Charles Michael Vaughn says pricing is among the important elements of marketing. Charles Michael Vaughn mentioned businesses should focus on, to make the product or service marketable. Over the last few decades, the trends in the market for choosing the right pricing strategy have varied. We have now come at a juncture where a relatively new model of pricing is being hailed by business experts as the most efficient pricing strategy, particularly for services. Value-based pricing is being sold as the latest marketing mantra but before we look at what it is, let us briefly look at some of the most common pricing strategies.
Perhaps the most common pricing strategy is cost-plus pricing. It does not require much data and input from the market, Charles Michael Vaughn states. The producer or service provider simply adds the profit margin to the cost, to arrive at the price. It is easy to calculate but the downside is that it provides no way to gauge whether the product or service is priced correctly or not. If underpriced, the producer loses revenue and if overpriced, the producer will soon lose out to the competition.
A very common pricing strategy for service providers, particularly accounting firms is the billable hour’s strategy, says Charles Michael Vaughn. Firms charge their clients based on the number of hours worked. While it may seem fair at first, this strategy has its pitfalls. If the engagement team works fast, they put in fewer hours of work and thus end up losing revenue. If the engagement team works deliberately slow, they can prolong the hours and thus increase the revenue. Billable hour strategy, just like cost-plus fails to be efficient for the business and the customer.
Another strategy that can be seen commonly among service providers such as Netflix, Adobe, and other services is the tiered pricing strategy. This is subscription-based pricing that can be divided into multiple categories, usually three with each category offering more features than the last one.
For services, tiered pricing is a good strategy because it can funnel down the customers based on their requirements and usage of the service. The more features you need, the more you have to pay, says Charles Michael Vaughn. This sounds absolutely fine.
But it turns out that even the tiered pricing strategy fails to maximize the revenue if the pricing is not set properly. In the graph shown above it can be seen how tiered pricing leaves gaps that the business fails to capitalize upon. The question here is, even with tiered pricing how do you set the price? A business can create three or more tiers but what are the criteria for setting the base level price?
The answer to this is Value pricing!
What is Value pricing?
Value pricing or value-based pricing is a pricing concept that aims to maximize revenue by focusing on the value metric. Value-based pricing required the business to first identify its value metric.
The value metric is an indicator that allows the business to quantify the value it is providing. The concept behind value pricing is that instead of using the profit margin or looking at the competition, businesses should price their products and services against the value that they create for the consumer.
By basing the prices on the value being provided, businesses can efficiently maximize the revenue because the consumer will realize that the price they are paying is exactly right for the value they are getting from the product or service. If the business chooses the right value metric, the price will neither be over nor undervalued.
The value metric is an indicator to measure the value being created. For instance, the value metric for Netflix can be the hours of entertainment that the consumers get. For Norton Antivirus, the value metric can be the number of threats detected and prevented in a month. For a business advisor like Charles Michael Vaughn, the value metric can be the number of sales leads generated in a month.
This is why it is absolutely vital for a business to do its research to understand its value metrics. It is also possible for a business to have multiple value metrics. Once the business has understood and identified its value metrics, it can use the value metric to price the services.
Although some businesses tend to use value metrics and then choose a tiered pricing strategy, ideally value-based pricing does not need tiered pricing. Because your value metric will itself create an infinite number of tiers, based on each customer’s preference.
Charles Michael Vaughn said another article would be required to explain value-based pricing in further detail. For now, it would be enough to say that by focusing on the value that the business is creating for its customers, revenue can be maximized in the most efficient manner.