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The most common pricing model for just about any product is ‘cost-plus’. This involves adding a margin to the costs associated with producing, transporting and promoting a product.

Another common pricing model is ‘competitive pricing’ where prices are set on the basis of what competitors are changing for similar products.

Perhaps a more prudent pricing model is ‘value based pricing’, where the price is based on the real or perceived value (benefits) delivered to consumers.

While cost-plus makes some sense in terms of setting a minimum price, and competitor pricing is important when products are directly comparable, value based pricing is the most strategic and profit oriented model. It is also the most difficult to implement.

Value based pricing, based on the perceived value of a product, recognises that value is all about perception, and not much about reality. It recognises that what consumers will pay for a product is based much more on what they feel about a product than what they know. Indeed, consumers rarely know the facts, and in that environment – perception is everything.

For the consumer, value based pricing, offers two benefits:

  • It recognises that value involves more than the product per se;
  • It delivers what they perceive to be value for money.

Value based pricing places the consumer at the centre of the equation. On a cost-plus basis a Ferrari is not worth what it costs. On a perceived value basis, purchasers see real value in a Ferrari – as they buy much more than a car, and non-purchasers look forward to being able to afford such a vehicle.

The consumer’s perception of value, of course extends well beyond the product per se to take into account the brand (and its values), service standards, and after sales support etc.

Value based pricing offers real benefits in that it:

  • Provides potential for higher margins
  • Facilitates brand loyalty

When there is an understanding of the perceived value of a product or brand, there is a clear idea of the maximum price that can be charged.

Utilising a value based pricing model requires an understanding of the primary target market and what that market values. In the case of the Ferrari – the purchaser is buying much more than a car and would, arguably, not purchase the car at all if it were half the price. Indeed, the price of a Ferrari is part of what the consumer is buying. It makes a statement about their financial capacity and, perhaps (in their minds at least), their success.

To utilise value based pricing, it is important to know what the primary target market values and what they are prepared to pay for. Ferrari buyers are, by all accounts, prepared to pay a great deal for prestige and ‘pulling power’. What are your consumers prepared to pay for?

What is the intrinsic and extrinsic value your customers are prepared to pay for, and how much are they prepared to pay?

A great example of value based pricing can be found in the fashion industry. When a designer is uunknown, consumers will generally only pay the intrinsic value of an item of clothing. That is, they will pay for the product per se, but not the brand. As the brand name becomes known and consumers want to be seen wearing the brand – they will start to pay a premium for extrinsic value – based on their perception of the brand and the perception of others towards the brand.

Understanding perceived value is difficult. It involves getting much closer to, and developing a much better understanding of, the primary target market. It requires a commitment to research.

Get closer to your market and understand what they value so that you can embrace value based pricing.

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D. John Carlson – Adviser and Speaker – 0402 273 350 or [email protected] .

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