Price is a promise. Unless there is a perceived different between offers, buyers generally chose the one that is cheaper. Of all the strategic decisions faced by a firm, one of the most important is setting prices for the various product and service offerings. The role of pricing is to proactively alter the buyer’s willingness to pay by understanding and leveraging the benefits sought by the buyer. Value-based pricing may be right for you. This is in contrast with customer-driven pricing approaches based on reacting to the customers stated pay willingness.

Everyday your customers are asked to make a decision between products.  If in some way a customer believe a product is better (Godiva chocolate), lasts longer (produce from Whole Foods), feels better, etc. then they are more likely to pay for it than what might be an equivalent alternative. Tastes better, lasts longer, feels better and so on are examples of a promise. Each time a buyer chooses one option over another, they match up a price with its promise(s). Your job is to understand what are the price and promises for your products and services.

What is Value Based Pricing

Value-based pricing is based on understanding that the overall value of an offering to any one buyer is derived from constituent utility components, or part-worths, from the price, product/service features or deliverables, channel deliverables, and brand equity. The individual part-worths comprise the total value or total utility of an offering, and are therefore directly related to the likelihood of purchase, or choice. For example, suppose someone is considering the purchase of a computer. A particular computer will have utilities associated with the price, processor speed, hard drive capacity, access memory, brand name, channel, etc. By measuring the value of the different components you can begin to determine the willingness to pay and begin developing value-based pricing.

Set Your Price Based on Value

Before you can use this approach you need to know your value.

  1. Determine your value. It’s hard to determine how much to charge for something without first knowing its value. Before you set a price, make an inventory of all the value factors of your product/service. To create your inventory, answer this question: What attributes of your product or service are noteworthy?For example, is there something noteworthy about the quality of the raw materials (for example in the food industry the organic ingredients, in the computer industry the speed or the processor), the finished product performance, or even the after-sale service associated with the product. For services, it might be the experience level of the provider or the ability to meet deadlines. Your ability to deliver various factors, over and above your competitors, directly impacts the prices you set and get.
  2. Validate your value. Conduct research to learn which factors are the most valuable for your target buyer. If possible use choice modeling. Find out how much more they will pay for each factor and a combination of factors, and whether they would pay more than what they pay now for a similar product to have the value. Remember, if you promise certain factors, yet fall short on delivering them, your price will be challenged and you will see a rise in customer complaints, delayed payments and/or customer defections.

How to take a value-based approach to pricing

Design Experiments to Support Pricing Based on Value

An effective way to obtain information about the individual value components is through the use of designed experiments. Studies can be designed to insure that separate value components can be precisely estimated. In addition, experiments can accommodate new brands, features, prices, and channels that currently do not exist. Because experiments can be expensive, some marketers resort to using preference structure techniques such as conjoint measurement methods or choice modeling in conjunction with experimental designs.

Conjoint measurements have respondents express preferences by ranking or rating product/service profiles. While a profile could be an actual product/service, in practice it is typically a verbal or pictorial representation. By having respondents evaluate and compare profiles, they are forced to make tradeoffs among the constituent features as must be done in the actual marketplace. This information is used to derive much more accurate estimates of the feature part-worths than traditional methods.

The choice-based methods present an entire set of product/service profiles and ask respondents to make a choice. Product/service profiles are evaluated in the context of a competitive set. Choice-based methods produce part-worths for the product/service features based upon actual choice data rather than preference based rankings or ratings that are associated with conjoint models.

To more precisely estimate demand and price sensitivity, all respondents should be grouped into segments based on their price, brand, feature and channel sensitivities. This allows you to develop a model still robust enough to estimate a highly dynamic marketplace and minimize the impact of washing out unique market behavior. Using parameters derived from the studies, a market response simulator can provide rather precise information on the impact on market share based on changing prices, changing existing product/service offerings, as well as the introduction of new product/service offerings. Once you run the simulation you can then take the firm’s costs, existing market conditions, advertising, and promotion strategies into account to develop comprehensive value-based pricing strategy. 


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