What are the Advantages and Disadvantages of Value Based Pricing?

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What are the Advantages and Disadvantages of Value-Based Pricing?

Value-based pricing is a strategy of assigning prices based on the customers' perceived value of a product or service. Depending on its execution, your business can reap the benefits of this strategy. There are advantages and disadvantages of value based pricing. 

Let's take a quick look at what value based pricing is, and the pros and cons of using it as a pricing method.

What is value based pricing?

Value-based pricing is one of the popular pricing methods businesses use in setting prices to their products and services. It is a customer-centric pricing strategy where companies base their prices on how much their target market believes a product is worth. Instead of looking within the company (considering your costs, profit margins, etc.) or laterally (maintaining competitive prices against business competition), this strategy looks outward, towards your target market's needs, wants, and willingness to pay.

This strategy works best for companies offering products and services that enhance a customer's self-image or provides unique life experiences when availed. Such products should be customer-focused, tailor-made to fit the wants and needs of your target market. Its perceived value depends on how much customers are willing to pay to own those products or experience those services.

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Since value-based pricing is consumer-centric, businesses who want to apply this pricing strategy need to have in-depth research and communication with its customers. Data gathered from customer feedback is essential to make this strategy work as accurately as possible.

Aside from open communications and strong relationships with customers, your company must also deliver high-quality products and services that satisfy the standards set by your target market.

Other factors that may give you an edge with value-based pricing are your brand recognition, your reputation in the industry, and your connections and associations with the big leagues. Prestige, uniqueness, limited editions, history, and influence are also factors that can add value to your products and services.

For example, raw materials for a painting can cost around £60, but if the painter was, say, Leonardo da Vinci, his name, prestige, history, and the fact that his death makes his paintings limited, makes that painting's value way higher.

Of course, the conditions do not have to be that drastic in order to employ value-based pricing successfully.

For small business owners, all you need are:

  • a good brand

  • high-quality and in-demand products and services

  • amazing track record

  • creative marketing strategies, and

  • great rapport and customer relations.

But you need to also be aware of the advantages and disadvantages of value based pricing for you business to asses if it is right for you. 

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Advantages of Value-based Pricing

1. You can easily penetrate the market.

It is easier for you to penetrate a market that is not brand-loyal and relatively undiluted, especially if your products and services are packaged differently. New and limited edition items see stronger sales when value-based pricing is applied.

2. You can command higher price points 

Prestigious and culturally important items have higher perceived values. Products such as art, fashion, collectables, and luxury cars are perfect examples of these. Customers care more about the perceived values of these products and are willing to pay more. Basically what they buy is the prestige of the name, the well-known skills and talent of the creator, and the appreciating value over time, or of a complete set, of these items.

3. It proves real willingness-to-pay data

Willingness-to-pay data is the maximum price your target market is willing to shell out for what they believe is the value of your products and services. This helps you conceptualise the overall demand for your products and helps you put a profit-generating price on them.

4. It helps you develop higher quality products

The constant feedback from your consumers helps you identify future product developments to continue satisfying the needs of the market. Value-based pricing relies on your consumer's perceived value, and perceived value depends on factors including quality. This provides a wealth of information not just on pricing, but also on how you can improve your business.

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5. It increases focus on customer services 

Customer-centric pricing is for the benefit of customer satisfaction. This also helps you improve customer service and provide unparalleled customer experience.

6. It promotes customer loyalty

Providing customer satisfaction, amazing customer service and unique customer experiences breeds customer loyalty. Of course, this means providing quality products and services that justify the perceived value your customers have attached to it.

7. It increases brand value

Value-based pricing increases your brand value by establishing that your business is dedicated to putting your customers first and ensuring that the products and services you provide are top-notch. Your high prices are justified by the superior quality of products and customer experience your brand provides.

8. It balances supply and demand

Value-based pricing provides a rough sketch of the demand for your product in the market. You have an approximation of the number of customers who can afford and are willing to buy, your products. This helps your business create a supply to fit the demand accordingly.

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Disadvantages of Value-based Pricing

1. Difficult to justify the added value for commodities

Value-based pricing for businesses selling commodities will find it harder to justify the added value of their products. The abundance of options and competition in the market makes it tougher unless there's something special about your product.

2. Perceived value is not always stable 

Perceived value is subjective, and it changes due to cultural, social, economic, and technological factors that are outside your control. Moreover, customers that grew accustomed to your products can grow desensitised to its perceived value and might start to see less value in it. Also, competitors might come up with a better offer that comes with a higher perceived value. With value-based pricing, this means you are forced to lower your prices in these situations, which can severely affect revenues and profit.

3. Price is harder to set

Your whole target market might have to vary perceived values for your products and services, making it harder to set a price point that works for every customer. In cases like this, market research, customer feedback, and competitor analysis can only go as far as giving you confidence in your pricing. However, you'll only see the results after comparing your sales forecast to your actual sales.

4. Niche market, and market competition

As such, you get a niche market. While niche market usually means customer loyalty, it also means you have tapped a very limited number in your actual market. When market competition arrives, your already limited market gets smaller.

5. Requires ample research, time, and resources

In order to execute value-based pricing correctly, you need extensive market research. This is time-consuming and requires a lot of resources. This is usually not as feasible for starting businesses.

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6. Not an exact science

Unlike other pricing strategies, value-based pricing is not an exact science. With the subjectivity and potential instability of consumer's perceived value, pricing is also subject to change. Whereas strategies like cost-plus pricing rely on hard numbers, value-based pricing depends on customer preference and willingness-to-pay.

7.  Makes scalability difficult

Value-based pricing works best for businesses in smaller sizes and sells highly specialised products. It is difficult to apply to a larger audience, which makes it hard to expand the business.

8. Production costs

Specialised products and continuous efforts to develop product lines and services mean higher production costs. You will need excellent raw materials and highly skilled labourers to maintain and improve product quality.

Value-based pricing works best in specific situations such as:

  • Recognised inelastic demand, where products have such a high demand that low pricing doesn't have an impact on sales and profit generation.

  • In highly competitive and price-sensitive markets, putting your customer's perceived value first gives you an edge in customer loyalty and satisfaction.

  • When promoting prestige in your brand and products, higher price points exudes exclusivity and grandeur. 

Optimising its advantages and minimising the disadvantages lies in your business model and marketing strategies.

Value-based pricing is not for everyone, but when properly executed, can drive profit, build value to your brand, and establish customer loyalty, which leads to success.

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About the Author

Annette Ferguson 

Owner of Annette & Co. - Chartered Accountants & Certified Profit First Professionals. Helping online service-based entrepreneurs find clarity in their numbers, increase wealth and have more money in their pockets.