Value pricing is an elusive topic but when done properly it can lead to long periods of exceptional profitability. We often hear companies improperly refer to their pricing methods as “value pricing,” when they are far from it. Like anything else, just using the words does not improve results, you actually have to use the framework to make different decisions about pricing. And because the competitive landscape changes over time, your value pricing needs to evolve over time. There are some things that you can do to ensure that your value pricing strategy will deliver the desired results.
Pricing Schemes Masquerading as Value Pricing
Value pricing starts with understanding the differential value your offering delivers to a customer relative to their next best alternative. There are several pricing schemes that may appear to be value pricing, but are not. Here are a few examples:
- Premium pricing: although this may appear to be value pricing, unless you set the premium based on measurable customer value then you are merely guessing at what the price should be. Not value pricing.
- Raising prices: if you raise your prices and don’t lose customers that would seem to indicate that you are delivering customer value relative to their next best alternative, but if you don’t understand the differential value your offering delivers relative to their next best alternative then you are merely guessing (and lucky if you don’t lose customers). Not value pricing.
- Pricing to total value created relative to doing nothing: unless there truly isn’t another competitive alternative, pricing to the total value your offering creates is problematic. It ignores the possibility that another alternative could deliver some of that value and risks losing the customer to a competitor. Value pricing misunderstood.
- Tiered or package pricing: if the tiers are designed for specific segments of customers with specific needs that are met by a specific grouping of features and delivers a specific amount of value then this could be value pricing. That is rarely the case though, it is often just bundling to get higher prices or worse yet volume discounts. Not necessarily value pricing.
Most pricing schemes are poor substitutes for true value pricing but are often used because they are easier. Don’t be lazy. Do the hard work to implement value pricing if you want to see results.
Two Examples of Value Pricing Failure Modes
Example 1: Not Understanding Value by Segment
In this example the company was pricing their product relative to the next best alternative of the majority of the market. Because for the majority of the market their product didn’t deliver any additional value relative to an entrenched competitor, they were discounting their product, not just a little bit, but up to 80% off the price of the predominant alternative. In the end it turned out that for a specific segment (about 15% of the total market), specific features of their offering delivered value of 2-3 times the price of the competitive offering. By pricing to value in that segment of customers, and not trying to compete where they could not win, they were able to raise their prices by a factor of 8 (not 8% but 800%), lower their selling cost and dramatically improve their profitability.
Example 2: Pricing against Current State rather than Alternative Solutions
In this example the company was trying to price to the total value created by the solution relative to what their customers were doing today. Unfortunately for them, there were other competing solutions in the market that delivered most of the value that their offering created and were priced significantly lower. This meant that they were closing very few sales at their intended price and the handful of uninformed customers who did buy experienced serious remorse when they discovered that there were competing alternatives. With sales lagging well behind plan, the company changed their strategy to focus on specific solution areas where the competing alternatives did not work as well. This allowed them to capture more value as well as lower their cost to serve.
Value Relative to Do Nothing
We are often faced with situations in which we are selling to potential customers where we can clearly see that our solution will create value (for example save the customer money) relative to what they are doing today. In these instances, we may be tempted to believe that we can price to this customer or other similar customers in the market relative to the “total value created” (see right). In reality, “total value,” although enticing, is usually irrelevant – value is by definition always relative to the next best alternative. Yes, with some new to the world products, there is no existing in-kind solution, and in these rare cases, you can value price relative to the ‘do nothing’ alternative or status quo solution. However, if alternatives similar to your solution exist or could be developed quickly then pricing to capture all of this a value would be a misapplication of value pricing.
However, if alternatives similar to your solution exist or could be developed quickly then pricing to capture all of this a value would be a misapplication of value pricing.
Value Pricing Relative to a Competitive Alternative
In general, a competitive alternative either exists, or could exist in the near future, that delivers at least some of the value that your offering creates. So, your maximum price is actually limited by the competitor’s price and the differential value that your offering delivers relative to that competitive alternative.
Don’t be fooled by the total value created when a competitive alternative exists (or could easily exist in a very short time). Although this does provide value for the customer, you cannot price to that total value and win – customers are smart enough to find alternatives, even if they are not currently aware of them. Some of our clients have lamented that this means prices are determined by the ‘dumbest competitor,’ and there is some truth in this. If all similar solutions were priced relative to the old status quo, prices would be higher for everyone. However, short of collusion (illegal, at least in the US), there is no way to force this outcome – good marketing strategies have to work in the world as it is, not the world as we wish it to be.
Five Musts to Value Pricing
There are a few imperatives to improve your value pricing.
1. Understand the value your offering creates for the customer relative to the current state.
2. More importantly understand the value your offering creates relative to the current next best alternative.
3. Make sure you understand where further competitive alternatives could come from and when they are likely to be available and how this will change the relative value you create.
4. Make sure your price is set not just based on the customer’s current state, but on their next best alternative or their likely next best alternative in the near future.
5. Frequently evaluate the competitive landscape to be sure that things haven’t changed.
Missing just one of these steps will undermine your efforts to value price.
Conclusion
Value pricing, when done right, is one of the quintessential mechanisms to optimize business profitability. But doing it well requires a commitment to embracing the concepts, using them correctly, and keeping them up to date as markets and competitors evolve.
