A Quick Guide to Value-Based Pricing - Harvard Business ...

I like to use this definition: “Value-based pricing is the method of setting a price by which a company calculates and tries to earn the ... Youhave1freearticlesleftthismonth. Youarereadingyourlastfreearticleforthismonth. Subscribeforunlimitedaccess. Createanaccounttoread2more. Pricingstrategy AQuickGuidetoValue-BasedPricing Reviewinghowtocalculateitanddispellingmisconceptions. by UtpalM.Dholakia by UtpalM.Dholakia August09,2016 Tweet Post Share Save GetPDF BuyCopies Print Tweet Post Share Save GetPDF BuyCopies Print Leerenespañol Leremportuguês Inmy15-plusyearsofworkingwithcompanies&teachingcoursesonpricingstrategiestoMBAstudents,Ihavefoundvalue-basedpricing(alsoknownas“valuepricing”)tobethemostcommonlydiscussedconceptthat’salsothemostmisunderstoodone.Itcreatesmoreconfusionamongmarketers,evenmanypricingexperts,thananyotherpricingconcept.Whatismore,thesemisconceptionsoftenleadcompaniestoshyawayfromusingit,insteadsettlingforcost-basedorotherpricingmethodsthatleavemoneyonthetable. WhatisValue-BasedPricing? Iliketousethisdefinition:“Value-basedpricingisthemethodofsettingapricebywhichacompanycalculatesandtriestoearnthedifferentiatedworthofitsproductforaparticularcustomersegmentwhencomparedtoitscompetitor.” Tounderstandhowvalue-basedpricingworks,let’staketheexampleofBrandAthatisabouttolaunchanewLEDtelevision.Itwantstofigureoutthepriceforitsnew65-inchLEDTV,thebiggestscreensizeinthemarketplaceatthetime.Thecompany’sclosestcompetitor,BrandB,recentlyintroduceda60-inchTVfor$799.BothTVshaveotherfeaturesthataresimilar—bothhavebuilt-inWiFi,thesamelevelofdefinition,samenumberofHDMIinputs,samerefreshrate,andsoon. Nowlet’sapplyvalue-basedpricingbyconsideringeachpartofthedefinitioncarefully: 1)Focusonasinglesegment.Thefirstthingtoknowaboutvalue-basedpricingisthatitalwaysreferencesonespecificsegment.(ForB2Bproducts,itcanbeasinglecustomer).BrandA’sfocusisonlyonbig-screenTVbuyers,notallTVbuyers.Marketerscan’tusevalue-basedpricingunlesstheyhaveaspecificsegment.Iftheyhavemultiplesegments,theymustdetermineasuitablevalue-basedpriceforeachone. 2)Comparewithnextbestalternative.Thispricingmethodonlyworkswhenthetargetsegmenthasaspecificcompetitor’sproducttheycanbuyinstead.Value-basedpricersalwaysaskthequestion:“Whatwouldthissegmentbuyifmyproductwasn’tavailable?”This“nextbestalternative”forthetargetistheessentialpointofcomparisonforcalculatingthevalue-basedprice.Forproductsthataretrulynew,withoutpeers,thevalue-basedpricingmethodologywon’tworkwell. 3)Understanddifferentiatedworth.Thenexttaskistofigureoutwhichproductfeaturesareunique,thatis,differentiated,fromthecompetitor’soffering.Inourcase,theonlydifferentiatedfeatureofBrandAisitslargerscreensize. 4)Placeadollaramountonthedifferentiation.Thelast,andarguablythemostdifficult,stepincalculatingvalue-basedpriceistoestimatethedollarvalueofthedifferentiatedfeatures.Forus,thisboilsdownto:“Howmuchwillbig-screenTVshopperspayforanextra5inchesofscreensize?”andthenaddthatamount(let’ssayitis$150)to$799,BrandB’sprice.Thevalue-basedpriceofBrandA’sTVis$949.Toaccomplishthisstep,marketerstypicallyuseresearchmethodslikeconjointanalysisorqualitativecustomerinterviewing. Onefinalpointaboutvalue-basedpricingisthis.Justbecausethedifferentiatedworthis$150doesn’tmeanthecompanywillgetitall.Inmanysituations(buyingorrentingahouseforexample),therewillbeanegotiationprocess,andthemarketermayhavetosharethedifferentiatedworthwiththecustomer. DispellingKeyMisconceptionsAboutValue-BasedPricing Value-basedpricingisusedinvirtuallyeveryindustry,topriceeverythingfromTVsanddrugs,tooilrigsandairplanes.Despiteitspopularity,marketershavesignificantmisconceptionsabouttheapproach.Herearethreeofthemostcommonones. Misconception1:Value-basedpricingrequiresthecompanytoevaluateconsumers’willingness-to-payforeachandeveryproductfeature. Somemarketerswronglybelievethatwhenacompanyusesvalue-basedpricing,ithastoassesshowmuchthecustomervalueseverysingleproductfeature,assignadollaramounttoeachone,andthenaddthemalluptocalculatetheproduct’sfinalprice.Eventhesimplestproductshavedozensoffeatures. ImaginethedifficultyofpullingthisoffforanoilrigorevenaTV.Thismisconceptionturnsmanymarketersoffattheoutset. Inreality,featurecommonwiththenextbestalternativeiscapturedbyitsprice.InourTVexample,thefactthatbothTVshave3HDMIinputs,built-inWifi,and4KUltraHDisincludedinBrandB’s$799.Wedonothavetocalculateeachfeature’svalueseparately.TheonlythingBrandAhastodoisfindthefeaturedifferencesandassesscustomers’valuationofthesedifferentiatedfeatures.Thisisaloteasiertodo. Misconception2:Evenifcompetitorsarenotsmartwithpricing,usingvalue-basedpricingwillleadtosuccess. Thisislikelythemostdangerousmisperceptionaboutvalue-basedpricingbecauseitcancreatefalse,highexpectations.Manymarketersthinkthatvalue-basedpricingisapanacea.Iftheyuseit,theywillmakelotsofmoneyunderanycircumstances.Nottrue!Thesuccessofvalue-basedpricingdependsonhowsmartlycompetitorshavepricedtheirproducts.Iftheyhavesetuntenablylowprices,value-basedpricingcan’tsaveyou. JustimaginewhatwouldhappenifBrandBfoolishlychosetosellitsTVat$399insteadof$799.BrandAwouldstillbeonlyabletochargethe$150extraforitslargerscreensize,notanymore.Itwouldendupwithalowprice,andperhapsevenlosemoneybecauseofBrandB.Competitorshavetopractice“intelligentpricing”ifvalue-basedpricingistoworksuccessfully. Misconception3:Thebrand’svalueispartofthevalue-basedpricingcalculation. Withvalue-basedpricing,themarketer’sgoalistoputadollaramountonitsdifferentiatedfeatures.Themethod’sfocusisonfeaturesthataddvaluetothecustomerandthatcanbeconvertedintodollarsandcents.Featuressuchas“longer-lastingbyX%,”“fasterbyYhours,”“lesslikelytobreakdownbyZ%,”allworknicelybecausetheycanbeeasilyconvertedintomoney. Butit’smuchhardertodealwithabrand’svaluethisway.Thisiswhybrandvalueisleftoutoftheequationwithvalue-basedpricing.AnditisonereasonwhythemethodismorepopularinB2Bsettingsthatgivelessweighttothebrandvalue. Value-basedpricingisaneffectivemethodtopriceproducts.Ontheonehand,it’saloteasierinpracticethanitappearstobeintheory.Themarketerneedstoidentifyandassessitsproducts’differentiatedfeaturesonly(exceptthebrand’svalue),noteveryfeature. Andwhencompetitorshavepricedtheirproductsfoolishly,value-basedpricingwon’thelp.Withastrongergraspofhowthismethodworks,marketerswillbeabletomakesmarterpricingdecisions,andemployvalue-basedpricingtoincreaseprofits. ReadmoreonPricingstrategy UtpalM.DholakiaistheGeorgeR.BrownProfessorofMarketingatRiceUniversity’sJesseH.JonesGraduateSchoolofBusinessandauthorof HowtoPriceEffectively:AGuideforManagersandEntrepreneurs.   Tweet Post Share Save GetPDF BuyCopies Print ReadmoreonPricingstrategy PartnerCenter Diversity Latest Magazine Ascend Topics Podcasts Video Store TheBigIdea Data&Visuals CaseSelections