Pricing a product or service is one of the hardest and most important strategic decisions for any business. How you price a product will help determine whether your customers will buy it. Set the right price and your business can generate higher profits and continue to scale. But pricing your goods or services too high or too low can result in reduced growth and profitability.

Here's everything you need to know about value-based pricing to help determine if it's the right strategy for your scaling business.

Table of Contents

• Understanding value-based pricing
• Alternative pricing strategies
• When to use value-based pricing
• How to apply value-based pricing
• Benefits of value-based pricing
• Challenges of value-based pricing
• Streamline with QuickBooks
• FAQ

Understanding value-based pricing

Value-based pricing is a strategy that prices a good or service based on its perceived value to a customer. In other words, it bases the price on what the customer thinks a good or service is worth. This is different from strategies that set prices based on how much the product costs to produce or how much competitors are selling it for.

Value-based pricing is often effective for emotional purchases.

For instance, customers will pay a premium to capture their engagement or wedding with a professional photographer. While it may only take a few days to shoot and edit the photos, the photographer can charge thousands of dollars to capture those once-in-a-lifetime memories.

Customers are also willing to pay more for an experience. Using this strategy to find the right price requires a great deal of market research, but it has the potential to boost your profits.

Alternative pricing strategies

Value-based pricing isn't the only way to price your product or service. Let's look at how value-based pricing compares to other pricing strategies.

Cost-plus pricing

Cost-plus pricing is one of the more straightforward strategies. To start, calculate the direct and indirect costs involved in producing your product or service. Then, add a certain percentage to ensure a profit.

For example, a custom furniture manufacturer can price its products by calculating the cost of materials, labour, and delivery expenses. To ensure a profit, they can then apply a 30% markup.

Competitor-based pricing

The competitor-based pricing strategy requires a market assessment to see how much competitors are charging. This strategy can be useful when it's hard to differentiate your product from others. Generally, you'll aim to sell your product or service at the same or a lower price than your competitor. Another way to keep your pricing competitive is to offer better payment terms.

Let's say you own a mid-sized fashion brand that sells T-shirts online. To price your products, start by researching similar brands. Then, price your T-shirts the same or slightly lower to attract customers.

Demand-based pricing

With this strategy, consumer demand dictates the price of a product or service. The price is not fixed, but instead fluctuates as customer demand changes.

• For instance, many boutique hotels and bed and breakfasts will increase their nightly rates on weekends, during holidays, or if there's a special local event. 

When to use value-based pricing

With several pricing strategies available, when does it make sense to use value-based pricing?

Here are a few examples:

Specialized good or service

Customers are willing to pay a premium for a good or service they deem special, such as a meal at a Michelin-starred restaurant. A $500 meal might only cost $50 in groceries, but the customer is paying for more than the food. It's about the experience, the culinary talent, and the status associated with getting a table at that restaurant.

Luxury goods

Whether it's a name-brand suit, pair of shoes, or handbag, customers will pay top dollar for luxury goods. While these products might use premium materials and cost more to manufacture, the prices exceed these extra costs. Customers are paying for the attention and status that comes with owning and wearing these products.

High ROI

Many customers have no problem paying more for a product or service if there's a clear return on investment (ROI). For instance, a customer might pay a website design company thousands of dollars to redo their site. They'll pay a premium price because they believe the result will generate more business and profit in the long run.

Differentiated product or service

Products or services that are unique or stand out in the market can often charge a premium rate. Take the iPhone as an example. The iPhone isn't priced based on the cost of production. Customers are willing to spend more due to its beautiful design and exceptional user experience.

Scarcity

Scarcity is another quality that can garner a higher price. Customers often see something scarce as more desirable and more valuable. Holding a business retreat that caps the number of attendees creates scarcity. With only a limited number of seats, customers might be willing to pay more for the experience. 

How to apply value-based pricing

To understand how to apply value-based pricing, let's look at an example. Imagine you own an organic health food company and you're preparing to launch a new health vitamin gummy.

Here's a step-by-step look at how to apply value-based pricing to your product.

1. Define the target market

Decide what market segment to focus on. Which customers will you target with this new product? Who is willing to pay more for this product?

To determine your target market, conduct customer research using surveys, focus groups, or interviews to see which customers are most likely to value this product. Is it busy, health-conscious millennial moms or tired, Gen Z university students looking for a boost?

2. Conduct a competitive analysis

While value-based pricing is different from competitor-based pricing, there's still value in gathering information about your competitors. All of this information will help inform your product pricing.

Are other organic food companies offering vitamin gummies? How much are they charging? Take a look at customer feedback — what do they like and dislike about other products on the market?

3. Determine the value add

Use your competitive analysis to determine what sets you apart from your competitors.

What do you offer that makes your product or service more valuable? What makes your product unique? Is it the taste, the ingredients (a lack of artificial flavours or sweeteners), or environmentally conscious packaging?

4. Confirm the pricing model

With all the information you've collected, confirm if a value-based pricing model is the right approach or if an alternative model makes more sense.

If you're struggling to figure out what differentiates your product or company from others, you may choose to go with an alternative model. But if your differentiating factors are clear, a value-based approach is most likely the right move.

5. Set prices

Using all the information and data from your competitive analysis and customer research, it's time to set your prices. Based on what sets you apart from other companies (your differentiation), what is a reasonable price to charge your target customers?

How much more are customers willing to pay for a product that tastes better, cuts out artificial flavours and sweeteners, and uses environmentally conscious packaging? You can conduct additional customer feedback using surveys, interviews, or focus groups.

6. Market the differentiating features

With value-based pricing, the goal of marketing is to highlight the differentiating features. Why should customers be willing to pay more for this product or service? How does this product create more value for the customer?

7. Keep collecting feedback

Once you've set your price, it's not the end. It's important to keep collecting feedback to confirm if your price is right.

Are customers buying your product? What do they have to say about your pricing? Keep researching the market and collecting customer feedback to find the sweet spot with your customers. 

Benefits of value-based pricing

Value-based pricing can offer several benefits, including:

• Greater profit potential. For the right product or service, value-based pricing offers the potential to increase profit margins.
• Strong customer feedback. This pricing model requires a strong customer feedback channel. Getting this feedback can help with pricing and can also inform the design of future products.
• Increased customer loyalty. The continued connection with customers to get their feedback can make your customers feel heard and increase loyalty. 

Challenges of value-based pricing

Deciding to use the value-based pricing strategy for your mid-sized business doesn't guarantee success.

Here are a few challenges to consider:

• Hard to determine pricing. This strategy can involve more time and effort to research the market and collect customer feedback data.
• Profit isn't guaranteed. There's some trial and error involved. You might not get the price right the first time.
• Requires ongoing research. This is not a one-and-done approach. To ensure your prices continue to meet your customers' expectations, ongoing research is required. 

Streamline with QuickBooks

A value-based pricing strategy can work for a range of products and services within any growing mid-market business. Employing this strategy can lead to greater profit potential and strong customer loyalty. But determining if value-based pricing is the right strategy for your business requires a great deal of market research and ongoing customer feedback.

To help streamline your approach, check out QuickBooks Online Advanced. With QuickBooks, you can track and analyze financial data to see if your prices are where they should be.