Has this ever occurred to you how companies decide the price of their products? Do they pick a number randomly? Do they consider essential factors like the production cost, the amount of the competitors’ product, demand in the market, or the perception of people about the brand?
There a few companies which decide the price of their product randomly, but most of the companies consider various factors before determining the price.
Based on these factors, pricing techniques are divided into different types, such as competition-based pricing, dynamic pricing, Cost-plus pricing, freemium pricing, hourly pricing, penetration pricing, premium pricing, project-based pricing, skimming pricing, and Value based Pricing.
In this article, you will learn about Value based Pricing and its advantages and disadvantages.
What is Value based Pricing?
Value based Pricing strategy is a pricing strategy where companies decide the price of their products or services depending on the value or estimated value perceived by the consumers. It is a customer-focused pricing strategy where the price of the product is decided not based on the cost of its production, but for the worth, it holds in the eyes of its consumers. The reason behind using this pricing strategy is to see how much your customers would be willing to pay to buy your product.
The Value based Pricing strategy is different from cost-plus pricing, where the cost of a product is decided by considering the various costs of production into determining the price of a product. In the Value based Pricing strategy, the price of the product is solely concluded based on the value of the product in the eyes of customers.
The value-based strategy, if used correctly, can improve the profitability of the company as a company can charge high prices for the products that hold a respectable position in the eyes of its consumers. The Value based Pricing strategy works well in niche markets where you are focusing on the specific needs of your customers.
However, this pricing strategy cannot be used to set the price of all types of products. The Value based Pricing strategy works best when products are not sold based on its importance but based on the emotions and feelings of consumers associated with the product or with the brand of the product. For example, people will willingly pay the $1000 to buy a bag of Gucci brand because the Gucci brand holds a high reputation in the eyes of the customers.
Therefore, they can charge any price for the product irrespective of its production cost or the cost of competitors’ products. On the other hand, you can’t charge any price for the commodities that people use daily and buy them out of necessities based on the value of the product.
For instance, if your company sells bread, then you are required to set the price of your loaf of bread the same as or close to the cost of the product of your competitors.
Definition of Value based Pricing
A Value based Pricing strategy can be defined as a pricing strategy to decide the price of goods and products based on the value perceived by customers or based on its estimated value rather than determining the price of the goods based on the price of competitors’ products.
Why use Value based Pricing?
A Value-based Pricing strategy is the pricing strategy used by businesses to get various advantages. However, this strategy is not appropriate for all types of products.
In this section, you will learn about the reasons based on which you can use a Value-based Pricing strategy for the pricing of your product or services.
1. The willingness of customers to pay
Value based pricing only works if your customers are willing to pay the price you set for your products. You should ask your valued customers whether they are willing to pay for your product or not. On other pricing strategies such as competitor-based pricing, you set the price of your products based on the price of the product of your competitor. Still, you make sure that your product has more qualities than the same product as your competitor.
Similarly, in cost-plus pricing, the price of a product is decided based on the cost incurred in producing the product. Therefore, using Value based Pricing, you set the price of a product based on its value in the eyes of customers irrespective of the cost incurred in its production.
2. To get to know your customers
Your customers are the ones who are the final buyers of your products. Their opinion matters a lot in the production of the product and deciding the price of the product. If you know your customers before you introduce the product in the market, you take one step forward in the direction of making your product a success.
3. Create the best product
Lastly, Value based Pricing is not only about the price of the product, but it is also about the features, qualities, and packaging of the product. With the help of this pricing strategy, you can learn what your customers want and can create a product to fulfill their needs.
In this way, you can increase the demand for your product in the market.
Advantages of Value based Pricing
1. Increased value of the brand
The first and foremost advantage of using Value based Pricing is the increased value of the brand. The high price of products makes people think that the product is of superior quality. Thus, the value of brand increases in the eyes of customers.
2. Increased profits
Value based Pricing helps in increasing the profits of the company. If your customers value your product and are willing to buy it at any price, then you have the opportunity to charge a high price for the product, and in this way, you can generate higher profit by selling the same units of products.
Take the example of smartphones. Apple sells its iPhone mobile phones at higher prices because of the value of the brand in the eyes of its customers.
3. Customer loyalty
Companies ask their customers about their requirements and willingness to pay the price for the product. When you consider the opinion of your customers and create products to satisfy their needs, then they also feel loyal to your company.
However, if you want to achieve the loyalty of your customers despite charging high prices, then make sure that the product that you sell must justify the high cost. By creating the right quality product, you will not only get customer loyalty and repeated business but will also get referral business from your loyal customers.
4. Supply and demand balance:
Value based Pricing gives you a rough idea of the demand for your product in the market. You will know the approximate number of customers who can afford your product and are willing to pay high prices to buy your product. Having the idea of the demand for a product in the market helps a business to create supply accordingly.
Disadvantages of Value based Pricing
1. Niche market:
One downside of Value based Pricing is that you can target only a limited number of customers who can afford your product. There are a limited number of customers in a market who can afford the high prices. A limited number of customers means limited expansion of business.
2. Difficult to expand the business
The Value based Pricing works for organizations of smaller sizes, and that sells highly specialized products. It is not feasible to implement this strategy on a larger audience, which makes a Value-based Pricing method the least favorable pricing method for companies that look forward to growing their business.
3. Competition in the market
Another major disadvantage of Value based Pricing is competitive in the market. When you charge high prices, then you leave scope for your competitors to produce and sell the same product at lower prices. In this way, they will share your already limited customer base and affect your profit.
In such a scenario, you can’t even lower the price of your product to compete with your rival because this will make your loyal customers doubt the worthiness of your products.
4. Higher production cost
It costs more to produce specialized products. You will require highly skilled employees to provide the right quality products.