ISSUE NO.30

Value-Based Pricing 101

A while back, we talked about competitive pricing, what it was good for, and how to use it to price your products. Today, we’re taking a look at another popular pricing model, value-based pricing.

Value-based pricing is a strategy that sets the price of a product based on the perceived value it provides to the customer. Unlike cost-plus pricing, which considers production costs and adds a markup, value-based pricing is customer-centric, taking into account the benefits, solutions, and overall value that a product offers.

Let’s get started.

The Benefits of Value-Based Pricing

Like all pricing models, value-based pricing carries a number of unique benefits:

Possibility of Higher Markups

Using value-based pricing for highly innovative products can lead to markups of 100x higher than the competition! Moderately innovative products can still claim up to 25x higher markups.

This is because unlike cost-based or competitive pricing, value-based pricing focuses less on what it costs to produce the product and more on what consumers are willing to pay.

You Can Increase Price Over Time

Because value-based pricing relies on customer perceptions of your product, it can grow over time. If, later on, you can convince consumers that your product is worth more—even if cost of production has remained the same—you can increase your price and people will continue to buy your product.

A great example of this in the CPG landscape is if, say, a celebrity or influencer publicly states that they love your product. This can create an increased consumer value perception, and you can bump up your prices to match.

The Downsides to Value-Based Pricing

Despite the chance of higher profits, value-based pricing also carries substantial risk:

Difficulty Setting Prices = Room For Error

Because value-based pricing isn’t very quantitative, it can often be difficult to find out what exactly customers are willing to pay. Unless you have access to raw data on your target market through analytics tools or extensive testing, you may accidentally set your price too high. Doing this will lead to a dropoff in sales.

On the other hand, you may underestimate consumer perception of you product and set your price too low, shrinking your margins and losing profit.

Needs Exceptional Communication of Value

Your product may be revolutionary, but if you can’t communicate its value to your customers, then they likely won’t understand its price point or be willing to pay what you say it’s worth. With value-based pricing, your marketing and advertising needs to be top-notch, because without that, your product is effectively worthless.

Risk of Changing Value

The market is ever-changing, and that risks destabilizing customers’ perceived value. For example, if you make a wheat-based food product and a new study comes out prompting a large share of your market base to go gluten-free, the perceived value of your product will plummet. This can happen as a result of technological advances, cultural changes, or even product development from competitors.

How To Use Value-Based Pricing

So, now that you know the pros and cons of value-based pricing, let’s look at a simple example for how it can be used in the 

Unlike cost-based pricing or competitive pricing, value-based pricing is rooted purely in the perceived value of a product. Let’s look at an example.

Let’s say you’re selling bottles of water. According to other pricing models, you’ve determined that your bottles should cost $1. This is very similar to what other companies are selling their water for on store shelves.

But, let’s say you’ve now switched venues—instead of selling your water at the grocery store, you’ve signed on to be the sole water provider at a local tourist destination in the middle of summer. While you could sell your water for $1 per bottle, you know that people will be willing to pay much more to stay hydrated in the heat.

This means that the perceived value of your product has gone up.

Over the course of the summer, you run some tests. You find that if you set your price at up to $3 per bottle, people continue buying your water at roughly the same rate. But, if you price at $4 per bottle, people skip on the water and start buying $5 sodas instead.

Congrats, you’ve now discovered that your value-based price is $3 per bottle.

That’s $2 more per bottle than you would have sold them for if you were to sell them at your normal price. Cha-ching!

Some final words…

Value-based pricing can be an amazing way to spike your revenue. That said, it’s important to remember that it’s not a model that will work for every business. As alway, do your due diligence and research what works best for your brand.

Until next time,
— The CPG MBA Team

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