Think of TAG Heuer watches or designer handbags and you probably think: expensive. However, people pay because they view them as products with higher value than other watches or handbags.
That value may be tangible, such as high resale value for a TAG Heuer watch or top-name handbag, or intangible, such as the prestige of owning a Rolex or a Louis Vuitton. Companies that persuade buyers to make this trade-off rely on a marketing strategy known as price-to-value, sometimes called value-based pricing or premium pricing.
What is price-to-value?
Price-to-value, or value-based pricing, is when your business figures out the highest possible price customers will pay for your product. A price-to-value strategy focuses on customer perceptions—how much the customer needs or wants a particular product compared with alternatives. Successful value pricing is potentially more profitable to businesses than other, more common price strategies.
Two other pricing strategies are:
1. Cost-plus pricing
In cost-plus pricing, a business tallies its production, fixed, and operating costs, then adds an arbitrary percentage markup over cost to arrive at a price that produces a desired profit margin. In contrast to value-based pricing’s focus on the customer, cost-plus focuses on your business’s costs. However, your business might miss out on potential profit if you’re only charging prices 15% above costs when consumers are willing to pay prices equal to 25% above your costs.
2. Competitor-based pricing
With competitor-based pricing, you see prices of competing products and charge about the same. Again, the focus is not the customer. Competition-based pricing can get you stuck in a tight price range, unless you can show some feature that makes your product special and more valuable. For example, competition pricing is why, among other reasons, fuel prices at gas stations vary so little.
Why does price-to-value matter for an ecommerce business?
Product pricing decisions can make or break a small business. A value-based pricing strategy is meant to maximize prices, and thus sales, without scaring off too many customers who might balk at the price tag.
For example, an online seller of men’s shirts studies the market and sees that the competition charges an average of $50 per shirt. Their business, though, charges $75, using advertising to show that it uses superior fabric and reinforced stitching to prevent thread from unraveling at the collar, cuffs, and buttons.
Based on market research and customer surveys, the business estimates it will sell 80 shirts monthly, for total sales of $6,000. If it matched the competition at $50, it might sell 100 shirts, for total sales of $5,000. So value-based pricing pays off with fewer unit sales at higher prices.
A value-based pricing model is often ideal for small businesses because the other two common pricing strategies can expose a company to the squeeze between supplier costs and low-price competition. Small businesses generally don’t offer the lowest prices because they can’t achieve economies of scale in production or purchasing supplies in bulk to reduce costs. They also risk bigger, more efficient rivals coming along and charging less.
What factors can affect value-based pricing?
The success of a value-pricing strategy can depend on a host of factors, among them:
- Product quality
- Unique features
- Brand reputation
- Market entry
- Market demand
- Trademarks, patents, legal protection
- Economic conditions
Customer perceptions of a product’s higher quality can influence their willingness to pay a premium price.
A product or service needs some feature that gives it the qualities to command a higher price. These features might include easy product return and refund policies, customer referral bonuses, and higher resale value.
Brand perception combined with specific, superior product features might lead to more successful value-based pricing. Luxury products capitalize on this for premium pricing.
A product introduction is the ideal time to make the most of a value-to-price strategy. Think about Apple’s launch of first-of-kind products such as the iPhone, iPad, and Apple Watch, all with premium prices. Raising prices for established products is much harder.
Premium pricing is more likely to succeed when a product has little or no competition. Competitors can face high barriers to market entry if a business has spent time and money to establish its premium products.
Pricing is influenced by market demand as well as product supply. Limited production of luxury and prestige goods can add to the sense of exclusivity and perceived value.
Trademarks, patents, legal protection
Premium-price-product businesses may need to take legal action against copycats, including enforcement of any patents and trademarks that make their products unique.
Pricing decisions must account for current and expected economic conditions, which affect consumer sentiment and spending. The unemployment level, inflation, and interest rates can change consumer perceptions of price and value, affecting their willingness to pay higher prices for products and services.
Will a price-to-value strategy work for you? 3 considerations
Use the following three tactics to assess whether a price-to-value strategy will work for your business.
1. Customer needs and wants
A pricing strategy must be in sync with a customer’s willingness to pay. The business needs to identify and highlight the special or unique features of its product that customers may perceive as valuable. Satisfied customers are more likely to be repeat customers and to refer friends and family to the products.
2. Customer data
A business can determine its target market by gathering customer data. Focus on demographics (where people live and work, household incomes, home values, credit card spending, etc.), and population shifts, such as increased migration to suburbs from large cities.
3. Customer feedback
Outreach to potential customers is essential. A business can canvass them for product preferences and the specific features they seek. Also consider surveys about price points to learn the most that customers might pay based on their perception of your product’s value.
Price-to-value pricing FAQ
How does the price-to-value strategy determine the value of a product?
A price-to-value strategy sets prices based on buyers’ perception of the value of a product. Businesses that use this strategy survey customers, respond to their concerns, and promote product features the customers consider valuable.
Can a high price relative to value indicate a poor-value product?
A high product price relative to its perceived value suggests customers think it’s overpriced. It also may indicate a business isn’t targeting the right customers.
What role does brand reputation play in a price-to-value strategy?
A good brand reputation certainly doesn’t hurt, but by itself may not help a business that wants to change a premium price. The product or service generally should have some features or attributes that can be identified and valued by a customer to justify a higher price.