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 blog post, I 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.
A short definition of value-based pricing
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 below and illustrated with a project case description.
Example of the value-based pricing process
1. 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.
- Interviews with experts from product development and management, marketing and sales were conducted to map jobs and problems that the software helped do and solve, as well as form hypotheses on value-driving attributes of the product.
- Decision makers with customers and non-customers in the Swedish, UK, EMEA and US markets were interviewed to provide insight into how the customers perceived the product, which problems it helped solve, which of the product attributes that were considered most valuable and how the company could create even more value.
Comparing the original strategy and ambition with results from customer interviews revealed several important insights:
- As expected, the software solution significantly improved communication between employees, resulting in substantial time-savings and more manageable administration. It also improved the end-customers’ experience.
- Customers without in-house IT departments perceived a decline in value over time, attributed to staff turnover and a lack of regular training and support. The decline in usage and value risked driving churn and decreasing customer lifetime value.
- In some markets, the status from using the best-in-class solution provided by the company seemed to be driving both purchase decisions and willingness-to-pay.
The interviews helped identify the existing offering’s value drivers shared by most customers, as well as segment and market specific value drivers.
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 a 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.
While acknowledging that the solution was best-in-class, smaller customers found the software to be too advanced and expensive for their needs and budget.
Customers from one target segment expressed concern that the price model was misaligned with their needs. They ran businesses with high staff turnover and a large number of employees covering all service hours, but the price of the solution scaled with named users.
The first finding indicated that a more modular offering would be successful. After creating and testing prototype packagings with customers, an S/M/L approach was the basis for two new segment offerings.
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.
4. Differentiate prices based on customer willingness-to-pay
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.
Read more from our related blog posts:
- What is customer profitability, and how does it affect your business?
- How should pricing and service design complement each other?
- Don’t forget the pricing strategy when developing new concepts
- Customer insights are fundamental for good pricing decisions
Don’t hesitate to book a meeting with Antti Kuusenmäki to talk more about your pricing potential: