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Shortly before their closure, Toys R Us slashed nearly all their prices by 10-30% in a desperate attempt to bring customers in, but the customers never came. Despite this store-wide discount, Toys R Us was selling nearly all of their toys at prices too high to entice buyers. Over the course of decades as the market and competition evolved around the retail giant, they lost sight of how their customers valued their products and what they were comparing them to. As a result, they shut their doors.
Their demise was a shining example of why value-based pricing is so important to retailers, and why it is vital to have a clear understanding of what customers want, and what companies they’re comparing to yours. This article will navigate you through the theme of value-based pricing, and how it can be used in your business.
What is value-based pricing?
Value-based pricing revolves around pricing items based on a customer’s willingness to pay. By reaching an equilibrium with consumers and understanding the value that they put on a given product, a retailer can maximize their revenue and maintain competitive prices. To comply value-based pricing with the overall strategy, retailers should have a comprehensive vision of customer’s requests and needs. The visual below highlights crucial motivations underlying consumer behaviour today.
There’s more to value-based pricing other than the consumers’ willingness to pay, however. The key to utilizing value-based pricing to the fullest extent is to truly understand how customers view your products, what they want and expect from products as well as the retailers they buy from, and what features they seek in a given item.
Value-based pricing adds necessary detail to other pricing strategies. Competitor based pricing, for example, can give you a general idea of the value of your products - if customers are willing to pay $20 for your competitor's t-shirt, they should be willing to pay $20 for yours. However, basing your prices solely on this concept misses a fundamental aspect of pricing products accurately; that you should differ from your competitors, and so should your products, the way you market them, and therefore the way you price them. Taking the time to find out exactly what your customers think about your business, your products, comparable products on the market, and other key information can therefore bring your pricing to the next level, increasing your sales and revenue as a result.
The basics of how value pricing works
One way to determine a customer’s willingness to pay is to calculate the TEV (True Economic Value). The basic equation for the TEV of a product goes as follows:
For example, you competitor may be selling a plain white t-shirt valued at $10. Your t-shirt however, has an admired brand name on it. Customers view this brand a $5 more in value compared to a plain white t-shirt, making the TEV $15. Calculating the TEV this way is a basic but decent method to determine how willing a customer will be to pay for your products.
As you may have noticed, the latter segment of the equation, the value of performance differential, is going to differ based on the customer segment you are focusing on. This makes it important to target the right customers and if needed, recalculate the TEV several times according to the various customer segments you are aiming to market your products to. Depending on the product(s) in question, the value of performance differential can vary by region, gender, age, or even on an individual basis. Therefore, if you are hoping to calculate the TEV to begin implementing value-based pricing, customer input is vital in getting your numbers right. This can be done easily by providing optional surveys and questionnaires for your customers, asking relevant questions to the right customer segment.
So let’s say you’ve surveyed your target segment, calculated your TEV, and set your prices according to your findings, only to find that customers find your price too high. Why is this happening? Because you did not get the full perspective on your customers’ view of your product(s). Prices can often be lower than the TEV you calculate. Why is this so?
You know the ins and outs of your product. You know it’s true value, all of its features, and how they compare to your key competitors and their products. You know all of these things that play a part in the true value of your product, but your customers do not. Customers will almost always have a more limited view of a given item. They may not be aware of certain features or how they compare to the next best alternative on the market. This is what creates the difference between perceived value and delivered value, and it is also why delivered value is usually a bit lower than the perceived value, with perceived value being close to or exactly the TEV calculated. The decrease in value from perceived to delivered value can fortunately be slightly lessened through the right marketing tactics or depending on the structure of your company, a very good sales professional. Proper marketing or a good salesman can educate consumers more about product features and differences between your product and the nearest alternative, increasing the delivered value as a result.
Conclusion
Getting to know your customers enough to understand how they perceive value has several benefits to how you do business.
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By understanding how they see your products, what offers they’re comparing to yours, and what features they value and expect, you can set prices that speak their language.
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Surveying and interviewing your customers to obtain this knowledge will allow you to understand your perceived and delivered value, and make offers that customers just can’t refuse.
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The proper implementation of value-based pricing is a sure-fire way to increase your revenue and sales and stand out from competition.
For what it’s worth, a value-based pricing strategy you should look into to thrive in the modern market.
FAQ
The knowledge of customers' needs and preferences is at the core of good value based pricing. That is why retailers willing to use this approach should regularly run consumer researches.
Cost based pricing takes product cost as a major factor contributing to the final price. In the case of value-based pricing, the product cost is rather an insignificant factor while the value product brings to consumers is considered primarily.
