Prices based on customer benefit through value-based pricing

In many companies, it is common practice to determine prices using “cost plus” or to base prices on those of the competition.
These types of pricing do not focus on the customer.
What are the disadvantages of this?
How does value-based pricing differ from these methods and what potential does it offer?

Advantages and disadvantages of cost-based or competitive pricing

In practice, prices are often calculated using two simple methods.
In cost-plus pricing, the company primarily bases its prices on production costs and also calculates a profit mark-up.
Competition-based pricing mainly incorporates the prices and offers of the competition into pricing, so that the company’s own prices are based on average prices or the prices of certain competitors.
Both methods have the advantage that the required data is relatively easy to obtain, the resulting prices are generally considered fair by the customer and the price pressure resulting from the competitive situation is taken into account.
However, this type of pricing can lead to suboptimal prices being calculated, which are either too low and thus give away margin, or too high and thus destroy sales opportunities.
The biggest disadvantage, however, is that the customer’s needs and requirements are neglected.
For the customer, neither their own production costs nor those of the competition are the focus of the purchase decision.
What is important for them is how high they estimate the value of the product at the time of the purchase decision.

Potential of value-based pricing

Even if cost-based or competition-based pricing is rarely used in its pure form, a holistic pricing process should also take into account the customer’s requirements and different price propensities in addition to the company’s own production costs and competitive prices.
This is where value-based pricing comes in.
Value-based pricing can be translated as “value-based pricing”, i.e. pricing is primarily based on the value created for the customer.
An attempt is made to set the price by determining the added value of an offer for the customer or to empirically determine their offer-related willingness to pay.
In order to be able to use value-based pricing, the value or benefit of a product for the customer must be known and measurable.
The different requirements of different customer groups for a product can be mapped through versioning.
Determining the value of the product for the individual customer is often more problematic when using value-based pricing.
This is due in particular to the following factors:

• The value of a product for the customer is a subjective assessment. For one customer, a well-known brand may result in a higher willingness to pay, while another customer may not consider the value of the product to be higher due to a brand name.

• Willingness to pay varies depending on the context.
  For example, a customer’s willingness to pay for an ice-cold beer in a good restaurant will be higher than for a beer of the same brand from the supermarket.
  The willingness to pay also changes with the urgency with which the product is needed.

In addition to these factors, the acceptance of a customer-specific price also plays an important role.
In the airline and hotel sectors, customers have become accustomed to the fact that the purchase price varies depending on the date of travel, customer status, sales channel and time of reservation.
However, this does not apply to all sectors, as an example from Amazon in the USA shows.
Customers noticed that the prices for books fell as soon as they deactivated cookies.
As soon as the cookies were reactivated, the prices for the corresponding books rose again.
Amazon had tried to adjust the prices for the books to the purchasing behavior of the customers.
In this case, value-based pricing was not accepted by the customers.
Even if determining a price based on customer benefit is significantly more complex than a cost or competition-based price, this process is worthwhile.
This is because it enables the customer’s willingness to pay to be exploited in an almost optimal way and therefore holds great potential for increasing margins and boosting earnings.

Conclusion

Determining and evaluating the basic information for the use of value-based pricing is more complex than cost-based or competition-based pricing.
The potential of value-based pricing can be seen in the fact that the customer is no longer offered a product at the lowest price, but at a fair price that corresponds to the benefit of the product for the individual customer.
To do this, the company must know what the customer’s requirements are for the product and how they assess the benefits and value.
Through targeted versioning of products, the creation of product bundles and the use of different sales channels, a product can be offered to each customer group at a price that is optimal for them and thus the individual willingness to pay can be skimmed off.
UNEX has developed a model for this based on Power BI and Excel, which determines willingness to pay and updates this in the future.
This is because willingness to pay changes over time.