Deciding on the right price for your product or service can be a challenge, especially during any major disruptions to logistics which could upset the balance of the supply chain and redefine what consumers need versus what they desire.
In this article, we’ll cover the fundamentals of value-based pricing, so you can find the sweet spot when deciding your pricing strategy in any economic climate.
The simplest way to price your product or service is to calculate its total production cost, then mark up that amount based on a desirable profit margin and/or the price of competing products. This is called cost-based pricing.
The problem with this approach is that customers usually don’t know or care about your costs. Their focus is on the potential value of the product or service to them. How productive, profitable and happy will it make them?
Value-based pricing takes a customer-centric view of your product or service. Instead of looking inwardly at your business, you look outwardly at customers’ willingness to pay based on their wealth, attitudes, beliefs, and goals. In doing so, you could maximise your revenue while keeping buyers happy and competitors at bay.
How do buyers evaluate value?
There are potentially dozens of conscious and unconscious factors to think about when a customer considers a purchase. Here are four of the most influential:
Ability to pay - Just because a customer can pay a specific price doesn’t mean they always will. How substantial is your price relative to what they earn as an individual or a business? If you’re expanding into a new market, you’ll need to consider if the average wealth and disposable income of your target demographic are different from your current market, then adjust your price accordingly.
Value proposition - How much will your product or service change the customer’s life? Rubber gloves might protect their hands while they clean, but a safety gate at the top of the stairs could protect their child’s life. How can you demonstrate the value your product or service can bring to your customer's lives? The more integral the product is to the things they care about, the more they’ll likely pay.
Convenience - What situation are buyers in when they make the purchase? A pocket-sized umbrella could be worth more to someone who’s emerging from a subway onto a rainy street than someone sat cosily at home browsing an online store. Identify all the ways you make the purchasing journey convenient, be it through stellar product education and clear marketing, speed and ease of delivery, after-sales support, or something else.
Comparison - What is your target customer’s “second-best option”? This is what they’re likely to compare your product or service to when making their buying decision. If you can’t differentiate your offering based on extra features, added convenience, or another value proposition, you will inevitably be compared on price alone. Comparison works in other ways too. How much does your product cost today versus last week? How much does it cost to buy three units instead of one?
Putting it all together
There's no single formula for calculating a value-based price as it's necessary to take a holistic approach that considers hard factors (e.g., production costs, export expenses, competitors, etc.) and soft factors (how people feel when they use your product or service).
Start with fundamental numbers. You can’t price your product lower than what it costs to produce, so that’s where you can begin.
Is there a like-for-like offering already on the market? If you can’t differentiate your product or service from it/them, your freedom will be limited when setting your own price based on the value you believe it offers.
Should all customers be offered the same price? If your target market contains a mix of buyer personas, you could consider “versioning.” That means offering an upgraded, extended or a customised version of your product to certain customers who will appreciate and pay more for the added value.
Be responsive. Cost-based pricing takes a fixed approach, whereas value-based pricing is inherently reactive. Be prepared to change your prices in response to competitors, economic conditions, fashions, and other social factors. This is especially important right now as the Covid-19 pandemic has reset consumers’ expectations for which products and services are relevant, which means many businesses must rethink their marketing and pricing strategies from the ground up.
The goal is to show that you understand your customers' preferences in these challenging times and that, where possible, you’re willing to put their needs before your bottom line by offering them better deals or more favourable terms.
If you’re feeling the strain of keeping customers engaged while protecting your cash flow, you can speak to us or your HSBC Relationship Manager for guidance.