What is value-based pricing?

If you have ever stepped foot in a museum, you must have wondered at least once:

“How much is that painting worth?”

In other words, how much would someone pay for this piece of art?

As you probably know, in terms of paintings, the best way of finding out is to look at how the art auctions work.

The auction ends, the painting goes to the highest bidder, and whoever owns it gets the money. Most importantly, gets the highest price possible. No analysis, no strategizing, just maximum profit. We all wish we could do that with our companies.

Unfortunately, there usually are no auctions in regular businesses. But there are other ways to determine the optimal prices of products or services and maximize profits. One of them is value-based pricing.

Let’s talk about the basics of the pricing strategy that helped many modern businesses reach a completely new level.

Value-based pricing basics

The idea of value-based pricing comes down to determining a product's or service's value to customers and how much they are willing to pay for it. To get the correct number, it’s necessary to consider many factors that influence a product's perceived value, from customer behavior to competition.

The goal is to understand a given product’s place in the market and how it responds to clients’ needs. And with that information, we can estimate the willingness to pay (WTP),  the maximum price a client is ready to pay for a product or service. In value-based pricing, estimating WTP is the cherry on top, allowing us to make accurate final decisions.

Raising the difficulty, raising the prices

Without a doubt, value-based pricing is a complex pricing strategy. It requires a lot of research and takes much more time than other strategies, such as cost-plus pricing or competitor-based pricing. It takes much more than calculating all costs or taking a sneak peek at competitors’ websites. It’s thorough, multi-dimensional, and never really stops because all the factors that influence the value of a product constantly change. Without the proper tools or expertise in the matter, it can be impossible to implement.

However, this difficult approach can bring significantly more profits to the company. With value-based pricing, we can more accurately determine the maximum price that customers will still happily pay.

Do you need more practical insights?

Learn more about pricing

The idea of value in value-based pricing

To understand value-based pricing, it’s good to take a step back and think about value first. How do we define it, and what factors make something valuable?

Practical example 1

For example, let’s take an electric guitar as an example and try to figure out what aspects may increase (or lower) its value:

• What brand is it? What’s the brand reputation?
• Is it popular among guitarists?
• Which famous guitarists use them?
• How many of them are available on the market?
• How is it advertised?

Of course, it could get much trickier if we took a vintage guitar as an example. We would have to turn into a series of questions about its condition and even who owned it before. Still, with any guitar, the process is fairly straightforward, but, as you see, many aspects other than the product itself affect its value. And now, it’s the right moment to introduce the term value drivers.

Value drivers are all activities or capabilities that add profitability, reduce risk, and promote growth in accordance with strategic goals. The more we understand the value drivers of our product, the better we’ll be able to price it. Ideally, we should be able to quantify our value drivers, but, of course, it might not be possible with everything.

Practical example 2

To explain it adequately, we’ll take an example closer to our world. Let’s say we have a trailblazing AI-based CRM tool that sells on its own. To determine its price in a value-based fashion, we’ll try to briefly go through a couple of examples of its value drivers.

So, if we’re saying that our solution reduces costs, what are we talking about exactly?

• How many work hours can our clients save thanks to our tool? How expensive would those work hours be? (e.g., how much money would cost 1000 hours saved for the sales team and additional 200 hours for the HR team per year?)
• How much money can our clients save on resources and software? (e.g., what other subscriptions/applications our software replaces, and how much do they cost?)

The more we delve into details, the more precisely we can communicate the actual value created by our product or service. Of course, we have to remember that we might never be able to fully communicate those values due to the intangible nature of many of them. But as long as we’re trying, we’re getting closer to the price and the maximum WTP.

To sum up, using value-based pricing, we’re trying to take the client’s perspective and precisely communicate all the crucial factors because they can play a part in a customer's final decision and perceived product value of the product.

Due to this complexity, the strategy can be far more challenging than cost-plus or competitor-based pricing, but it leads to more precise (and profitable) results. For companies that haven’t dealt with any similar approaches to pricing previously, it can even be a little shocking at first. It provides a fresh look at their business and a better perspective on how their products or services are used and perceived. The focus on value often results in better product development and overall product or service quality.