The impact of pricing on the bottom-line by far exceeds the effects of cost-optimization or volume gains. But although pricing is the key profit driver, many companies do not get it right.
Most B2B companies still rely on a cost-plus pricing approach which derives selling prices by determining the cost of the product or service and adding a markup on top. Despite being a simple and intuitive pricing approach, cost-plus can affect margins negatively, as opportunities deriving from the customer’s real willingness to pay might not be fully exploited.
In contrast to cost-plus pricing the value-based (sometimes also called customer-focused) pricing approach takes full advantage of the customer’s willingness to pay. As the competitive position of the product or service and its perceived benefits very much influence the achievable markup and final price point, this pricing strategy is considerably more difficult to be established than cost-plus.
As value-pricing is a smart way to boost your profits, we want to give some inputs on how you could make it work for you and how you could get started.
First, you need to work out all costs incurred that need to be recovered. This would result in a base price of your product and service.
Second, you need to specify and evaluate all value drivers (specific benefits that the product or service provides to the customer compared to competition) the customer is willing to pay for.
here are 4 aspects you must factor in to performing value pricing:
- Know which are your target customers, based on the products values/characteristics they look for.
- Assess which are the value drivers of your products. This seems to be very complex but remember, you do not need to consider each component of the product, but only the aspects that provide extra value to customers. Keeping that in mind will make it easier!
- Associate a monetary value to each value driver: how much extra are customers willing to pay to get the special product or service you offer. To get started an approximation can be derived from historic data or to be more precise you engage in a panel based conjoint survey to deep dive on that matter.
- Benchmark with competition.
A simple example will illustrate how value-pricing could be implemented.
As sales manager for corrugated packaging, you can offer boxes with special coating, a unique finishing and have the possibility to supply different order sizes to different customer segments in different geographical areas.
To engage a value-based pricing strategy you first need to know your customers’ exact needs. On a granular level that is possible through detailed customer analysis and interviews. Alternatively, surveys, panels and subsequently a needs-based segmentation could be performed to understand needs of individual customers or market segments (we have addressed this topic in detail in one of our last articles).
After clarifying your customers demand and needs, you need to assess the extra value provided through your product or your service (in our simplified case: special coating, the flexibility in order size and geographical supply). You will then need to apply markups per single value driver to establish a final product price.
The benefits of value pricing go beyond this; they are also reflected in product development and innovation.
In fact, understanding the full benefits you provide and benchmarking value drivers with competition, helps developing innovative products tailored to the market you operate in. This will not only allow to stay ahead of competition but will also increase customer satisfaction, as you provide products and services that your customers truly want and need.
Finally, value-pricing empowers the sales force giving it a comprehensive understanding of customers’ needs and how these can be satisfied through specific benefits: price discussions will be replaced by conversations about the added value the product or service delivers to the customer.
To summarize, value pricing is more complex than the traditional cost-plus approach, but the effort to develop it pays off through increased results and long-term optimizations.
To develop a value pricing strategy, you need to consider:
- Customer needs
- The value drivers of your offering
- The monetary value of those value-drivers
- Competition
The improvements you can get through smart value pricing are:
- Increasing profitability and avoiding missing opportunities
- Customer satisfaction
- Innovation in product development
- Empowerment of the sales force
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