Value Pricing Relies on Effective Segmentation

I was having a conversation with someone the other day around pricing and it got me thinking about the critical elements of a good value pricing model.  Before I get into that though, let me first tell you how our conversation went.

During our discussion on pricing, of course the conversation turned to value pricing (I don’t think that I can have a conversation about pricing without it focusing on value pricing).  The person said, “I really believe in value pricing.  I think that “good, better, best” is a good example of value pricing.”  My response back to him was that not only am I not a believer in good, better, best pricing, but I don’t believe that it is really value pricing at all.  That sparked a more spirited discussion.

First, a good, better, best pricing model relies on providing a base-level defeatured version of your product for a low price.  A version of your product with all of the bells and whistles at “premium” price.  And finally, a mid-range of your product with some, but not all of those features at a price somewhere between the two.  At first blush, this could seem like it is pricing to the value of each of those levels.  But is it really?

Studies show that in retail, given the option of good, better, best the majority of consumers will choose the better option.  Most consumers don’t want to be seen as cheap, nor do they want to overspend.  Thus, the “better” is often the easiest choice.  But, does that thought process really translate into the complex buying processes of B2B? With a few exceptions, it does not.

The definition of what is “best” is always in the eyes of the beholder, not what your engineers think, and not what your brochure might say.  And too often, ‘best’ is defined along one dimension (e.g., horsepower or number of settings) and usually fails to capture the complex economic trade-offs that your customers face when deciding what to buy.

In reality, ‘best’ is defined by each customer based upon their needs.  Some customers may have a less complex set of needs based on their situation and therefore the defeatured product adequately solves their problem.  That would mean that what we defined as good would really be best for that customer; and worse, what we are calling ‘best,’ they would call ‘over-engineered and over-priced.’ Defining different versions of your product as “good, better, or best” is really quite internally focused on what you think, and often almost arbitrary from the customers’ perspective.  How do you get past that?  The answer is segmentation.

Rather than arbitrarily bundling a set of attributes or features, you should first evaluate the needs of your customers.  What you are looking for is groups of customers that have the same set of needs, which we would define as a segment.  Then you can configure your product to meet those specific needs.  When you get done with this exercise, hopefully you will find a handful of different segments where all of the customers have a similar set of needs and you can design product and services to fit the specific needs of each of the segments you choose to target.  You may find that the customers that were traditionally buying what you defined as “best” don’t really need some of the features that you were providing, and you can lower your cost to serve them without lowering your price.  On the other hand, you may find that some of the customers that were buying what you defined as “good” could really use some of the other features, but they weren’t willing to pay the price for “best,” but by adding those features they would be willing to pay more than you were traditionally charging for “good”

Once you have your target segments and the offerings defined for each, you can then set about value pricing for each segment.  By doing this you will likely find that you can both increase your sales to each of the segments and increase your profit margins (by increasing price and/or lowering your cost).

Bottom line, effective value pricing relies on first having a good segmentation that is based on customer needs.  Or, as we often say in our workshops, “value and segmentation always go hand in hand.” Thoughtfully segmenting your market and understanding the needs of each segment is the only way to fully achieve the benefits of value pricing.  For more information on these topics, Grassroots Strategy explains segmentation in chapter 6 and value pricing in chapter 8.

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