Value-based pricing is a better strategy than ever in today’s business world. Challenges imposed upon businesses, like the Coronavirus, have fueled innovation as well as intensified competition. The dedication to deeply understand the customer’s needs and how they can be met provides insight into what truly differentiates one offering from another. This helps companies to avoid the trap of commoditization and allows them to charge a price premium where it is justified by the value delivered.
Furthermore, it will guide the choice of market position to attract customer segments where maximum value delivery and maximum value capture are possible.
In this article, we will go through what is needed to introduce value as a basis for your pricing.
Activities from a pricing project with a global software solutions provider are described to illustrate the process.
We define value-based pricing as the practice of setting prices based on the value delivered by your products and services, as the customer perceives it. Thus, cost and an internally decided required margin are not the base for pricing. This means that if the perceived value does not exceed the production and sales cost, the product or service should not be offered.
Let’s take a closer look at the value-based pricing process, as outlined in the four main activities to the right and illustrated with a project case description.
Example of value-based pricing process1. Define and quantify the value that you create
The key to value-based pricing lies in asking customers about their situations, needs and how to satisfy them. How does our current offering create customer value? What can we do to create even more value? What is the customer’s willingness to pay for the products and services that we offer?
Consider the journey of a Swedish company that went from producing and selling machines and consumables to developing software for managing complex patient and customer flows in, e.g., healthcare and retail. To truly understand customer needs and perceptions of the offering’s value, the company sought to capture both the internal and the external perspective.
Comparing the original strategy and ambition with results from customer interviews revealed several important insights:
2. Quantify value and translate into list prices
Quantification of value is where many initiatives to introduce value-based pricing grind to a halt. To progress, it helps to divide into functional and emotional values, as was done in the project.
The value of each driver was calculated or estimated using data from various sources. A list price for the largest market was set using competitor list prices as baseline, and then adding and subtracting the differentiating monetary value of each attribute. The resulting amount is the customer’s maximum willingness to pay.
3. Segment your customers to increase your market and capture more value
Although the majority of customers shared many needs and had some alignment in their value perception, the interviews helped identify two customer segments with unique needs that had not previously been met.
The first finding indicated that a more modular offering would be successful. After creating and testing prototype packagings with customers, a S/M/L approach was the basis for two new segment offerings.
4. Differentiate prices based on customer willingness-to-pay
The final finding required a change from price per named user to the price per concurrent user. It was a quick fix, allowing customers to subscribe to the actual number of users at one time, avoiding having to share logins between colleagues.
As the figure shows, by structuring and pricing your offering to meet the differing needs of specific customer segments, you will increase the market share that you attract and capture more value.
Finally, to really leverage deep insight into market and customer needs, we need a discount structure that reflects the differences in perceived value and willingness to pay between customers. Provided that the process is regularly maintained and developed, your offering and pricing will stay relevant and competitive for customers of different sizes, across segments, and in all markets.
Lotte Kylberg is Senior Manager and Pricing Lead at Capacent_x in Sweden. Lotte has 15 years of experience from developing and implementing strategic and tactical pricing with clients in a wide range of industries, such as industrial manufacturing and trade, business services, rental, retail and MedTech.
Do you want to know more about pricing and how we can help you with your pricing strategy? Book a meeting with Lotte using the calender below!
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