Give me a lever long enough, and a fulcrum on which to place it, and I shall move the world. - Archimedes
Pricing is one of the most powerful and underused strategies for growth in any business. Most companies focus on metrics other than price: fixed and variable costs, revenue or increase in unit sales, decreases in inventory. In fact, because price is not commonly associated with bottom line profitability, the result is often reactive pricing strategies which undermine rather than enhance profitability.
Proactive pricing is a lever for profitability, and the fulcrum for proactive pricing is value. This combination can have a profound impact on business growth. Higher the value of a company’s offerings, greater the pricing leverage, and greater the profits. Unlike legacy strategies such as cost-plus, historical-based, and volume-driven pricing, which tend to decrease price premiums and profits over time, value-based pricing optimizes a company’s pricing structure for the current market conditions. It is also highly adaptable and can therefore accommodate market changes without loss of profit.
Value-based pricing is a strategic tool to be championed by the executive suite and business unit leads. This paper outlines the elements of a successful value-based pricing strategy.
Defining the Fulcrum
As a major factor in leveraging business growth, it is important for a company to fully understand the concept of value. The basic definition is:
VALUE = Benifits/Costs
Unlike other factors that contribute to pricing, value is neither quantifiable nor static. It is a buyer-side quality that is founded on perception, proportional to the buyer’s perceived benefits and inversely proportional to the buyer’s perceived costs. Benefits are those aspects of your product or service that differentiate it from competitor offerings - in ways that matter to the buyer. Cost can include factors besides the financial price; the product or service may require a time or resource expenditure by the buyer, or it may involve opportunity costs (see Table 1). If benefits outweigh costs, perceived value will be positive, and the higher the benefit-to-cost ratio, the higher the value - in the perception of the buyer.
Influence buyer perception, then, and you influence value. Influence value so that it increases in the view of the buyer, and you have the makings of a value-based pricing strategy.
Three Ingredients for Value-Based Pricing
There are three necessary “ingredients” that must be in place in order to establish value-based pricing in a company:
- Focused Data Analytics
- Appropriate Company Culture
- Positive Stakeholder Behavior
Focused Data Analytics
Data is the place to start. There is a range of data and information that must be captured in order to effectively pursue a value-based pricing strategy. This data is analyzed to determine the key analytics that will help convert value to numeric expression. These focused data analytics may vary by product line and customer type.
In our engagements across a range of companies, we have found that many companies have one or usually more of these challenges to address before they can move forward: