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Value-based pricing is a highly effective method used by a variety of industries to price innovative new products.
The goal is to calculate the differential worth of the features the product may have. A pre-defined segment of customers will assign value and a dollar amount to those features in order to calculate the final selling price.
However, the concept of value-based pricing is often misunderstood and therefore companies will opt for cost-based or other pricing methods which may leave money on the table.
In this month’s blog, we explore what value-based pricing is and dispel what the common misconceptions are.
Value-based pricing can be used in every industry to price everything from cars and TVs to drugs and medical devices. Despite its popularity and success many people have misconceptions about what value-based pricing is and what is involved. Below we have listed the main ones:
This misconception can create dangerously high expectations about value-based pricing. The success of this approach actually depends on whether competitors have practised intelligent pricing when they decided the price of their product.
If they have misjudged the value of their product, and priced it too low, using value-based pricing for your product will not help you gain a profit.
Imagine that the dollar amount customers assign to the new differential feature of your product is relatively high. As the value of common features are captured in the price of existing products, you may still end up with a low price and perhaps even lose money.
Some mistakenly believe that value-based pricing research involves evaluating how much the customer values each individual feature of a product, and to assign an amount of money they would pay for each. You would then add up the assigned price for each feature in order to calculate the product’s final price.
In reality, this would require a huge amount of work, as even the simplest medical device (for example, consumable medical devices) has multiple features. This misunderstanding can discourage marketers from using value-based pricing from the offset.
With this approach we do not have to calculate the value of each feature separately. Instead, we need to identity the differential features of the new product (vs. existing competitor products) and understand the value customers places of these features. The value of the common features will be captured in the price of existing products.
The goal of value-based pricing is to put a dollar amount on the new differentiated features of a product. It focuses on evaluating new features that will add value to the customer and that can also be assigned a monetary amount.
For example, introducing a new feature on a POC device that allows bilirubin levels to be measured in newborns non-invasively works nicely, as most accurate tests are done invasively.
But measuring brand value in this way is much harder to do, which is why this is often left out and why it is favoured in settings that place less weight on brand value.
In order to use the Value Based Pricing method, the marketer needs to consider the steps listed below:
The first thing to note about value-based pricing research is that it always focuses on one specific customer segment. When planning your market research project, it is important to consider this when defining your target sample.
In order to achieve this sample, you will need to write a screener which consists of a series of questions that will either screen respondents in or out based on their job role/setting/use of the product.
The ‘next best alternative’ is a crucial point of comparison in a value-based pricing study, without it you will not be able to calculate a reliable value-based price.
As we have mentioned value-based pricing focuses on the value of the differential feature/feature set your new product has, you are relying on the price of the competitor product which shares common features to make the final calculation.
For this, consider which product your target customer segment would buy if yours was not available.
Next you need to figure out which product features are unique compared to the competition. You will need to assess the extent to which your pre-defined customer segment values these features.
The final and most difficult step in the process is to place a dollar amount on the differential features. With this you will be able to calculate a final selling price.
Essentially, it boils down to “How much more will my customers pay for this differential feature/feature set?”. Conjoint analysis is a highly effective method to use in order to accomplish this step.
If used correctly, it can help companies gain significant profit with their new innovative product, as it considers the value of the new features. Although it does not work well in every case. It is important to investigate different pricing methods and consider what would be the most appropriate one for your next pricing project.
As a renowned market research industry leader, we have conducted projects in over 30 countries to drive success of brands, products, and services of our clients.
If you are interested in conducting a value-based pricing project do not hesitate to contact us. We would be delighted to offer a primary consultation, by telephone or face-to-face, to discuss how we can assist you.