Getting Value-Based Pricing Right Is Difficult, But Worth It
Read Time: 5 Minutes
Establishing the right price isn’t easy. Value-based pricing focuses on how to optimally monetize a brand’s value. By comparison, the more often used cost-plus approach monetizes the cost of a product with a markup.
Value-based pricing works when the markup reflects the value your customers perceive. It requires comprehensive knowledge of what your product is worth to your customer or prospective customers. They may be happy to pay a $40 or $80 premium but nothing more if they don’t see a meaningful difference from competing products.
Pricing Insight Is Elusive
Value-based pricing must go hand in hand with value-based product development. Companies should develop products based on a clear understanding of what customers value and price the products based on a good understanding of their assets. If customers don’t see these assets, they’re simply not there. Customer-perceived value, or the customer’s willingness to pay, is therefore the single most important piece of information. It is also the most elusive.
You will not easily find reliable data on willingness to pay. Only very few companies have the means and the will to systematically experiment with prices in the marketplace. Historical sales numbers are also not helpful here. They describe what prices customers have accepted in the past but do not describe what they would have paid in other scenarios or what they will pay in the future. It’s also difficult to ask customers directly. Many will give a price below what they’re willing to pay.
Even if you obtain reliable insights on a customer’s willingness to pay, the information is likely to expire soon. Consider how the pandemic is disrupting people’s willingness to pay for travel or office space, or how technologies such as cloud computing have disrupted a company’s willingness to pay for software and infrastructure. These changes and disruptions have implications about what buyers perceive as meaningful assets, and businesses cannot trust today’s value-based price to hold steady for the next year or two.
Pricing Research Is Worth the Effort
Because smart value-based pricing is likely to lead to success, it is almost always worth the effort of gaining insights into customers. But smart pricing requires deep research to observe customers, what they want, and what they are willing to pay. You can use the insight gleaned from this research to develop optimized products and services, the right features, benefits, and — of course — the best price. Customer insights will also help adapt and transform business models or strategies to capture value with the right payment model.
Toward Effective Pricing Research: Van Westendorp
Pricing research involves much more than just asking about price acceptance in a survey and putting a price tag on a product. It considers the customer’s perspective on the perceived value of products, benefits, and features throughout the entire product development and life cycle.
There are two methods to discern customers’ willingness to pay. The first is a simple and nimble tool to understand price sensitivity in product development and, in particular, early product development. The second is more complex and extremely powerful. It’s an approach for innovation and for the optimization of product and price together.
The first method, Van Westendorp’s Price Sensitivity Measurement, does not directly ask about the accepted price. It identifies critical price thresholds. Respondents divide a spectrum of prices into critical areas. In a survey, we would introduce a product or service concept and ask these questions: At what price would you say that this product is cheap, so that you would doubt the quality? Or too expensive, so that you would no longer buy it? These insights into customer price sensitivity to a new idea are often good enough in early innovation. This early insight can help to align product development and pricing from the beginning.
It’s not necessarily difficult and expensive to get these early insights. Bear in mind, this method is not recommended for testing multiple concepts. If you have four ideas, you don’t want to ask these questions four times in a row in the same survey. If you want to understand what really constitutes added value as perceived by customers, or to optimize the price architecture for a portfolio of products, there’s a better method.
Toward Effective Pricing Research: Conjoint Analysis
Conjoint analysis, or discrete choice models, is very popular across industries, including services, automotive, electronic devices, and software. Many companies use the method regularly as they can see how accurately it explains and predicts the choices people make when buying products.
Conjoint analysis can be used to price products as well as optional features. It can be used to determine the best feature and benefit mix in new product development. It’s also great for existing products that need to be adapted to changing customer needs.
So how does it work? We break a product into parts, like a house made of Legos. In a conjoint survey, respondents would not assess bricks, roofs, or doors, they would choose among houses. From these choices, we can derive the perceived value of bricks, roofs, and doors. These perceived values can then create “what if” scenarios and build hypothetical new concepts and products and simulate that preference share among customers.
In the conjoint exercise, we’re not asking direct questions — we’re just asking people to make choices. They probably won’t even know that this is a pricing study. They are just expressing their preference among products.
The goal of all this is to learn how customers would choose in hypothetical situations, not to understand choice among products as they are today.
Learning from data, as opposed to only having the data, requires a full grip of your underlying business goals. The two sides complement each other, like Lennon and McCartney. Bringing methodology expertise and subject matter knowledge together in an efficient and fruitful way is a challenge, but it’ll be well worth the effort.
Read our other article in the GLG Applied: Value-Based Pricing Series:
Value-Based Pricing Research: What Is Conjoint Analysis?
About Bernd Grosserohde
With over 20 years of marketing research experience, Bernd Grosserohde has worked with many global companies on building stronger, more profitable products. His area of expertise covers choice modeling, segmentation, and other advanced analytics tools. Before joining GLG, Bernd held a position as Global Head of Pricing and Portfolio Management at Kantar. He is based in Hamburg, Germany.