value. The value associated with the premium image projected by the company, products, and overall brand image is another component. People feel that the value added by a coffee from Starbucks is worth the higher price.
You may be familiar with the Louis Vuitton fashion brand—particularly their handbags. Most of their bags cost between $2,000–$3,000. This luxury brand sticks to its understated designs and recognizable colors and logo to make its bags easily recognizable. Customers are willing to pay the price for a bag, rather than an equally attractive and functional high-end bag that costs $200–$500 because of the perceived value of Louis Vuitton. The brand is synonymous with high-end luxury, social versatility, and exclusivity.
And to the right customer, a Louis Vuitton bag is a great value compared to a Hermes Birkin bag that can cost up to $300,000 (also using value-based pricing)!
Based on our description of value-based pricing, is it right for your products? Here are some reasons you might choose to use it.
Exclusivity is a key component of value-based pricing. If your customers believe that your product is prestigious, exclusive, or culturally relevant, buyers will want it based on the perceived value, regardless of price. The intangible value of owning a product with these qualities is thought by customers to be worth the higher prices.
Art is a great example of value-based pricing. People will pay exorbitant markups to own a piece by a famous artist so that they can reap those intangible benefits.
With value-based pricing, you can set higher price points based on the perceived value of your products. If your brand is thought to have a higher value than others in your industry, you can set higher price points for your products and services.
Setting higher prices can increase the prestigous status of your products and brand. Let’s look at premium watches as an example. The Rolex brand watch makes customers feel like their successful and elite. When others see him wearing it, they also make the association between Rolex, success, and exclusivity.
Pro tip: To successfully employ value-based pricing, you must do significant market research during product development. That way you’ll develop what your customers want and thoroughly understand your customers' willingness to pay.
Cost-based pricing and value-based pricing are two of the most frequently-used pricing strategies. Do you know the difference between them?
Cost-based pricing, sometimes referred to as cost-plus pricing, is very straightforward. Prices are set based on the cost of materials, production, operating costs, distribution, and markup for a profit margin, specifically set by the company. It’s easier to implement than value-based pricing—customer sentiment does not need to be researched and analyzed for the pricing process.
This pricing strategy is often used for products that are not luxury products and are available at various price points from competitors.
Value-based pricing is used to gain additional profit based on the value ascribed to your brand or product. Prices are set based on this value and your customers’ willingness to pay. It’s a more complex pricing strategy but yields high rewards when it works.
Put simply, cost based pricing is cost-focused, and value-based pricing is customer-focused.
Thinking of using a value-based pricing model? Use this step-by-step guide to guide you.
You can’t definitively know the value your target customers assign to your brand or products without market research. Though you’re looking for information to help with value-based pricing, much of this research can be used to support other business decisions and evaluations.
A logical starting place for market research related to pricing is customer segmentation. This strategy divides your customer base into groups based on shared characteristics. Once completed, you can refine the rest of your research by identifying the various target groups you’re interested in.
There are several ways to segment your target market. You’ll choose one or more of the following traits to select the segment you want to assess regarding value-based pricing.
Ultimately, you’ll look toward value-based segmentation. This is the segmentation strategy that focuses on the value customers receive for the money spent on your product or service.
Value-based pricing is often directly related to whether customers know your brand and how they view it. Once you’ve performed your segmentation, it’s time to find out how familiar people are with your brand and what they think of it. Measure brand awareness and brand perception to gain insights into how customers view your business.
Use an NPS to evaluate your current customers’ loyalty, happiness, and willingness to refer your business to others.
It’s time to assess your product compared to others on the market. What are the customers in your target segment paying for similar products from other companies? Your price analysis takes into account your product’s features, performance, and price in comparison to competitors.
The final piece of market research necessary for value-based pricing is price optimization. We suggest starting with our Price Optimization solution, which uses the Van Westendrop Price Sensitivity Meter, a powerful tool for identifying the maximum price customers are willing to pay for your product. This solution includes assistance from our survey experts for design, programming, multi-methodology research design, and more.
Your product’s value is relative to other products on the market. Find out what customers value about your product over your competitors’ products to ensure that your product retains that value.
This assessment includes:
Use the data from all your market research to determine the value your product or brand offers to your customers. With that value in mind, choose the price point you think customers will be willing to pay for your product.
Hopefully, you’ll hit the right value-based price right away, but be aware that you may not. It’s critical to test and monitor the success of your pricing strategy—if you overestimate value, your sales may fall below your expectations.
Research, monitor, and refine your price until you reach the price point that reflects the value your customers feel your product provides and delivers the highest profit for you.
Is a value-based pricing strategy right for your brand and products? If you can differentiate your product by the value perceived by your customers, value-based pricing may work well for you. All it takes is some market research to get started.
SurveyMonkey offers a Price Optimization solution to help you determine optimal pricing for your products. We will uncover specific information from your target audience.
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