Why Value-Based Pricing is Overrated
Whenever we meet with organizations that are eager to reap the benefits of adopting more sophisticated pricing approaches, we always ask executives what they want to accomplish through better pricing. The nature of the answers that we receive ranges from spot-on to muddled to being in open conflict with sound business practices. Often there is someone in the organization that either has some good experience with pricing, has been to some conferences or has read one of the many great books on pricing that are out there. Their typical position is that their firm needs to implement “value-based pricing.”
While familiarity with the principles of value-based pricing gives organizations a huge leg up, some significant perspective is required. To help with that perspective, here’s a question to ponder: Over the last ten years what percentage of the revenues and profits of the Fortune 500, Russell 2000 or any other group you choose can be attributed to the adoption of value-based pricing? While I haven’t done the research, as a bit of a pricing insider, I can assure you that answer ranges from negligible to very low.
Don’t get me wrong, organizations that focus on improving pricing performance often see major jumps in both revenues and profits. The questions is what is at the root of those results. There are typically three stages that lead to improved pricing results over time. The first stage typically involves getting control over unearned discounts and closing loopholes in the full set of terms under which transactions are conducted (a.k.a. the price waterfall.). Since most firms do some form of cost-based pricing, Stage 1 benefits are often a result of becoming better at cost-plus pricing.
The second stage is focused on setting list prices that more accurately reflect customers perceptions of value and the alternatives presented by competitors. By tempering the view of what competitors are doing with a sense of the unique value that they offer, firms at this stage are often engaging in what we call disciplined market-based pricing. They look at competitor prices but they also adjust price levels according using data that helps define their value position relative to those competitors. At this stage, that value data doesn’t necessarily have to be overly scientific. It could be based on something as simple as a survey of the sales team regarding the circumstances under which they have or do not have pricing power. It might also come from traditional, attitudinal market research that shows customers preferences or perceptions of one product vs another.
This brings us around to Stage 3: full-on value-based pricing. While this should be every firm’s objective, the truth is that implementing a sustainable value-based pricing program is extremely difficult and can take years to become standard practice in the organization. It requires sophisticated knowledge of the economic benefits received by customers; changes in market research, how competitive strategies are conceived, product management, sales practices, and incentive systems at all levels of the organization – just to name a few.
The thing to remember in all of this is that the primary purpose of doing the hard work on pricing is to achieve sustainable, long-run improvements in profitability. Value-based pricing is not a prerequisite for achieving this objective. All it really takes is a commitment to improving on whatever pricing approach that your firm is currently using – whether it is cost-plus, market-based, or value-based.
Whilst there is much in this article to agree with, I believe there are many points in it which are highly misleading about Value-Based Pricing and I would like to correct them.
The need to know what you want to accomplish by adopting ‘better’ pricing practices is unquestionable, as is the claim that familiarity with the principles of Value-Based Pricing will give you ‘a great leg up’. But just because very few Fortune 500 companies have reported success with the technique doesn’t mean it is flawed.
Tightening up procedures to eliminate unearned discounts and to create more favourable terms and conditions applies just as much to Value-Based Pricing as to any other form of price setting. There is a universal need to have an integrated selling and pricing strategy – One cannot live without the other.
But if your organisation is compelled to publish product lists and list prices then Value-Based Pricing probably isn’t the strategy for you. Value-Based Pricing works well in fields where the notion of charging different prices for different value – even if the work done is similar – can be assimilated.
If you do feel so compelled AND you feel compelled to ‘reflect competitor prices’ in your own, then you have chosen to operate in a commodity market with all that that choice entails, and so Value-Based Pricing probably isn’t the strategy for you.
I am not sure that Value-Based Pricing should be the ‘objective of every firm’. One size rarely fits all.
When it comes to implementing Value-Based Pricing by those for whom it is a great idea, it is both easy and quick to do. It is not the truth that it is ‘extremely difficult and can take years’. It is easy and it can take days to harvest the rewards that come from adopting a Value-Based approach to pricing.
Unquestionably Value-Based pricing ‘requires knowledge of the benefits to the customer’, So you ASK THEM! You often have to help them understand the ‘value’ because they have never asked themselves the right questions before, but this is a necessary skill that all adopters ought to be eager to acquire. And once acquired the process of understanding the value that the customer understands is extremely easy.
Any minor difficulties there may be will lie in knowing what to ask, and in having the ability to ask, then keep quiet and listen to the answers. No salesperson ever ‘listened’ themselves out of a sale!
Yes, Value-Based pricing can bring sustainable profit improvement, and yes it does require commitment from the whole organisation to its adoption.
David Winch