Value­Based Pricing

Value­Based Pricing

An increasing number of companies are basing their prices on the product's value­based pricing

perceived value. Value­based pricing uses buyers' perceptions of value, not the Setting price based fin

seller's cost, as the key to pricing. Value­based pricing means that the marketer buyers'perceptions of

cannot design a product and marketing programme and then set the priee. Price product values rather

is considered along with the other marketing­mix variables before the marketing than on cost.

programme is set.

Figure 16.7 compares cost­based pricing with value­based pricing. Cost­based pricing is product driven. The company designs what it considers to be a good product, totals the costs of making the product and sets a price that covers costs plus a target profit. Marketing must then convince buyers that the product's value at that price justifies its purchase. If the priee turns out to be too high, the company must settle for lower mark­ups or lower sales, both resulting in disap­ pointing profits.

Value­based pricing reverses this process. The company sets its target priee based on customer perceptions of the product value. The targeted value and price then drive decisions about product design and what costs can be incurred. As a result, pricing begins with analyzing consumer needs and value perceptions and a

price is set to match consumers 1 perceived value:

Genera/ Pricing jipprotte/ies • 703

Consider Thorn selling its 10\V 2D energy­saving electric light bulbs to a hotel manager. The SL18 coses far more to make than a conventional 60­ watt tungsten light bulb, so a higher price has to be justified. Value pricing helps by looking at the hotel manager's total cost of ownership

rather than the price of electrie light bulbs. The life­cycle costs of the manager using a tungsten bulb tor the 1,000 hours that they last includes

the price of the bulb (60p), the labour cost of replacing it (SOp) and electricity (£4.80). The life­cycle cost of the tungsten bulb is therefore £5.90. The Thorn 10W 2D bulb uses a sixth of the electricity of a conventional bulb and lasts eight times longer. Its lite­cycle cost must

therefore be compared with the cost of owning eight tungsten bulbs: 8 x £5.90 = S47.20. To work out the value of the Thorn bulb, its cost of

ownership is also considered: changing the bulb 50p and electricity £6.40 (one­sixth the electricity costs of eight tungsten bulbs). The maximum value­based price of the Thorn bulb to the hotel manager is therefore:

Maximum value­based price = competitor's cost of ownership ­ own

operating eosts ­ £47.20 ­ (£6.40 + SOp) = £40.30

Using this evidence, Thorn can argue that it is worth the hotel manager paying a lot more than 60p to buy the energy­saving bulb. It is unrealistic to think that the manager would pay the full £40.30, but based on these figures, the actual price of £10.00 for the Thorn energy­saving bulb looks very reasonable. At first sight it seems hard to justify replacing a 60p tungsten bulb with a £10.00 energy­saving one, but value­based pricing shows the hotel manager is saving £30.00 by doing so. The value­based pricing using life­cycle costs can be used to justify paying a premium price on products: from low energy­condensation boilers as domestic

boilers to low maintenance jet fighters. 1 "

704 * Chapter 16 Pricing Considerations and Approaches

Figure 16.7

Cost­based versus value­based pricing

A company using perceived­value pricing must find out what value buyers assign to different competitive offers. However, measuring perceived value can be difficult. Sometimes consumers are asked how much they would pay for a basic product and for each benefit added to the offer. Or a company might conduct experiments to test the perceived value of different product offers. If the seller charges more than the buyers' perceived value, the company's sales will suffer. Many companies overprice their products and their products sell poorly. Other companies underprice. Uuderpriecd products sell very well, but they produce less revenue than they would if prices were raised to the perceived­value levels.