When launching a company, the majority of entrepreneurs invest their imaginative energy into conceptualizing an idea and making it into a profitable product. You need to decide what the worth is of the product or service before you can sell it. This is where pricing strategy comes into play.
It is important to have competitive pricing and to choose the best pricing model for your business.
What is Value-Based Pricing?
The pricing strategy known as value-based pricing charges for products and services at a rate the company believes consumers are willing to pay. Instead of calculating production costs and adding a standard markup, businesses charge what they think the customer perceives the product is worth.
Value-based pricing is a method of setting prices based on the perceived value of a product or service to the customer, rather than on the cost of the product or service. This pricing strategy is often used with products or services that are considered to be unique or have high customer loyalty. All three of these industries take into account a few standard truths about value-based pricing:
- The market influences how much a consumer will be willing to pay for a product.
- The benefit that the product provides to the customer influences the value of that product.
- Competitors’ pricing can influence how valuable consumers perceive a product to be.
After considering these universal truths, companies then set prices based on their goals or the state of their industry. It’s used in a few different scenarios:
- Recognizing inelastic demand, where the need for the product is so high that a lower price would have little-to-no impact on unit sales.
- Highly competitive and price-sensitive markets, since the level of competition, usually settles at the price that consumers are willing to pay and charging more could turn away interested buyers looking for a good deal.
- Promoting prestige, where markups will be higher-than-usual to denote the exclusivity and grandeur of the product.
- Selling companions and add-ons to other products that enhance their functionality, like a new charger for your cell phone or laptop if your old one breaks.
For lower-priced products, the pricing is similar to that of the competition, while for those higher-priced products, the model shares a lot in common with pricing for prestige items.
Value-based pricing thrives on the ability to negotiate, so consumers must be prepared to do so. A conversation between the consumer and sales rep should take place in order to establish how much value the consumer places on the product and if the price reflects this. It is important for the seller to make a reasonable profit from the sale.
How to Choose a Pricing Strategy
This text is discussing how to create a pricing strategy that is effective for your business. It does not matter if this is the first or fifth pricing strategy you have tried, the advice in this text will be useful.
Understand costs
In order to determine your product pricing strategy, you will need to calculate the cost of bringing your product to market. The cost of goods sold is the amount you spend on each unit of product you sell.
You’ll need to calculate the total cost of materials and production if you’re creating products yourself. How much does a bundle of raw materials cost? How many products can you make from it? You should also consider the time you spend on your business.
Some costs you may incur are:
- Cost of goods sold (COGS)
- Production time
- Packaging
- Promotional materials
- Shipping
Short-term costs like loan repayments
The price of your product will take into account the costs necessary to make your business profitable.
Define your commercial objective
Think of your commercial objective as your company’s guide to setting prices. This will assist you in making any pricing decisions and ensure you are making progress in the right direction. What is your goal for this product? No, I don’t want to be a luxury retailer. Would I like to create a brand that is chic and fashionable, similar to Anthropologie? You should keep in mind this objective as you determine your pricing.
Identify your customers
This step is parallel to the previous one. The goal should be to find a profit margin that is acceptable to you and also what the people in your target market would be willing to spend on the product. Your hard work will only be successful if you have potential customers.
Consider the disposable income your customers have. Some customers are willing to spend more on certain items, while others are more price-sensitive and look for bargains.
Find your value proposition
What makes your business genuinely different? You need to find a pricing strategy that makes you stand out from the competition while still reflecting the value you are bringing to the market.
For example, Tuft & Needle offers high-quality mattresses at an affordable price. The company’s pricing strategy has made it a successful brand by providing a mattress option that wasn’t previously available.
Common Pricing Strategies for Small Businesses
After you’ve gathered the necessary information, you can select a pricing strategy. Here are some common tactics to get you started.
Cost-plus pricing: a simple markup
The easiest way to determine the price of a product is through cost-plus pricing, or marking up the product. The product is made, a fixed percentage is added on top of the costs, and it is sold for the total.
What would be the selling price for a shirt if you just started an online t-shirt business? The cost of making the t-shirt is:
- Material costs: $5
- Labor costs: $25
- Shipping costs: $5
- Marketing and overhead costs: $10
$45 is the “cost” of your product, so 35% of that ($15.75) is your “plus” or markup. Here’s what the formula looks like:
To find the selling price of an item, multiply the cost by the markup.
Competitive pricing: beating out the competition
Pricing your products below your competitors.
This tactic is usually driven by the product value. For example, in industries where there are few differences between products and price is the only differentiator, relying on price to win customers may be necessary.
Value-based pricing: customers’ perceived value of a product
This pricing strategy involves figuring out how much your target market is willing to pay for your product or service, then charging that amount. The approach starts with your target market’s wants and needs. Rather than including the cost of products in its pricing calculation, this method takes a different approach. Value-based pricing is more beneficial for companies that sell unique or highly valuable products compared to those that sell standardized, commodity items.
Some general requirements for using value-based pricing include:
- A solid brand
- High-quality in-demand products
- Creative marketing strategies
- Good rapport with customers
- Stellar track record
Value-based pricing is a pricing strategy where a company sets their prices based on the perceived value of their product. This is common in markets where a product enhances a customer’s self-image or offers a unique life experience. For example, people normally think that luxury brands like Gucci or Rolls-Royce are worth a lot. With value-based pricing, businesses can set the price of an item based on its worth or value. Companies need to have a product or service that sets them apart from the competition.
Price skimming: higher, short-term profits
An eCommerce business that uses price skimming charges the highest price that customers are willing to pay at first, and then lowers the price over time. As more people buy the product and competitors enter the market, the business can lower prices to attract a new customer base that is more aware of prices.
The goal is to increase revenue while demand is high and competition is low. Apple prices their products high in order to make up for the costs of developing new products, such as the iPhone.
Skimming is useful under the following conditions:
- There are enough prospective buyers that will buy the new product at a high price.
- The high price doesn’t attract competitors.
- Lowering the price only has a small impact on profitability and reducing unit costs.
- The high price is seen as exclusive and high quality.
Price skimming also works when there is product scarcity. For example, if there is a high demand for a product but a low supply, the price of the product will be higher. Once the supply of the product catches up with the demand, the price will go down.
The main advantage of price skimming is that it can lead to high short-term profits when launching a new, innovative product. Skimming can help maintain a prestigious brand image and attract loyal customers who want to be the first to get access to an exclusive experience.
The main downside to price skimming as a business strategy is that it doesn’t work well in markets where there are a lot of similar products available. Unless you have unique features that none of your competitors can copy, you’re likely to lose customers to other brands that are cheaper. If you cut the price too soon or too deeply after launch, it can cause problems for the people who were quick to buy your product.
Ways to Set Your Value-Based Price
To set a value-based selling price, a few extra steps are required. Price strategies can vary in their complexity, with some, like cost-plus, being relatively straightforward, and others requiring more consideration to arrive at the final price tag.
Analyze your customers
Your price point will only be based on what your customers are willing to pay, so you need to be confident in what that price point is.
To increase your customer base by 50%, find out how much your current customers would spend on your product if they saw its value. This pricing approach should be based on the perceived value of your customers.
Use these to reach out to customers to find out how much they would be willing to pay for your product.
Analyze your total addressable market
Although customer data is very useful for setting a price point, it may not be accurate because it only includes people who have already bought your product.
Conduct market research to determine how much your target market would be willing to pay for your product. This will help you set a price point that is accurate for acquiring new customers.
This kit will help you understand your competition and market position better so that you can find your ideal selling price.
Conduct a competitive analysis
If you cannot afford professional market research for your new product, look to your competition to get an idea of how much they charge and how similar your product is to theirs.
If you want to know how much your target market values your product, a good approach is to set your product’s price at a similar level to the prices of your competitors’ products. If sales are lower than projected, it could be because your competitors have stronger brand loyalty associated with their products. This could force you to adopt a competition-based pricing model.
This guide will help you uncover important information about your competitors without spending a lot of money.
The Pros of Value-Based Pricing
It could be easy to penetrate the market.
If your target market is not brand loyal, it will be easier for you to acquire market share compared to a market where people are loyal to one or a few brands.
If your product or service is differentiated from others, it is especially important to be clear about what your product offers. Luxury items that appear “new” or “limited” tend to sell well, especially when priced at a value-based amount.
Higher markups are possible.
The value-based pricing model benefits sellers when an item is seen as prestigious or culturally important. When customers are only interested in the value they see in a product, not how much it cost to produce, this is referred to as a value-based market.
There is a higher cost associated with owning something in the art, high fashion, or luxury car category because these items are seen as having more value. People are willing to pay more for things that have intangible benefits, like the work of a famous painter or a rare sports car.
This means that you can charge a lot more for your product if people believe that it is worth a lot.
Your perceived value can increase.
The value of your product or service is determined by your customers. You can try to influence how much they value your product or service, but ultimately it is up to them. Making your product seem prestigious or elite through branding and advertising can convince customers that it is worth a higher price.
You can also try to emphasize the value that your product creates instead of intangible benefits. A hammer is just a piece of metal and wood, yet it is invaluable to carpenters and handymen. The value created by this simple tool is immeasurable.
Is Value-Based Pricing Right for Your Business?
Three factors that are critical to value-based pricing are analyzing how the market affects perceived value, determining how much value your consumers place on the products you sell, and understanding how your competitors play a role in your value-based pricing strategy. This pricing strategy is not effective for all businesses, but it can be a good way to expand into a new market, make more money, and improve how the public sees the brand.
You can test to see if value-based pricing is right for your business by predicting your sales using different prices to see what revenue totals you would make. The HubSpot Sales Pricing Calculator can help you estimate your potential revenue from using various pricing strategies.
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