What is Value-Based Pricing?

Cost-Plus Pricing Vs Value-Based Pricing

In general, companies calculate the selling price of a product or service based on the costs incurred in manufacturing that product or delivering that service. This is what we call Cost-Plus Pricing strategy where the price of a product is proportional to the manufacturing cost.

We very well understand that a superior brand can charge slightly more for a product than a less-known company that produces the same product, which is the usual case. There's a brand value attached to products that belong to a superior brand. In such cases, the price difference between the products do not vary much, because even the premium brand cannot increase its selling price in a disproportionate manner as it would significantly impact the sales volumes. Value based pricing is completely different from this scenario.

In Value-based Pricing, a company can charge a significantly higher price for a product or service, and the pricing is completely independent of the manufacturing cost. If we have to define Value-based pricing, then "it's a pricing strategy to calculate the selling price of an item or a service based on its perceived value rather than its actual value."

Examples of Value-Based Pricing

Not every product or service can command a premium price. Following is a list of situations where Value-Based Pricing can be effective −

When there is limited supply

For example, if a reputed watch maker comes up with a designer collection to mark its centenary. The company will produce only 1000 such pieces. Then, a person who is an admirer of this watch brand would be ready to pay a premium price to own a piece from the designer collection.

Let's take another example. Imagine how much you pay for a bucket of popcorn inside a multiplex. You would get the same bucket of popcorn at half the price, outside the multiplex. The difference in price, in this case, is due to high demand of popcorn and its limited supply.

When there is a novelty factor

Suppose Samsung comes up with a new 5G enabled smartphone with an all-new feature that is not available in other smartphones, then this new product can command a much higher price based on its novelty factor.

When a product is rare

A collector of postal stamps would not hesitate to pay a premium price for a stamp that is rare. In this case, the perceived value of the stamp is much more than its actual value.

When there's an emotional value attached

People sometimes pay exorbitantly higher prices for costumes designed by famous and renowned designers. Sometimes famous paintings sell for millions in auctions. The pricing in such cases is derived from the emotional value that the buyer attaches to such products.

Let's take an example to understand this scenario. Yamaha RX-100 was a popular bike model in India and it is still a favorite among bike-lovers, but unfortunately, the company is no longer producing this model. Since there is an emotional value attached to it, the second-hand bikes of Yamaha RX-100 are still in demand and bike-lovers pay a premium price to own an RX-100.

How Does Value-Based Pricing Affect Sales Volume?

Normally, when the prices increase, the volume comes down. However, in Value-based pricing, the selling price does not have much of an impact on the volume of items sold. It's due to the inequality between the demand and supply of such products that the companies can charge exceptionally high prices without affecting the volume of sales.

Sometimes, companies tend to take advantage of Value-Based Pricing to increase the selling price of some of their products disproportionately, thereby increasing their profit margins at the cost of minimal reduction in their sales volume.

Is It Easy to Apply Value-Based Pricing?

It is not at all easy to implement Value Based Pricing because there's no correlation between the manufacturing cost and the selling price. The pricing entirely depends on the perceived value which is not easy to find out.

In most of the cases, such products enjoy monopoly and they don't have any competitors. However, if there's a similar product with high perceived value, then it is all the more difficult to differentiate the products and fix a price.