Ask how a price was set, and you may hear one of three stories.
"We added our margin to our costs." "We looked at what competitors charge and came in a little under." Or, "We worked out what it is worth to the customer." All three are reasonable places to start. Only the third connects the price to the reason anyone buys.
That third approach is value-based pricing. It takes more work than the other two, and this guide explains what the work involves and why it is worth doing.
What value-based pricing means
The value of your product is the difference it makes for the customer. That could be hours saved, revenue gained, a risk avoided or a headache removed. Value-based pricing asks what that difference is worth to the customer, and sets the price below it.
The important word is difference. Customers judge your price against their next best option, which might be a competitor, a cheaper tool, an in-house workaround or simply doing nothing.
Your customers compare your price with their alternatives. Your costs are invisible to them.
How it compares with cost-plus and competitor pricing
Cost-plus pricing adds a margin to what the product costs you. It is simple and it protects your margin. It also ignores what customers would pay, so it can leave money on the table or price you out.
Competitor-based pricing matches or undercuts the market. It is quick, and your price then follows someone else's choices, including their mistakes.
Value-based pricing starts from the customer's gain. In practice it uses the other two as guide rails. Your costs set a floor you never go below. Competitor prices tell you what customers have already seen. The price itself comes from value.
How to set value-based prices
1. Find out what customers value
Talk to customers, and to people who chose not to buy. Ask what problem they were trying to solve, what they compared you with, and what changed once they started using you. The people who said no are useful too, because they show you where the value fell short.
2. Name the next best alternative
For each customer group, write down the option they would choose if you disappeared tomorrow. Its price is your starting point. A customer comparing you with a large competitor and a customer comparing you with a spreadsheet are making very different calculations.
3. Work out what makes you different
List what you do better than that alternative and what each difference is worth to the customer. Some differences save money directly. Others reduce risk or effort, which is harder to measure and can matter just as much to the buyer. Be honest about where the alternative wins too.
4. Set the price inside the gap
The right price sits above the alternative and below the full value of your advantage. In that gap, the customer is better off choosing you, and you are paid for the difference you make. Where you land in the gap depends on how clearly customers can see the value.
5. Package for different customer groups
Different groups value different things. Plans or tiers let each group pay for what matters to them. Some companies offer three levels, often called good, better and best. The aim of tiers is fit, so each group finds an option that matches its value.
6. Explain the value, then watch what happens
A value-based price needs a value-based explanation. Your sales and marketing should describe the gain in the customer's terms. Then watch how customers respond: how often deals close, where discounts are requested, and which plans people choose.
When value-based pricing is harder to apply
It takes more effort when customers struggle to measure the value, when products look alike, or when buyers compare on price alone. Even then, knowing what customers value can guide which customers you pursue and how you describe what you offer.
Getting help with value-based pricing
The method is simple to describe. Applying it to your own customers and your own data takes time and an outside view. Our pricing strategy consulting covers the research, the price and package design, and the rollout.
Common questions
What is an example of value-based pricing?
A software tool that saves a finance team several days of work each month can be priced against the cost of that time. The cost of building the software sets only the floor.
Is value-based pricing better than cost-plus pricing?
Value-based pricing starts from what customers gain, and cost-plus does not. Cost-plus is still useful as a floor, so you never price below what the product costs to deliver.
How do you measure customer value?
You use customer interviews, usage data and a comparison with the customer's next best option. The aim is a range you can defend.
