Value-based pricing. Transforming the way you capture market value

Pricing strategies often hinge on competitive positioning, cost-plus calculations, or the complex but rewarding realm of value-based pricing. While many companies default to matching or slightly adjusting prices based on the competition, true strategic advantage lies in understanding and leveraging the full spectrum of pricing methodologies to capture the value delivered to customers. In this essay, we dive into three core approaches to pricing, exploring their practical applications, challenges, and the transformative potential of value-based pricing to elevate business success.

Three ways to approach pricing

When it comes to setting prices, businesses typically navigate through three main strategies: competitive pricing, cost-plus pricing, and the nuanced, yet potentially most lucrative method—value-based pricing. Each approach carries its unique set of considerations and challenges, from straightforward competitive adjustments to the intricate calculations of cost-plus, and finally, the strategic depth required for value-based pricing. Let’s briefly look at these three strategies.

1. Competitive pricing

The most common pricing approach is to look at existing prices and decide to follow or go a little higher or lower. This is called competitive pricing and is very practical in cases where products or services can be easily compared, and prices are transparent. Also, when prices are very dynamic, this is an important logic. Of course, there are limits. On the low side, if prices fall below variable cost, such as raw material costs, every unit sold creates more losses, not a very good business approach. Many commodity players, including those in oil, petrochemicals, building materials, and agriculture, are very aware of this and use cost curve analyses to guide their pricing. On the high side, for example, in the case of a near or temporary monopoly or undersupply, prices can go up a lot, but the number of buyers will go down, and often regulators start to step in. Think of the big internet companies, the pharma example, and tulips in the 17th century. A deep understanding of demand-supply curves and competitive regulations is needed here.

2. Cost plus based pricing 

The second approach relies on the principle that prices should cover all relevant costs, known as cost plus based pricing. This ensures every sale contributes positively to the company. It sounds straightforward but presents numerous challenges, such as determining which costs are relevant. Should the ten years of R&D that contributed to the product be included? And if so, should these costs be allocated based on last year’s sales or projected over the product’s lifetime? Finance teams often engage deeply with these questions. Another complex issue is allocating fixed manufacturing costs to products, especially for new or innovative offerings where many variables remain uncertain.

3. Value based pricing 

That is also a prime example of when to consider pricing based on the value delivered to your customer compared to the next best alternative available to them. Known as value based pricing, it is generally viewed as the most complex yet rewarding pricing strategy. A quick search for ‘value selling’ on Google yields over 3 billion results, 20 million plus videos, more than 200,000 consultants, and thousands of books. Despite the abundance of resources, most companies, marketing and sales managers, and teams still find it to be their biggest challenge.

Can you always use value selling? 

You can use value selling in many more cases than most people practice today. Any one of the below conditions is a good starter:

• When the product or service is customized.
• When costs and value have large differences.
• When there are variations in customer needs, known as segments.
• When the value to the customer is at least a little transparent.
• When customer relations are important, involving multiple interactions.
• When very diverse products or solutions exist.

But your capability and desire to push for a value selling approach is also determined by the relative importance of the transaction to you and your customer. If both see it as a necessary evil, then the most logical approach must be simple, efficient, and likely cost plus. If both parties see high value, circumstances are ideal for value selling. When the value to you – and your competitors – is high, but low to the customer, you will very likely end up in a competitive pricing mode. And interestingly, when the value to you is low but it is high for the customer, you can often create the highest value capturing approach.

Customer value can have many forms

When looking for ways to create value for your customer, you probably know some elements off the top of your head. But it is important to look at all possible elements; the most common categories are:

• Cost saving at the customer or further down in the value chain.
• Higher prices for the customer’s products/services.
• More growth for the customer or the end consumer.
• Investment avoidance at the customer.
• Better reputation or brand image.

The toughest part is to really quantify their impact relative to the next best – competitor – offer. Not all effects will be positive; on some elements, you may well have a lower value than the alternative you are comparing with. This analysis is often referred to as Economic Value to the Customer (EVC).

Examples of value selling or pricing

Examples of value selling can be found in any and every type of business: high volume commodities, super specialized technological products, all kinds of services, consumer goods, et cetera.

Some nice cases are summarized in the below table.

Examples of value pricing

Obviously value pricing is everywhere. Let’s explore some interesting examples.

SALT – FROM ESSENTIAL MINERAL TO CULINARY GOLD

Everybody knows what salt is, the chemists call it NaCl and it has been around as a life-saving product for all of human history. Its value is well recognized and, in the past, has been very expensive. Our word for income payment – salary – even comes from the Roman times ‘sal’ where legionnaires sometimes got paid with salt. Still, many people would call it one of the most basic commodities.

In today’s world, salt is easily available and used in the millions of tons per year. Most of it goes into chemical processes for the making of thousands of different chemical products, ranging from PVC to pharmaceuticals. And with these large volumes, it is not surprising the buyers look for low cost. Still, the chemical processes are very sensitive to value pricing. Certain impurities create extra costs and lower efficiencies, so it is worth to pay more for a purer salt. Actual prices can range by a factor of 4! The most expensive being 300% higher priced and still being a better economic solution for the customer.

Another well-known use of salt is road de-icing in winter. Safety first, but still, large volumes and no incomes are generated by using it, so low prices are crucial. But some differentiation is possible – and therefore value pricing. Most trucks and salt spreaders need an optimal particle size distribution and even form to be able to drive as fast as possible and still spread the salt evenly. Also, having enough salt at the right place at the right time is very important. Here, the value premiums can be 50 to 100%.

The third group of uses is in human and animal consumption. And here differentiation reaches extreme possibilities. Our normal kitchen cooking salt is bought by the kilo. But for on the table, we are tempted with the many beautiful, packaged sea salts, with many claims of better taste and health benefits. Some top-of-line products, recommended by well-known chefs, are pyramid-formed crystals, kosher salts, dead sea salt, and the so temptingly pink-colored Himalaya salt – apologies for not mentioning your favorite here. These products are no longer priced per ton or even per kg, they sell by package – often not so easy to see weight.

Not to forget the use of salt in hospitals around the world for infusion – saline drips. Of course, the purity and safety for this use is paramount.

From the lowest priced salt at €10 per ton to the highest of €10 for 20 grams – €500,000 per ton – is a whopping 50,000 multiple. Okay, there are some extra costs, but still.

Now, of course, these extreme prices address only small markets, and my point is not to go look for these. But I do claim that value pricing is everywhere, also for high volume commodities, and has huge potential for improving your – and your customers’ – results.

WATER – FROM FLOODS TO SPECIALIZED AQUA’S

Without water no life, without clean water no civilization. Most of us consider water the omnipresent commodity. After all, Earth is the watery planet with over 70% of the surface covered by oceans. Too much water through rain, storms, avalanches, floods, and tsunamis can create major disasters. Our current climate challenge is most often expressed in cm’s increase of the sea level. But at the same time, lack of sweet, clean water can create disastrous droughts, failed crops, animal, and human suffering. The increasing size of the world’s largest desert, the Sahara, is well known and being fought with some modest success.

Clean water and hygiene systems in all our societies depend on the smart use of water. Irrigation, water energy from dams, but also the toilet and safe drinking water from the tap are some of the biggest lifesavers we have created.

So, what is a good price for water? Well – it depends. It depends on the circumstances. If we look at actual prices charged for H2O, as the chemists like to call it, varies enormously. Probably fair to say that for free is the lowest price. Though some theorists would argue that just like oil recently a NEGATIVE price is certainly possible in some special circumstances, but for today I will let that go.

Normal pricing for tap water in most countries is charged in cents per cubic meter 1000 liters. In my home country, it is actually close to 1 cent. So, let’s take that as the bottom price.

As we all know, we also buy a lot of bottled water, at a really good price of 10-50 cents per bottle of 1 liter. That is already 10-50,000 times as expensive. And in some countries, it can be defended as safer, purer, better but in many countries there is no chemical or physical difference from the municipal tap water. Lots of the value is perceived! And the important lesson for value pricing is that perception is reality.

And this is before we come to the real fancy marketing and branding. Because if you want to go all out, you can also buy a very special water for $400 there are much more expensive bottles but that includes jewelry on the crystal carafes, so also on this extreme high side let’s leave them out of the equation. Still, we now have a range from 1 cent per 1000 liters to $400 per 0.75 liters an incredible value pricing range of 500,000.

Maybe not the top of the range in price per liter, but close! are the laboratory and pharmaceutical grades and the cosmetic aquas. Any water to be used in hospitals or for the making of vaccines must be extremely pure and safe, so here a high price can be defended on rational-economic arguments. Cosmetic waters are closer to perception again. Special tattoo cleaning waters or facial cleaning products using special formulas give ample opportunity for branding and emotional arguments.

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FRAGRANCE – FROM NATURAL ODORS TO HEAVEN SCENT

What is your favorite outdoor experience? Most likely it involves a special scent, the cleansing salty seaside wind, the slightly moist and green smell of the forest, the lovely fresh cut grass early in the season, the crisp mountain air, the explosion of smells in a tropical jungle, the dry smoothness of the desert, and the list goes on and on. And although you need to go there, the experience is for free.

Smelling is also well known as the most powerful of our senses in creating memories. And we all have read the stories about pheromone type scents influencing mood, attraction, and behavior.

In our ever more enclosed lives in big cities, we have an incredible craving for nice smells. First to mask the unhappy odors collecting in the towns and villages of the Middle Ages and later more and more to create our own bubble of special experiences.

Therefore, it is maybe not so surprising to see the great efforts that companies do to create special perfumes, deodorants, etc. And yes, a lot of research goes into finding the right fragrances and mixes to delight us, but as much effort goes into communicating the special experience that the perfume will create.

When looking at the value pricing opportunity, the baseline could be said to be for free, but for sake of calculation, I have looked up the lowest priced version and I found some at €2 per 100 ml. Many perfumes sold on airports are in the range of €30-100 per 50 ml. More specialty fragrances with very elaborate packaging range well into the €1000 per 30 ml and some rare extremes are priced at €10,000 per small bottle of 30 ml. this gives a huge price multiple of more than 15,000 times on a base price that is not cheap.

From a value selling and pricing point of view, it is crucial to realize which buyer and final consumer you are targeting and how much you want to sell. For perfumes to a limited degree so-called ‘champagne marketing is applicable: the higher the price the more you sell for the economists an upward sloping demand curve. This is counterintuitive and of course does not apply over the whole pricing range. You need to find the sweet spot and also support the pricing with the right product and communication and right channel. Here the value is in the experience of the buyer, the user, and the audience of the user. The whole value selling approach needs to be synchronized.

LEGO – FROM SIMPLE PLASTIC BLOCK TO TOP SELLING MOVIE

I must admit to being totally biased on this example of value pricing and selling. I still have my 50+ year-old Lego box from my youth, and my family are avid collectors of the Harry Potter series. Still, few companies have succeeded in creating so much value from such a humble material.

Currently, all Lego pieces are made from ABS, a very normal polymer, going for about €1 per kilo. And if you go looking for unsorted Lego blocks sold by weight, the price is already about 10 times higher.

The real value selling starts in the beautiful boxes with smart design and marketing. Whether it is the police station or the mini farm with animals, prices start to shoot up. And interestingly, finding huge audiences around the world. Lego is in several overviews the most successful toy company, despite the fact they sell really only one product. Going even further up the value chain, you come to the movie-related co-marketed sets. For the top-level sets, prices move into the hundreds of euros. This translates into numbers like €800 per kg.

But the story does not end here, there is a large after-market of unique pieces either made in small series or needed to fill out the dream set for an avid collector. Here, prices go as high as €1800 per piece, and if I assume at 10 grams, that is €180,000 per kilo.

Segment the market

By any definition, Lego has succeeded in segmenting the market and using value selling to reach each group with a very compelling product. Here, the customer journey is also not simple because who are they actually selling to? The children, yes, but it is the parents buying and paying, or the grandparents or the friends. And interestingly, the popularity of Lego with adults is maybe even higher than with the kids. Most countries have extensive Lego fairs/events with thousands of participants and guess what, the majority is definitely over 30, mostly even over 50. The appeal of being able to create your own versions of buildings, cities, and even events is enormous. On YouTube, you can find countless examples of stop-gap movies, painstakingly (hundreds of hours!!!) made by fans of rock concerts, soccer or other sports games, and historic events. Go find your favorite.

The ultimate Lego format is now virtual; now Lego has huge incomes from movies and games based on the ever-so-simple pieces. The price per kilo has no more meaning.

What can we learn from this? 

First, value is in the eyes of the beholder. And when it comes to buying something for children, there are almost no barriers or limits. Especially if you can defend the purchase with a noble goal of stimulating creativity and self-expression. Still, endless segmentation pays off.

Second, it is great if you can join others in doing the marketing, deliberately or indirectly, but make sure you control the pricing.

Third, get your customers so involved that they help you develop your product. Lego actively supports customer design groups and initiatives.

Lastly, consistency can pay off; my 50+ year-old pieces work fine with those just bought this year in one of the flagship Lego stores.

Looking ahead

Now after  close to 65 years working with ABS  the Lego team is working on the next generation material, totally sustainable and circular, but I am sure they will still fit with the oldest pieces. But at the same time, I might be tempted to replace my whole collection with the new material, and I guess that the company will come up with a smart way to stimulate that …

After nearly 65 years of utilizing ABS, the Lego team is shifting to the next generation of materials – entirely sustainable and circular. Yet, I’m sure these new blocks will still be compatible with the oldest pieces. Concurrently, I’m contemplating renewing my entire collection with this new material, confident that the company will ingeniously encourage such updates.

CONSULTING – FROM OUTSOURCED ROUTINES TO TRANSFORMATIONAL EXPERIENCES

None of us can be great at everything, and therefore the advice-consulting market is huge, exceeding €100 billion per year, and continues to grow through all economic cycles, crises, and pandemics. The cost for advice isn’t easy to predict, depending on factors like the uniqueness or urgency of the need, how much you can pay, and whether you need just advice or help executing it.

Consulting varies from routine activities requiring specific expertise not present in your company, to special projects solving new problems or creating plans, up to unique experiences that shift a company’s motivation.

Not surprisingly, pricing for these services varies widely. Some offers might seem close to minimum wage, often requiring less time than billed, with automation significantly impacting this area. Gone are the days of analysts carrying calculators and pens to make presentations. Professional multinational consultancies charge hundreds of euros per hour.

Some consultants share risk and value by tying part of their fee to the client’s results. For example, I could offer value pricing advice at half my normal rate if my client agrees to share, say, 1% of the price increase with me. This approach, while requiring a strong mutual trust and clear definitions and measurements, is applied especially in M&A. Then there are the consulting “rock stars,” motivational speakers who, due to their fame or impact, can command fees up to €25,000 per speech. This demonstrates how content, quality, reputation, and trust are critical in value selling and pricing services.

Navigating value pricing. My experiential framework

Of course, it is inspiring to see examples of value pricing in the real world for products and services. It is important to realize that they are the outcomes of many years of trying, failing, and trying again. So, how should you approach it for yourself?

From my own experience, I have learned to see it in four major steps that are not perfectly sequential and have several feedback loops.

• Understanding customer needs
• Comparing your own offering versus competitors
• Embedding value pricing in a value selling journey
• Creating fair sharing as a foundation for long-term equitable economic benefits for all parties

The whole process starts with your own belief that you can create real value for your customers. The challenge is that what you think the value is may not be fully correct. So, you need to be a bit schizophrenic about this. On the one hand, be fully convinced and driven that you can bring superior value, but at the same time be open and self-critical to learn what your customer really needs.

1. Understand what different customers need

Most teams have not conducted sufficient customer needs quantification or competitive product/service comparison to enable effective value pricing. Additionally, value pricing is powerful for segments of the market, and sometimes even for individual customers, rather than for the market as a whole (standard pricing is the adversary of value pricing). The key steps in the journey include:

• Building a standard starting list of customer needs that are often relevant, such as speed, accuracy, reliability, customization [ref: Blue Ocean Strategy].
  • Attempting to group customers into segments with similar needs profiles.
  • Always being on the lookout for special needs.
• Utilizing your own knowledge but definitely adding outside inputs from other suppliers to the customer, not necessarily your direct competition.
  • Engaging multiple people at the customer’s end, trying to identify the decision-makers/influencers.
  • Considering the customers of your customer—if you understand what makes your customer successful, you have much more leverage.
  • Involving your own marketing and sales teams, as they are knowledgeable about your customers (which will assist greatly later when you want to implement changes).
  • Additionally, employing an outside agency to obtain more objective and systematic inputs, but ensuring to delve deeper than the standard Net Promoter Scoring type of surveys, ideally conducting telephone interviews.
• Determining the best alternative to your offer and assessing how it measures up to the needs.
  • This could range from doing nothing, using a competitor’s product, creating an in-house solution, or following a radically different approach [ref: competitor analysis], then proceeding to step 2.

2. Comparing your own offering versus competitors 

It is very difficult to be objective about your own product versus the competition, yet this is the second important ingredient for high-impact value pricing. Part of the challenge is determining who or what to compare to. Sometimes there is an obvious market leader or standard product, but often there are two or three major offers in the market. These offers are not always similar to your offering. Different technologies or different customer operations can position alternatives differently. For services, the in-house solution is a competitor to always take seriously.

• Make a detailed comparison between your offer – offers, if you have choices – and the best alternative(s) identified based on the needs from step 1.
• Be ruthless, not rose-colored when comparing; get outside opinions and inputs.
• Try to quantify the effects for the customer as much as possible, especially when claims of cost savings or higher performance are used [ref: Economic Value Analysis, cost curve analysis], and do not forget to subtract those elements where you score below competition.
• Weigh the different needs against each other; this weighing is often different for different customer segments.
• Conclude what the extra value is that you can create for the customer.

But realize this is your homework before the rubber hits the road when you start your interaction with your customer in step 3.

3. Embedding value pricing in a value selling journey 

Value creation does not start or stop at the sale; it needs to be during the whole customer life cycle. Especially a great product or service needs selling and value communication – perception is reality.

• First, do not talk about the price, ask about the customers’ needs and how they are met or not met.
• Second, do not talk about the price, talk about how your offer is different.
• Third, do not talk about the price, show how the difference adds value.
• Still, do not talk about the price, but listen to the reaction.
• Think about how to prove your extra value before discussing price, use a pilot or some small test work.
• Ok, now you can start talking about how to share the value created.
• What is fair? – see the next step below.
• And finally, you can start talking about the price.
• The price is not a number; it is a mutually agreed way to share the value created.
• In every communication – before and after – the negotiation makes the value come to life, every time.

Next to the steps in the process, it is good to recognize who is responsible for value pricing. Of course, this will need to be different across companies. Size, B2B or B2C (or any other 3-5 letter combination you like to use), geographic complexity will influence exact choices. Still, some fundamentals can be described:

• Value pricing is not exclusive to marketing and also not to sales; a close cooperation is crucial – a careful balance of centralized knowledge consolidation and decision-making helps rigor – but front-line input and execution are fundamental to success [ref. roles of sales and marketing in pricing].
• Many more functions need to be involved to truly create and communicate the value proposition. Technical service, intelligence roles, R&D, operations, finance, etc.
• Organizations with strong (key) account management should use the power of these teams [ref. (key) account organization].
• Organizations with deep brand and marketing communication teams should leverage them in the whole process (and not only at the beginning and the end).
• When (re-)introducing value pricing/selling, it’s best treated as a transformation type change with a top-level steering, a dedicated change team, and all functions part of the project. [ref. transformation approaches]. But a lot of attention needs to be given to avoid transformation isolation, the teams stay in the working organization and are the ambassadors of lasting change.
• Value selling/pricing has the best long-term impact when fully embedded into the core company processes and culture; it is a crucial driver of customer centricity [ref customer centricity].

4. Creating fair sharing as a foundation for long-term equitable economic benefits for all parties 

Capturing your fair share needs to combine analytics, power balance, and cultural sensitivity to what is considered fair. A quick Google search gave me 400+ million references, so there are enough definitions to choose from. Fair pricing is also defined in many laws, usually to ensure that, for example, monopolists cannot create extreme pricing. Still, most definitions use the freely agreed transaction between a supplier and a customer as a basis, often with a form of market reference. And if you reflect on this, this is exactly what value pricing strives for!

• What is fair is determined by the balance of power and the relative size of the effort versus value
  • If it takes only 2 hours of work to create €2 million value, this will not likely allow a 50/50 split, but why not ask €100k?
  • For a 20 man-years project (I guess €3-4 million costs) for €20 million value, maybe you can get 25-30%
• Pricing can be different kinds of money – direct payments or indirect payments
  • One-time payment, installment payments, pre-payment, post-payment, performance-related payment
• Value sharing can also use other currencies besides money:
  • Repeat business, extended work
  • IP ownership, or allowed to use (part of) results for others
  • References, publications, introductions to other customers

Remember, every product/service has opportunities for value pricing – even the most traditional commodities. Repeat business, long-term relations, are built on fair sharing of the value.

Ready to elevate your pricing strategy?

Ready to revolutionize your approach and drive unparalleled business success? Let’s dive deeper into the world of value-based pricing. Reach out at peter.gommers@peter4strategy.com or +31-6-53361249 to explore how to begin your journey towards pricing excellence.

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