So, how do you drive e-commerce sales using value-based pricing? Let's talk about it.
Picture this; you walk into a supermarket to purchase a can of green beans. You spot two brands but can’t seem to decide between them. Brand A has the supermarket’s label and costs £1.49 while the second option has a company’s name and goes for £1.69. Which one will you choose and why?
At a first glance, the only difference between the two is branding and you ask yourself whether it’s worth paying 20 pence more for just the brand? But when you dive into it further, you notice other differences. Maybe there’s a difference in ingredients or in shelf life. At the end of the day, when you pick the one you’ve settled on, you’ll pay for it because you are convinced that its value matches the price.
This is the same scenario that your customers face every time they come across your brand and your competitor’s brand. Is the value worth the price? That’s the question.
Shoppers have to make choices every day and this can be overwhelming.
As an eCommerce business, your job is to understand the factors that affect your customers’ choices and use them to your advantage to enable customers to choose your brand.
This is where value-based pricing comes in.
Value-priced pricing refers to a situation in which businesses set prices for their product or service based on the perceived value. So, this means that the focus is on the customer’s perception of a product’s worth and not the time or cost incurred in producing the product.
So, why would you consider value-based pricing?
We know it may not seem like it but businesses that adopt value-based pricing enjoy high margins. Let us explain.
The initial cost of producing an item can be high but once you get that done, the cost of replicating it is lower. You can initially set a high price point to recoup your production costs. After that, you can adopt a price that your customers feel is fair and worth the value of the product. This means that your customers will be able to afford the item and happy to pay for it because they feel that they are getting their money’s worth. In turn, your business can grow faster and bring in huge profits and as you continue to add value to your product, the price point might rise and bring in higher profits.
However, you need to be crystal clear about your target customer base and the value they prefer for a specific price tag. For example, your customers can be individuals who are into designer perfumes, or T-shirts. By entering a specific market or targeting a certain subset of your audience, you need not worry about the general players out there. For example, you won’t have to worry about businesses that sell regular perfumes or T-shirts if your niche is designer and your target audience is far wealthier and demands different things.
Hence, your customers will accept you charging higher prices because of your special niche as they might see the value of it being a ‘status symbol’ or just a high-quality product.
Now that you have seen why you need to embrace value-based pricing, let’s look at how you can come up with a strategy on this model to help your eCommerce business maximize profits.
Spot Your Niche: Customer Segmentation In Value-Based Pricing
Yes, you can market your product to every tom, dick, and harry who might or might not see the value in your product. By doing so, you are spending your time and effort on relatively lower returns. Target your focus and you’ll earn higher profits in the long run.
This is the reason brands have embraced customer segmentation which is all bifurcating your customers into various groups while considering their similar characteristics in order to tailor your marketing and sales efforts.
But obviously, for segmentation to work, it needs to be done right. Well, not all of them hit the right mark.
Professor Clayton Christensen from Harvard Business School stated that out of 30,000 new products that are launched in America alone, 95% of them fail due to poor market segmentation.
The first step to fixing your customer segmentation process is tweaking your market research. Understand why people buy particular products, what makes them think of a product as valuable and what is their ideal price point for that value.
Get granular in your approach and set price points for each group based on this research.
What Value-Based Pricing Is Not (Myths To Bust)
As important as value-based pricing is, many people (including marketers) misunderstand the concept and hence, fail to see real ROI from it.
Let’s debunk two common myths about value-based pricing.
Myth 1- Value-based pricing is one that brings the most sales
This misconception is dangerous because it sets marketers up for failure. As a brand, you need to be smart while setting prices. You can’t just undercut your competitors and set an absurdly low price. There’s a reason they might set that price point. Equal importance must be given to your costs and other factors such as supply.
Think about this. What if you start an online clothing line and the cost of making a particular shirt is £4. If you sell it at £2, you’ll have everyone flocking to your site to buy it because after all, who doesn’t like to pay less for an item? What you should be asking yourself is whether £2 is the right price to which the answer is definitely no. Yes, you will have lots of sales but you will also make huge losses.
You, therefore, have to be careful even as you set low prices, discounts, and promotions because they will always make your customers expect lower prices and if you change them then they will flee. Don’t only consider the sales volume and forget about other things.
Myth 2: Each feature needs a Value-based pricing strategy
There is a common belief that a business needs to evaluate how much every single feature is worth according to your customers. This is pointless and exhausting.
Let’s say you sell phones online. Before you set a price for a specific phone, you shouldn’t figure out how much your customers think the screen size, battery life, camera resolution, infrared remote control, memory, storage space, and each accessory are all worth separately and then just add it all up. As strange as it sounds, some brands believe this is how value-based pricing works, which is not the case.
Instead, focus on your USPs and the features that set you apart from the rest. So, if the phone has extra storage space, multiple windows, high speed, and a long-lasting battery then customers would not mind paying extra to enjoy these features.
Should You Go For Value-Based Pricing?
There are various types of pricing models that online business owners use such as cost-based pricing, competition-based pricing, and what we are discussing is value-based pricing. Therefore, it’s normal to ask yourself whether you should adopt value-based pricing for your eCommerce business, the pros, and cons of this model, and how it fares compared to others. As you read further, we answer these questions.
Advantages of value-based pricing
Below are some of the benefits you stand to gain from using a value-based pricing strategy.
Makes it easy to penetrate the market
What sets the value-based pricing model apart from the rest is the fact that it takes into account internal and external variables. By applying this model, you consider various factors (even though the value is at the forefront) before you settle on a price. The research and consideration involved helping you to develop and package your products differently thus draws customers to you. Therefore, it becomes easier to penetrate a market.
You can enjoy higher $$$
Since you are dealing with the most important person (the consumer), you can charge the highest price they are willing to pay. The beauty of this model is that you can even do this right off the bat and then adjust the price as you go on.
Think about this. If you apply other models like competition-based then you will be forced to settle for whichever prices your competitors set. What if they are using low-quality materials to develop their products and so they can still make a profit even if they set the price low? What if they didn’t do proper research on the resources required to create a product and so the price they set cannot allow them to enjoy high profits? You would be losing out yet your customers find your product more valuable and wouldn’t mind paying more.
Drives Better Quality Products & Customer Service
“Customer is King” - Philip Kotler
This pricing model puts the customer first. It considers what the customer wants, how much they are willing to pay for it, what they consider as value, and what drives their purchasing decisions.
To get answers to these questions, you will need to conduct customer surveys and interviews. The data you get will help you understand the customer more and help you figure out how to serve them better. Since customers are at the heart of this approach, you will be motivated to offer the best possible service to justify your price.
Similarly, you will be driven to come up with better quality products that your customers will appreciate especially if you are considering adjusting your price upwards.
Disadvantages of value-based pricing
It’s not all great with value-based pricing. Some things make it difficult. Here are a few such demerits.
Can be Complex and Time-consuming
This strategy is not an exact science. There isn’t a single method to be followed that guarantees 100% success. What you get from your research are approximations of the right price but not an exact figure. Therefore, you have to play around with the figure and the packaging of your product to reap the benefits of the strategy as discussed in the previous section.
And so, coming up with an effective value-based strategy and implementing it takes a significant amount of time and money. The work doesn’t stop when you create your strategy, you have to use customer feedback to continuously build on it so it can be more effective.
Additionally, your many customers may have different opinions on how much your product is worth which makes it difficult to choose one price. These are the reasons why brands prefer competitor-based and cost-based pricing.
Comparison between value-based, cost-based, and competition-based pricing models
If you're wondering which pricing model is most suitable for your eCommerce business, the comparison between the different models below can help you to make that decision.
Characteristics of Cost based Pricing Strategy
- Price is based on the cost of producing a product
- Has fixed profit margins
- Product price is fixed
- It's easy to implement since you can have a figure for production costs and so you can simply add your preferred profit margin
- Works well for both startups and established businesses
- Is not flexible when it comes to consumer demand trends
- Price is easy to justify
- Businesses are not obligated to improve on their products or services
- Works well for physical products
- Cares about covering production costs
Characteristics of Competition based Pricing Strategy
- Price is based on how much competitors charge for a similar product
- The risk of not making profits is low. Since the pricing has worked for your competitors’ you can also benefit from it.
- Price is fixed since you are pricing your product relative to that of your competitors.
- It's simple to implement since you are using your competitors’ pricing information
- Works well for startups since you apply tactics already tested by your competitors
- It considers consumer demand trends
- Price has already been accepted by customers so no need for justification
- Limited chances for adding value since businesses can’t increase the price given that they are depending on their competitors’ prices
- Works well for both physical products and services
- Cares about providing something that already exists in the market
Characteristics of Value based Pricing Strategy
- Price is based on customers’ perceived value of the product
- Has the highest profit margins
- Price is more flexible and falls on a ranges.
- It is complex to implement since there are many factors involved
- Works better for established businesses
- Takes into account consumer demand trends and is quite flexible with this regard
- Can be difficult to justify value added when you increase the price
- Encourages brands to develop better quality products
- Works well mostly for services
- Cares about providing value to customers
When Does Value-Based Pricing Work?
It takes time to come up with a value-based pricing strategy that works because of all the research and analysis that goes into it. Therefore, if you are a new online business or are just entering the market and want immediate results then this pricing strategy may be the wrong approach for you.
If the market you are getting into is very saturated and you can get profits by following the already set costs then it is not advisable to go for value-based pricing since you lack a specialized market/niche.
Apart from the two scenarios mentioned above, value-based pricing will always be best for you.
If your brand focuses on prestige then it is a good idea to go for value-based pricing because you have a specific market that will be happy to pay more money to enjoy the high-end product purchased by a few.
If the product you are selling is subjected to inelastic demand then you should choose value-based pricing because the demand for the item or service is already so high to an extent that charging lower would have almost no difference on the volume of sales. The same applies to when you increase the price which you can then do to achieve higher profit margins.
If your business sells companion products then value-based pricing will work well since the main product already has a huge market that you can capitalize on. Customers will be willing to buy your products since they improve the functionality of what they already own. An example of this is selling laptop chargers so if someone’s charger gets damaged, they will be forced to buy a new one since they need it for their laptop to function.
Creating A Profit-Maximizing Value-Based Pricing Strategy
You now have a better understanding of what value-based pricing is and how it can benefit your eCommerce business. It’s time to create a strategy to help you enjoy the benefits of this pricing model. Here’s how you can go about it.
Conduct research on your target customers
To come up with a price for your product using the value-based pricing method, you need to know the value your customers place on your product. This is where research comes in.
Through research, you will know what customers think of your product, how much they are willing to pay for it, if your product solves their problems, and areas you can improve on.
There is no specific value-based pricing formula to be followed. You can conduct surveys and interviews with your target audience to get the information you want.
You can start with your existing customers and figure out how much they feel your product is worth and the features of your product they like most because this might be the reason they are buying from you.
Then approach those who have never purchased your product but you would like to cater to them and determine if they would be interested in buying your product and why and how much they are willing to pay for it. If they don’t want to buy your product, you can also ask the reason because this might be an opportunity for improvement.
Creating customer personas may also come in handy here to help you understand your customer and their buying choices better.
Conduct research on your competitors
Yes, value-based pricing mainly focuses on how valuable customers think your product is.
However, the reality is that you are not operating in a bubble. You have other brands producing similar products as your eCommerce business and when customers are presented with choices, they will prefer value, but they will also look at the price. If customers can get a product similar to yours at a way cheaper price, there are high chances they will pick that unless there’s something significantly unique about yours.
Assessing your competitors also helps you to know their strengths and weaknesses, why customers buy from them, and what aspect of their marketing is working that you can use to improve your own.
Now that you know the importance of understanding your competitors, let’s look at how you can do competitive research.
The first step is figuring out which other option your customers have if they don’t settle for your product or service. Find out how much that second option costs and anything that makes your product better than it. Assess how much your customers think the differences between your product and option B is.
Then look at the advantages that option B has over your product or service. I know this is hard because we would like to think of our products as the ultimate prize but it’s necessary to do this. Then, ask yourself how much your customers would be willing to pay to enjoy these features your product lacks.
Set a price for your product
Now that you have all the information you have from research, it’s time to set a price for your product or service.
Since you know how much option B costs, take that amount and add the value of the key features that your product has over the next option. For example, if we still use the example of a smartphone, ask yourself how much the longer battery life you are providing is worth, what about the extra speed and storage space? You will now have a total when you add the price for option B to the value of the advantages your product has. Remember we have the advantages of option B too. So, give these advantages a figure and subtract it from the total you have. That’s how you arrive at a value-based price for your product.
Test the price
As we have mentioned throughout this article, arriving at the right price will take time and maybe even trial and error. That is why you need to test the price you have set and see if it will favor both you and your customers. If it doesn’t work the first time, brainstorm again, play around with the first figure and test again until you get a good price. Then, you can implement it by putting it in front of your customers.
Success Stories That Can Inspire You
At this point, you have an excellent idea of what value-based pricing is and how it works. We can then look at some famous value-based pricing examples that can teach you a thing or two about this approach.
Starbucks has become so popular worldwide to an extent that it is recognized even in countries where it doesn’t have stores. The massive brand awareness resulted from the fact that it changed the way people drink coffee by providing good-coffee-based beverages and an amazing experience that promoted social interactions. To many, Starbucks has become the stopover between work and home, the place where you go to catch up with a loved one or where you go to have your quiet moments and reflect as you enjoy the ambiance.
Starbucks has gathered a loyal fan base over the years because of the value they provide which include:
- Being able to relax and socialize without fear of being asked to leave if they don’t constantly make orders.
- The cool feeling they get from holding a Starbucks cup due to the prestige associated with the company. Starbucks appeared on Fortune Magazine as the 5th most admired company globally so this says a lot about what people think of it.
- Enjoying amazing products and a good social image for an affordable price. The thought of always enjoying some good luxury coffee made with premium beans while talking to other customers in a cool relaxed place is enough to make one part with their hard-earned cash.
Starbucks has had the confidence to increase their prices over the years because their customers feel the value they get is worth the extra cash and so they are loyal to the company. Presently, the company appeals to mainly higher-income earners and some middle-income individuals.
Everlane is an eCommerce brand that sells clothing. This company practices value-based pricing which has earned their customers’ trust, strengthened their brand, and brought them lots of profits.
Everlane prides itself in being radically transparent with its customers. The company does this by showing a breakdown of the cost of raw materials, transportation, coming down to how much it cost them to produce each item of clothing and they also show the profit they get from the product.
Aside from the price, the eCommerce company also shares the factories that make their clothing, and they even show photos of the employees as they make the clothes. This radical transparency has endeared customers to them who see the value they provide and do not mind paying for it. The value that Everlane customers get include:
- Quality clothing made from the finest materials.
- Knowing that they are dealing with a trustworthy company because of their ‘radical transparency’ policy.
- The comfort of knowing that they’re buying from a brand that deals with ethical factories.
Fast Company, a magazine company in the US that publishes content on business, design, and technology, did a piece on Everalen under ‘most innovative companies.’ The founder of Everlane, Michael Preysman appeared in Forbes magazine under the 30 under 30 section in 2015. He was featured as someone who reinvented retail and eCommerce. These are testaments that the company’s strategy is working.
A lot goes into creating a value-based pricing strategy but once you have something solid to work with, the benefits are endless. If you are looking to work less and earn more than this price model will get you there.
Value-based pricing helps your brand to become stronger because it provides you with information on what customers are looking for in your product. In the end, you’ll have superior quality products and a loyal customer base that will buy from you even if you increase the price of your products. Of course, it involves some work from your side too.
You have to be committed to showing your customers that they matter to you and you want to improve their lives. Value-based pricing is something you may want to explore as an eCommerce business. Brands are gaining big from it and you cannot afford to be left behind.