My take on value-based pricing.
From the client’s perspective, the following formula does an excellent job of defining the value of a product or service.
Value = Perceived Benefit – Perceived Sacrifice
The value to the client is what the client perceives is the total of all the benefits of the product or service minus what the client feels they need to give up or lose by buying the product or service. The perceived benefit is the easier part to understand where a client is coming from. It is the perceived sacrifice that is the more difficult part as this becomes very subjective. There is a wide range of perceived sacrifices. The client could feel they could be judged for spending a certain amount of money. They could feel that they would have to admit prior mistakes if this is replacing a prior product they paid for. They could feel that they shouldn’t be buying something that is not local. They could feel like they don’t deserve the product. This list goes on and on and on.
The best we can do is to help educate them so they understand what all the benefits are, and what are different perspectives they could have to overcome their perceived sacrifices.
This all describes the value to the person receiving the product or service. In the equation, there is no mention of who made the product, who is marketing the product, or what anyone else thinks about the value of the product. It is what the client feels the product is worth
When we are trying to figure out value-based pricing, understanding what the client values the product as is a good starting point.
The problem comes when we the people delivering the value need to determine who has contributed what percentage of the value. Many times, the client is also contributing to part of the value.
There are two types of contribution to the value, multiplier value and intrinsic value.
If a company has an inventory of a product, that inventory is going to have intrinsic value whether it is sold or not. This value is loosely related to the cost to create the product, including labor and prior research and development.
A marketer has a multiplier value based on realizing the intrinsic value plus a profit amount. If a product can be produced for $100 and a marketer helps create the process that results in that product being sold for $100 then they have a multiplier of 2. In the real world, it is not that simple. It is not one entity that just creates a product or service and another entity selling the product or service. There are many other people, processes, and resources involved. It could even be that the product is so good it just sells itself. Each person in the process needs to decide what percentage they are contributing to the overall process. Even the business owner, by creating the business, is contributing to the sale and so deserves a piece of the profits. Determining the breakdown of the percentages is a difficult process.
That brings us to the last part – the value base pricing. This is simply a choice a business makes for what they are going to sell the product for. They have some influence on the client’s perceived benefit – perceived sacrifice, but after whatever education they can provide it is what it is. As an example, if you have a service that increases a client’s profit by 5% and you want to sell it for $5000 then the 10% increase the client gets in profit needs to be higher than $5000 to make be of value to the client. If the client is making $100,000 or less the value isn’t there. If the client is making a million, then there is a huge amount of value. Again, the value depends on the client.
If the business decides on setting the price high, then there will be fewer clients that deem the product has that value so there will be fewer sales, but more profit per sale. If the business decides on setting the price low, there will be more sales but less profit.
So, pick the type of client you want to work with, get an idea of the amount of value they will get out of your product or service, and set prices accordingly.