Value based pricing offers businesses an opportunity to charge a premium for the benefits their products or service deliver.
Quick takeaways if you’re in a hurry
– It’s common for businesses to suffer from tight margins because they are pricing their offering based on costs or the competition
– Value based pricing allows businesses to price their offering based on the value their customers place on it
– By moving pricing conversations with customers from costs to investment, the business is able to charge a higher amount for the service that they offer.
Read on: Tackle tight margins with value based pricing
(estimated reading time: 6 minutes)
Value based pricing offers an opportunity to change the conversation that a business has with its customers. By moving from price to benefits, a business can increase the amount it charges for its products or services. This is a customer-centric approach that can significantly change the way that businesses price their offering.
It’s not uncommon for businesses to under-price themselves in a bid to be competitive, or because they have based their pricing on their costs and underestimated their required margins.
This can be a particular struggle in the service industry, especially where a business comprises a single operator charging an hourly rate. It can also be a challenge where a business offers a product with enhanced features but finds itself unable to charge a premium because of the low prices of the competition.
Value based pricing offers a potential solution to tight margins and cost-focused customers.
What is value based pricing?
Value based pricing is a two stage process. Firstly the product or service offering is designed to fulfil the needs of the customer and deliver a tangible benefit. Secondly the pricing of the offering is set based on the value that the customer places on the fulfilment of these needs.
Developing value-based pricing is at it’s heart a research solution: it requires an understanding of the needs of a group of customers and the value that they attribute to having those needs fulfilled. As such it usually requires upfront research investment, causing many businesses to shy away from it and put it in the ‘too hard’ or ‘too expensive’ basket.
It’s important to understand who potential customers are, and remember that any insights generated may still vary by customer and by market. The most effective value based pricing often aligns with segmentation to recognise the value that different types of customers attribute to different needs being fulfilled.
What is the benefit?
Without a value-based product or service offering, the purchase or business decision is often focused on price, i.e. the cost to the customer. And because of the transparent nature of most pricing, if a customer is comparing two costs it is all too common that they will choose the lower one. Or perhaps they will challenge the higher price and question where the justification is for it being charged.
Value-based pricing focuses on the benefit that the business is delivering to the customer. It takes a conversation which could have been about a price or cost and makes it about the importance of investment. This links the service directly with the end benefit to the customer. It also makes it possible to charge a much higher price than merely the cost of getting the job done.
Tailored pricing solutions
Another important benefit of value-based pricing is that it can be developed in partnership with the customer and directly tailored to their situation. If there is a chance that customers are likely to have different levels of needs then a menu can be developed.
This can offer different benefits to the customer, and therefore different tiers of cost: each attributed to the value that they will generate for the customer. In this situation customers can choose to invest more or less, and get more or less of the benefits that the service or product will generate.
Value based pricing requires a strong understanding of the customer’s needs, and the value they would place on having those needs fulfilled. It is not just a pathway to correcting a business’s pricing strategy, it also allows businesses to get more involved with matching their product to their target audience.
This means that products and services are developed to a higher standard to ensure that customer’s needs are being satisfied. The process of researching the customer’s needs can lead to new product and service enhancements or development opportunities.
Product and service attributes that do not add value can also be removed. Because value-based pricing requires an understanding of what customers need, it will quickly become apparent if part of a product offering serves no purpose other than being a good idea that customers will not value or pay for.
The end result? Value based pricing allows businesses to charge a premium for their ability to deliver tangible benefits to their customer. Their enhanced understanding of the customer’s needs allows them to build stronger relationships, encouraging repeat business and referrals. And because the business deals in benefits and value rather than product and cost, they are competitively more difficult to match.
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