Question

Numerous companies are using the value-based pricing approach in establishing their pricing strategies. How would you define the value-based pricing approach? What are the main differences between the cost-based pricing and the value-based pricing approach?

Answer 1

Value-based pricing is the method of setting a price by which a company calculates and tries to earn the differentiated worth of its product for a particular customer segment when compared to its competitor. The goal of value-based pricing is to figure out how much your customers are willing to pay for your product, so that you can maximize your revenue by charging each customer the exact amount they are willing to pay. The goal of value-based pricing is to figure out how much your customers are willing to pay for your product, so that you can maximize your revenue by charging each customer the exact amount they are willing to pay. Value-based pricing in its literal sense implies basing pricing on the product benefits perceived by the customer instead of on the exact cost of developing the product.

Differences Between Value-Based and Cost-Based Pricing

The primary difference between value-based and cost-based pricing is that value-based pricing is almost exclusively focused on the benefits a product or service offers a customer, whereas cost-based pricing is focused on the features and characteristics of a product or service. Value-based pricing has a larger range of prices than cost-based pricing because value is an estimate of what people will pay to obtain desirable benefits, whereas cost is based on quantifiable numbers.

Cost-based pricing is typically less expensive than value-based pricing because cost-based businesses offer competitive prices to lure customers away from competitors. Value-based businesses are more expensive because they are based on the willingness of buyers to pay higher prices for benefits that are difficult to quantify. There is usually a higher profit margin with value-based pricing, but fewer of these products and services are sold than the more affordable products and services that use the cost-based pricing model.

Cost-based pricing generally results in competitive prices. Companies that use this strategy may attract consumers who are looking for inexpensive products and services. Value-based pricing companies often earn high profits on each item sold, but some consumers may not be willing to pay the high price and purchase from a competitor.  

Cost-based pricing focuses on the company’s situation when determining price. In contrast, value-based pricing focuses on the customers when determining price. A value-based pricing company develops a means by which to calculate the potential value their product or service may bring customers and prices accordingly. Some companies use computer software to determine the value a product or service can offer.