Following-up my last post ‘What Are You Worth?‘, one of my fellow blogger colleagues, kizaza, raised the question of how a business can actually determine and calculate the ‘worth’ of a product or service to its customers in order to implement a value-based pricing strategy.
As far as I can see, the concerns he expressed regarding the transparency as well as the difficulties that come along with the try to determine how valuable a product or a service is to a client are completely comprehensible.
The concept of ‘value’ is very subjective and what impact a product or service will have may differ considerably from one customer to another.
Yet, as I already pointed out in my two previous blog posts, the shift towards pricing strategies based on value cannot be neglected.
How do they do it?
So, how do businesses and professionals actually do it? How do they manage to calculate a value-based price?
What is important to state right away is that there’s no exact science to determining prices based on value. However, you can follow guidelines to map out where you want to price your product or service.
Phillip Chappell, professional writer and contributor for www.ehow.com points out that determining the value of your product to your customers also involves estimating “how much money or grief it saves them”.
Nevertheless, other established pricing strategies such as positioning the price of your product to that of your competitors need to be considerated as well.
Pricing strategist Mark Stiving adds, that in order to successfully understand and implement value-based pricing (VBP), it is crucial to first look at value-based buying (VBB).
VBB essentially is how customers make their decisions when they deliberate about which product to purchase.
As an example, imagine you are at a supermarket and you want purchase a package of pasta. Two different packages catch your eye, the store’s own-label pasta costing 59ct and a branded product at 89ct.
Now, how do you choose? Is it worth to pay 30ct more for the brand name pasta?
In order to answer this question, you think of all the differences between the two packages. One choice of pasta may be cut differently. One may take longer/less time to cook. One may have a prettier label/packaging. You may have had better experiences with the branded variety.
It’s completely up to you what you think is important.
After you’ve figured out the important differences, you place a value on them and then decide what choice you opt for.
Of course you don’t actually do these calculations. However, this is how your mind makes the decision – you ask yourself and answer the question, is the branded pasta worth 30ct more than the no-brand one?
Doing the maths
Becoming aware of this VBB process your customers (probably even unconsciously) use, underpins the importance of talking to them in order determine the value of your product or service.
If you then choose on of these competitors you made out from their answers, you can do the value-based buying maths for yourself.
How much is your product at the moment? How much is your competitor’s? What are all the differences? How would you value these differences and how do you think your customers do?
You can than apply this technique to set a price that captures the value a potential customer receives, for example using these steps:
- Identify your customer’s second best option. If your customer won’t buy your product or service, then what would he or she choose?
- Determine the price of the second best option.
- List all of the ways that your offering is better than the second best option. Estimate how much you think these differences are worth to your customers?
- List all of the ways that the second best offering is better than yours. Be very honest here. How much do you think these are worth to your customers?
- To calculate the best price — take the price of the second best option (step 2 above) plus the value of your advantages (step 3) minus the value of the second best option’s advantages (step 4).
Consequently, PRICE = STEP 2 + STEP 3 – STEP 4
“However,” Stiving points out, “this does not give you the ‘right’ answer. This gets you close.”
Using this analysis method only helps you see how your customers are making decision and creates a calculated price so you can see if it makes sense.
As I pointed out in the beginning, the result might differ greatly if you do it for a customer that buys from you and one that doesn’t as they will probably put very different values on your advantages and disadvantages.
Still, from a marketing point of view you should keep in mind that your target market should be the customers who value your advantages. You should hence price for them.
Implementing value pricing isn’t a trivial journey
To sum it up, the implementation of value-based pricing is not a trivial journey as Mark Burton, leading marketing and pricing strategist, highlights.
It requires amongst others new skills in being able to quantify customer value at a strategic level and training the sales department on how to work with customers to analyze value at a tactical level.
Nonetheless, he also underlines that value-based pricing approaches are likely to result in considerable improvements in profits.
After all most important to bear in mind for businesses, according to Burton, is commitment:
No matter what your pricing approach is or what you want it to be, its a commitment to the pricing journey that’s important. With that commitment, firms will see continuous improvements in financial performance as they improve their pricing maturity.
And again we realize that the corporate world in fact is not that different from our everyday life: If you are truly committed to an idea, chances are high that you will be able to achieve your goals.