The Pros and Cons of Implementing a Value-Based Pricing Strategy
Wouldn’t it be great if you could price your services by shaping how your clients perceive the value you provide? Welcome to value-based pricing, a pricing strategy that has the potential to explode your profits.
What is value-based pricing?
When you employ value-based pricing, you set your prices on your service’s value to your clients. This should let you maximize revenues and profits:
Your competitor’s prices are not a restriction, as they are when using a competition-based pricing strategy
You free yourself from the mindset of a set profit margin, which is the foundation of pricing models like cost-plus pricing
Value-based pricing determines the price that people are willing to pay for the value that your service provides. It works best when you can demonstrate uniqueness or high-value features.
Can you really influence what clients are willing to pay?
It might seem weird that a client would be willing to pay a far higher price for what is, essentially, the same service . But we all do it. We’ll pay more for a coffee from our favorite café. We’ll pay more for a meal at a top restaurant (think flavorful French cuisine v a boring McBurger).
The Ramsey effect: a value-based pricing example
Sticking with the theme of dining out, here’s a great example of how much extra people will pay for what they consider a premium meal: Outback Steakhouse v Gordon Ramsey Pub & Grill.
Visit Ramsey Pub and Grill & Grill, and order soup to start, with a main course of fillet mignon with fries, and a brownie for dessert, and you’ll need to hand over almost $100 – before gratuity.
At Outback Steakhouse, order soup, fillet mignon with fries, and a brownie for dessert, and you’ll be charged $55. For an extra $6, you could add a lobster to your steak. And you just know that you won’t be able to eat for a week after.
Both restaurants serve the same basic human need for food. But Gordon Ramsey’s product is that little extra special, and for many diners most definitely worth double the money. Yet it’s basically the same raw ingredients. That’s what I call the Ramsey effect – and it’s a great example of value-based pricing.
The psychology behind value-based pricing
That extra pricing boils down to the perception of value, and the way you differentiate your service.
Value-based pricing strategies work because clients believe that you are providing a specific service that enhances their image, produces unequaled experiences, or delivers higher understanding, ability, etc.
The price that clients are willing to pay reflects the value that clients assign to the service. It also reflects the circumstances of the customer.
You might talk for weeks about the great meal and service you got dined at ‘Ramsey’s place’. Not so likely to brag about filling your stomach at Outback.
The Million Dollar Logo
How much does the design of a new logo cost? If you’re Pepsi, $1 million. In 2008. For a logo.
Now, why was Pepsi willing to part with so much cash for a logo redesign? Because they could afford it, and it was crucial that they got it right. Even though many market watchers felt that Pepsi overpaid by a long way, Pepsi was happy with the result.
Arnell’s documentation described the logo they created as displaying the ‘gravitational pull’ of the brand, in proportions of the golden ratio (which plays ‘an essential role in human perception of beauty), and ‘going back-to-the-roots moves the brand forward as it changes the trajectory of the future’.
When selling the service of creating a new logo, Arnell got the first rule of value pricing spot on – know your client.
How to do value-based pricing
To be successful with value-based pricing, you must:
Offer a service that is different (or seems different) from competitors’ services
Provide a service that is client-focused, and customized to meet the particular needs of a particular client.
Create a service that is high in quality and considered high in value
Let’s look at how to put these elements together in a value-based pricing strategy.
1. Know your clients
It’s imperative that you know your clients. Everything about them. Most importantly, the way they think and feel. What is it that motivates them? Like a clothes shop learns whether a customer wants to stay warm (any coat will do) or wants to look stylish (Canada Goose is worth far more).
You also need to know where you will find your clients and who they are, but your ability to sell based on value is how well you deliver to their problem. You’ve got to learn the ‘why’ of your clients.
2. Know what your customer wants
Identify your ideal customer’s most pressing issues. Ask these questions:
Why do they want to buy your service?
What services are they currently purchasing?
What are their main concerns about the services they are using?
You must gain a deep understanding of the problem your client has and the outcome they desire. A great strategy for this is the ‘jobs-to-be-done’ framework.
When using the jobs-to-be-done framework, you uncover all of your client’s needs. You learn about their struggles. You discover how to solve their pain. It’s this deep insight that gives you the knowledge to produce highly customized solutions. Services that take your client from pain to pleasure.
Make sure you ask questions that discover the problems that the customer has, elements that would enhance an existing solution, and what would get them really excited about your service.
3. Develop your service
Now, take the knowledge that you have collected in the first two steps to develop and customize your service for your client. This is where you do the highest level value creation – and eliminate your competition! As you do so, consider the following:
How does it solve the problems your potential clients need to be solved? How does it change their experience, feelings, or status?
How does this solution compare with your competitors – making it different, and better?
What extra does it give, or how is it unique?
Of the elements that give your service its uniqueness, can any (or all) be offered separately?
What costs must be covered by the selling price of the service?
How quickly can you deliver the solution to the market?
As you develop an offering, always remember what Harvard Business School marketing professor Theodore Levitt has to say:
“People don’t want to buy a quarter-inch drill. They want a quarter-inch hole!”
So, what does this actually mean? Here’s an example:
A client of mine was approached to help a company that was merging with another. The merging company wanted the process to run smoothly. It didn’t want to lose any employees, and it desperately needed to ensure that the merger was a success.
What my client did was to get a deep understanding of the problems the business faced. Most importantly, it gathered a huge amount of insight into the results it wanted to achieve. It learned that the company it was merging with also had the same desires.
My client then designed a solution that ensured all of those desired results were met – not just by his clients, but by both companies. My client was able to say, “Here is a customized model that will enable you to take advantage of both of your companies’ strengths and crush any weaknesses. This solution could add millions of dollars into your combined sales while drastically reducing your costs.”
My client sold the outcome, not the method of doing it. They sold the hole, not the drill – and ended up working for both merging companies.
When you adopt this mindset, you’ll see the value of your service take off. Customization of service enables customization of price – all you need do is make sure that the price you charge covers the costs of development, delivery, time, and of course, includes your profit – whatever you decide that should be.
4. Forget pricing analysis
It’s at this stage that you may consider conducting pricing analysis. This is the traditional way of thinking – central to competitor-based pricing (which your service business really wants to avoid – it’s a trap to limit your profits).
Your service is now so customized that there is no comparison to be made. Your job now is to estimate what your differentiation is worth to clients. Give this a dollar value. This is what you will charge.
Test your price
Here is where the real fun begins. It is time to test your pricing in the market, by charging the price you have placed on your service. Then watch how your sales react to your new pricing and adjust accordingly. This takes courage, but it’s the way that the most profitable firms sell. The secret is to be ready for objections by knowing the value you bring to the table.
What do you think Gordon Ramsey would say to a customer who compared the meal at Pub & Grill to the meal at Outback? I can hear the conversation now:
“A hundred bucks for the same food I can get at Outback? Are you nuts?”
“No,” says Mr. Ramsey, “but you are if you eat elsewhere.”
Price it. Charge it. Perfect your pricing, always remembering that what you are offering has a uniqueness that adds a huge value to your client.
Remember, though, that fewer sales at higher prices could mean less work and higher profits. It’s all about offering the right value to the right clients at the price they consider provides value for their money.
The pros and cons of value-based pricing
As with all pricing strategies, there are both pros and cons to consider.
The potential to develop higher price points
If your clients are willing to pay higher prices for greater perceived value, you can start at higher prices. As you add more features, you can price higher.
Promotes innovation of higher value
Moving to a value-based pricing model encourages you to continually aim higher, developing new innovative services that will enable you to push prices even higher. This also helps you stay ahead of your competition.
You naturally deliver better service
You will conduct much of your research and analysis by contact with your clients.
You’ll ask what they like and don’t like, what their issues are and what problems they are experiencing. You’ll give them the opportunity to voice their opinions and suggest improvements, and you’ll deliver a service that promises the outcome they desire.
This level of engagement with your clients will be viewed as great customer service – and this should help you develop enduring client loyalty.
You must commit time and resource
Sounding out your clients takes time and resources. You don;t gain deep insights in a single, five-minute online survey.
Your pricing may never be fully optimized
You will need to continually assess your pricing. Customer needs and wants change, as does their ability to pay.
You can’t set-and-forget value-based prices. You must continually offer value and deliver to perceived value.
You must be courageous and confident
I won’t beat about the bush. It takes courage to price on value. You’re not following others. You’re standing up to be counted. How do you do this? By being confident. You know your service will deliver. You know there is nothing to compare it to.
Is value-based pricing right for you?
Value-based pricing is the pricing strategy that has the power to deliver enormous differences in your profit margins.
To make it work, you must be highly client-focused, understand your client’s needs and desires, and have the courage and confidence to charge for a highly customized service that delivers value that your client simply would find elsewhere.
When you do it right, the ultimate outcome of value-based pricing is higher-quality services sold at higher prices with higher margins. It’s also a strategy that you can combine with tiered pricing to drive your sales sky-hig. If you’d like to know how to blend these strategies successfully, contact us.
You want to know more about pricing? Download my eBook ‘How to Raise Your Prices without Losing Your Clients’.
Also, if you have any specific questions or advice you need, please don’t hesitate to contact us.