Value-Based Pricing Pros and Cons

So the third pricing model is value-based pricing and value-based pricing is as I’ve already said is my favorite pricing model. And the reason is that this is the model where you charge based on what the customer is willing to pay. So you have a lot of control over how you can influence the customer in that process. Value is not determined by those who set the price, value is determined by those who choose to pay it. What a great quote. So some of the advantages that you have and one of the reasons why I like this model so much is you have a lot of control over pricing as I mentioned before, you are getting all the value that you’re delivering.

You’re actually getting paid for that value, which is also terrific. Usually you can gain higher margins for that because you can be charging higher price, because you’re creating more value, and also you can get more for the differentiation that you’re actually creating the market and you can charge that differentiation as well. The ideal profile for value-based pricing looks like this. It’s our products are more unique their differentiated from the competition they’re harder to compare, products tend to generally be more scarce, their first of a kind or custom products as well, again hard to differentiate. It usually works where competition is lower where quality is higher and products or services can be packaged or add-ons to be created.

So some examples of this include like tour operators, cooking classes, software products, jewelry, high-end fashion also fits into this category high-end Resorts and luxury cars all fit within this category of value-based pricing. So there are some advantages to value-based pricing. I think there’s a lot of advantages to value-based pricing. Number one is you can maximize your profits which I think is probably the most important thing any business can do you get paid for the value that your delivering which I think it’s wildly important. Also you’re focused on what the customers want your focus on the customer as opposed to your competitors or other things that you might obsess over in the other model.

This is all customer focus on how you deliver value which is why I like this model so much. Here you get pay for your efficiency the more efficient you are the more money you’re going to make it’s not like the Cost model where you’ve been drag down or to Market model where you’re being compared against competitors, right? and as much as I love value-based pricing, there are some disadvantages. First one is that you must actually have some differentiated value. You can’t just kind of create this out of thin air it has to be something that customers really perceived as valuable and you can differentiate from your competition. So it doesn’t actually work for all businesses.

The other thing is that it may require more upfront investment in R&D in marketing in other types of things that you may or may not be able to do so that can be a disadvantage because if want to create that differentiation, you have to Leap forward ahead of your competition. And then finally your price can actually get negotiated. The problem with value-based pricing is customers are going to be looking at it. They’re going to be looking at higher price and they’re not going to have as much to compare against so they might actually want to negotiate pricing negotiate down, obviously. So for value-based pricing I actually want to use a service example for this.

Now in the service business, you can be either one of two things, you can be hourly based, or you can be fixed bid. Essentially fixed bid is another way of saying package pricing now, I will tell you from my personal experience of being in the service industry for 20 plus years. In fact, if you fixed bid something and you bundle price it you’re so much better off. You’re going to make much more money than if you use it on an hourly basis. Let me give you an example talked about my digital agency before called Search Commerce, and essentially we fixed bid absolutely everything, now. Most of our competitors actually priced based on an hourly rate.

And when you price based on an hourly rate, the first thing customers do is they start obsessing over the hourly rate and they start to try to negotiate it down. Second thing they do is when they get the bill and they say you spent 20 hours on this I could have done it in 15. Okay. So then the customer starts to think you’re nickel and diming them for everything. They get upset you’re bothered because you’re not getting as much value and they’re negotiating down the value of what you’re actually delivering in the price of what you’re delivering. That doesn’t sound very good.

However, if you fixed bid it, while the fixed bid is generated based on kind of an hourly estimate, but you’re now saying I’m going to guarantee I’m going to fixed bid this I am going to guarantee the price, you can actually build that price up at least 20% and you can even add additional value to increase that price more and so in the search business, we actually almost always generate North to 60 percent margins based on our fixed bid piece, which we always fixed bid. I can tell you that it really works. So another example of something that happened recently to me as is remodeled to my home.

And oh boy, what a chore that was now, what’s interesting about it is that 20 years ago even 10 years ago, all Contracting out there when people were remodeling their home. Where all hourly basis. They would line item everything and of course what would customers do? they picked everything they nickel and dimed all of that and they got down to a price. Now, what my contractor’s did and what everybody does today is I got all pricing was bundled all pricing was fixed bit. It was all bundled into a nice package, right? It included everything, the paint, the glass. The tubs the vanities even furniture and other things they bundled all into one price.

Now, I got three quotes of course being a consumer. I took the cheapest of the three and there was wide variation between the quotes. So that’s something that you might run into but at least I know exactly what I’m going to be paying and if I choose to change something it’s a change order. I’ll pay for it, but I don’t let them just have an open checkbook and they can pay whatever they want, as a consumer that is not the kind of relationship you want.