Value-Based Pricing
A strategy for pricing goods or services that adjusts the price based on its perceived value rather than its historical price
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What is Value-Based Pricing?
Value-based pricing is a strategy for pricing goods or services that adjusts the price based on its perceived value rather than on its historical price. The value-based pricing strategy is used to increase revenue by increasing prices without a significant effect on volume.
Summary
- Value-based pricing is a strategy for pricing goods or services that adjusts the price based on its perceived value rather than its historical price.
- The strategy is used when the purchasing decision is emotionally-driven or when scarcity is involved.
- Value pricing is going to price items at a higher level than cost-plus pricing by increasing the perceived value of the good or service.
When is Value-Based Pricing Used
Value-based pricing is used when the perceived value of the product is high. The strategy tends to involve products that possess a certain level of prestige in ownership or are completely unique.
Designer apparel companies are well-known for using value-based pricing. While a designer shirt may cost nominally more than a non-designer shirt to produce, the status carried by the designer brand increases the perceived value of the shirt. Many companies capitalize on such perception, increasing their margins greatly, while minimally reducing sales volume.
A similar strategy may also be used when the purchasing decision is emotionally driven. For example, while a famous painting may sell for millions of dollars at an auction, the cost of creating that painting is meaningless relative to the sale price. The value and price are being derived from the prestige of the artist, as well as other emotional aspects that the buyer may connect with.
Value-based pricing is also often used when scarcity is involved. For example, at a concert, bottled water may be on sale for $6. However, you can buy the same bottle from a vending machine outside of the concert area for $1 only. The difference in pricing is reflected in the scarcity of water at the concert, and the need for concertgoers to drink water.
Cost-Plus Pricing vs. Value-Based Pricing
To better understand value-based pricing, you need to understand how it differs from cost-plus pricing. In cost-plus pricing, the seller simply takes the cost of producing the good or service and adds a premium. In this sense, the main determiner of price in a cost-plus pricing strategy is the cost of producing that item. In value-based pricing strategies, prices are always equal to or higher than in cost-plus pricing strategies.
The above diagram shows that a cost-plus pricing strategy adds a certain markup, making the price of the item dependent on its cost. The value-based pricing strategy is used on items that demonstrate a level of perceived value much greater than the cost.
Issues with Value-Based Pricing
Value-based pricing may not always be the best pricing strategy for a company, and implementing it can come with several obstacles. It can be very difficult to evaluate the perceived value of a product or service. With cost-plus pricing or competition-based pricing, a price can be decided relatively easily by evaluating costs or the competitor’s prices. The value-based pricing strategy involves guesswork and is more qualitative in nature.
Execution of Value-Based Pricing Strategy
The way that a product is marketed and perceived by consumers is especially important in a value-based pricing strategy. As the price level is going to be higher than a cost-plus strategy, the perceived value needs to be strong. This can cause implementation costs to be more with value-based pricing, as extensive research must be done to arrive at a pricing decision. Also, differentiating the product from similar competing products may require a substantial investment.
Example
Assume an individual works for a film production company and is tasked with pricing merchandise for an upcoming Spiderman film. The production company owns all rights over Spiderman-branded merchandise, meaning it won’t need to compete with other companies on price. Additionally, the new Spiderman stars Tobey Maguire, a fan favorite.
The merchandise would be the perfect candidate for a value-based pricing strategy. First, as other companies can’t legally produce the merchandise, you won’t need to worry about lowering the price to remain competitive. Additionally, the fact that Tobey Maguire is starring in the film means that the fans are willing to pay more for the same item. Therefore, the perceived value of the product increases.
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