A strong pricing strategy is essential for companies looking to achieve their various goals and objectives, whether it be to increase their profit margins or determine the return of investment for newly developed products. However, with the multitude of pricing research methods available in the field, how do companies decide which to implement for their particular product or service? In this article, we explore two major types of pricing strategies, and also highlight the key differences as well as their advantages and disadvantages.
Cost-based pricing can be described as a strategy to determine the selling prices of a company’s products based on their production costs, while value-based pricing is a strategy of setting prices of a product or service based on its value perceived by customers.
The following table shows several key differences between cost-based pricing and value-based pricing:
|Areas||Cost-based pricing||Value-based pricing|
|Focus||Focuses on the costs when determining price||Focuses on the customers when determining price|
|Prices||The price is set between the floor and ceiling amount, usually influenced by market conditions.||The price is set in a range determined by what customers are willing to pay. The price is often equal or higher than if cost-based pricing was used.|
Cost-based pricing is commonly used in retail and manufacturing sectors, as the physical nature of the products being sold would mean that there may be raw materials and labour costs that need to be covered by companies.
Cost plus pricing is considered to be the most straightforward cost-based pricing method. To determine a product’s selling price, the method entails adding a certain profit percentage (also known as markup percentage) on top of the total costs (including fixed and variable costs) of making a unit of the product.
An example of cost-based pricing is as follows:
Company A sells hair products, such as shampoos, conditioners etc. To produce a bottle of shampoo, let’s say the total unit cost (fixed and variable) is $6. If the company wants to make a 50% return, they would need to sell a bottle at a price of $9.
Selling price = $6 * (1 + 0.50) = $9
✔️Advantages of cost-based pricing
Does not require much research or expertise: As long as a company is certain of the costs involved, the strategy can be a great starting point as no competitor information or market trends are needed to determine a selling price.
Easy to justify price increases: Should market conditions cause a rise in the cost of materials in the future, companies would be able to defend the resulting changes in prices.
❌ Disadvantages of cost-based pricing
Ignores a consumer’s willingness to pay: Companies could lose revenue or market share if their products’ prices are set too high.
Does not consider competitive positioning: Companies relying on cost-based pricing could risk getting outpriced by competitors who are selling similar products at more appealing prices.
Provides little incentive to control costs: Companies could be operating less efficiently, which could put them at risk of falling behind in the future, as adapting to changing market conditions could be more difficult.
The value-based pricing strategy can technically be applied in any industry, however it’s more commonly applied to products that are:
- Solid in its brand image
- Unique and in demand
- High quality
Value-based pricing is often seen in the tech or SaaS industry. Let’s look at an example of this:
Company A is about to release a new desktop monitor. What Company A should do before setting their monitor’s price is to compare it with the next best choice for the same target audience in the market. If Company B sells a similar monitor except for a few features, such as size or screen resolution, Company A then needs to determine the dollar value of the features that differentiate their monitor to that of company B. This process can be quite complex, thus companies would typically use robust pricing research methods such as conjoint analysis to properly achieve this.
✔️Advantages of value-based pricing
Higher price points: If a customer’s willingness to pay for a product is known, companies could potentially use that information to set higher price points and maximise their profits.
Facilitates product development: Value-based pricing could also help with continuous product improvement as companies could adjust or enhance the features of their service or product to increase its perceived value, potentially increasing its profitability.
Enables stronger customer service: As this strategy would most likely require obtaining customer feedback through surveys or interviews, companies may find that the process simultaneously helps to improve the quality of their customer service, allowing them to sustainably increase their brand value.
❌ Disadvantages of value-based pricing
The method is not exact: As it requires understanding consumer’s willingness to pay and their preferences for particular features, this measurement itself can vary depending on factors such as geographic location, the economy and market trends.
Requires time and resources: Unlike cost-based pricing, there is no one formula to calculate selling prices of a service or product. Techniques to determine a customer’s willingness to pay typically require extensive, in-depth analysis, such as Gabor-Granger’s Pricing Method or Van Westendorp’s Price Sensitivity Meter.
Conjoint analysis is another powerful research tool that can provide valuable insights into the value that customers place on specific features of a product or service. To investigate this further in a competitive context, statistical techniques such as the Brand-Price Trade Off could also be utilised to understand how the product is perceived by customers compared to other competitors.
For these reasons, Conjoint.ly recommends the value-based pricing strategy. With our easy-to-use platform and expert support, these tools can help guide product development decisions to ensure that products are optimally priced for profitable growth.
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