A value based pricing model is a pricing strategy in which a company prices and promotes products or services based on tangible or perceived value. This story illustrates value-based pricing perfectly:
Value based pricing has nothing to do with the time or cost involved in producing a product or service, and everything to do with the value that you are providing to your customers. For a more tangible example, if I have a product that costs me $10 to create today, but it has the potential to save you $1,000 tomorrow, charging $500 for that product is still a really good deal for you.
Value based pricing has very little to do with the cost of manufacturing and delivering your product or service, and everything to do with the value and the benefit your customers get from product.
Value Based Pricing: Perception is Everything
The most important part of the definition of value based pricing is the phrase perceived value. Perception is everything in marketing, but it's important to make the distinction that it's NOT your perception it's your potential customer's perception that is everything. As business owners and entrepreneurs, it's easy to mistake our perception for the perception of the marketplace.
If you've ever had someone tell you your pricing is too high, they may be right, but it's more likely that there is an opportunity to better communicate your value so that new customers perceive the pricing of your products and services as a good deal.
Advantages of a Value Based Pricing Model
High Profit Margins
One of the great benefits of value based pricing is huge profit margins. In the information marketing and software industries, after your product is developed, it costs virtually nothing to duplicate your product and sell it again. These are two industries where value based pricing is very common. High profit margins allow the opportunity for rapid growth and product innovation.
Specialization and Differentiation
To get the best results with a value based pricing model, it's essential that you specialize and cater your product or service to a specific audience. Specializing allows you to command a higher fee because your knowledge is more valuable to your customers. Specialization allows you to differentiate yourself in all of your marketing messaging.
Disadvantages of Value Based Pricing
Room for Competition
Whenever there are big profit margins, there is an opportunity for a competitor to undercut your pricing. This is something that you must be on the lookout for because if your product or service is wildly successful, it will happen. It's a good idea to have a plan of action already in place so that when this does happen, you are responding from a place of strategic action, opposed to frantic reaction.
Difficult to Scale
If you are delivering a service, it's often hard to scale that service as a company grows. It's more difficult to maintain a high-end service at scale because skill levels tend to vary widely and training reps can be very expensive.
Common Value Based Pricing Challenges
One thing that many small business owners struggle with is recognizing the value of their products, services and, most importantly, their time. Most small business owners are used to working for pennies on the dollar today because they know the fruits of their labor will multiply into much more than an hourly wage down the road. But the fact that most small business owners might deliver their product or service for free if they could is a hurdle that many face when considering a value based pricing structure.
If you find yourself in this place. it may be a good idea to seek outside counsel; don't be afraid to ask your mentors, colleagues, industry partners and even your customers for their feedback or thoughts on the value of your product or service.
Not Serving A Niche
Another challenge that I see people run into when trying to implement a value-based business model is that they don't hone their products, services and marketing messaging to service a niche. Value based pricing works best when you are able to position yourself as the leader in a given segment of the marketplace and differentiate yourself from potential competitors.
Over-Zealous, Value Based Pricing
Sometimes marketers and owners get too carried away with the concept of value based pricing. Value based pricing is not "charge-a-lot-of-money-for-no-reason pricing." It's important to get your messaging down and test it with your target audience before you invest heavily in your marketing efforts. Make sure that your marketing messaging is communicating your value effectively so your customers are undoubtedly willing to pay you what you're worth!
Value based pricing is something that many small business owners find to be a drastically different approach to their pricing and business strategy. While value based pricing is one great way to increase your revenue and scale your business, there are other options too! Check out this free ebook we have to offer you that covers 8 different ways to grow your small business.