Value-Based and Cost-Based Pricing Concepts

Abstract

AbstractValue-based price (also value-optimized pricing and charging what the market will bear) is a pricing strategy which sets prices primarily, but not exclusively, according to the perceived or estimated value of a product or service to the customer rather than according to the cost of the product or historical prices. The approach is most successful when products are sold based on emotions (fashion), in niche markets, in shortages (e.g. drinks at open air festival on a hot summer day) or for complementary products (e.g. printer cartridges, headsets for cell phones) (Anderson & Wynstra, 2010). Goods which are very intensely traded (e.g. oil and other commodities) are often sold using cost-plus pricing. Goods which are sold to highly sophisticated customers in large markets (e.g. automotive industry) have also in the past been sold using cost-plus pricing, but thanks to modern pricing software and pricing systems and the ability to capture and analyse market data, more and more markets are migrating towards market- or value-based pricing. Value-based pricing in its literal sense implies basing pricing on the product benefits perceived by the customer instead of on the exact cost of developing the product. For example, a painting may be priced as much more than the price of canvas and paints: the price in fact depends a lot on who the painter is. Painting prices also reflect factors such as age, cultural significance and, most importantly, how much benefit the buyer is deriving. Owning an original Dalí or Picasso painting elevates the self-esteem of the buyer and hence elevates the perceived benefits of ownership. Where it is successfully used, it will improve profitability through generating higher prices without impacting greatly on sales volumes. Value-based pricing is a strategy of setting prices primarily based on a consumer’s perceived value of a product or service as shown in Fig. 7.1. Value pricing is customer-focused pricing, meaning companies base their pricing on how much the customer believes a product is worth. Value-based pricing is different than “cost-plus” pricing, which factors the costs of production into the pricing calculation. Companies that offer unique or highly valuable features or services are better positioned to take advantage of the value pricing model than companies which chiefly sell commoditized items.