What is Value Based Pricing? 2 Rules of Price Optimization

Warren Buffet said, “Price is what you pay, value is what you get.” Put another way, value is what builds the price. Implementing value-based pricing is the surest way to monetize that value and the best way to make sure you’re not leaving money on the table. Value-based pricing provides the greatest revenue and margin potential.

Price Optimization CHALLENGE

There are many pricing strategies and all have their time and place in a product’s lifecycle. But the strategy used to the greatest effect, that consistently drops the most profit to the bottom line is value-based pricing. Understanding it is the key to pricing
success.

RULES OF PRICING

There are two basic, yet highly powerful rules in pricing and these rules form a foundation for sound price decision-making. Understanding them helps to organize your approach to pricing from a scientific value-based position. Coined by iconic pricing practitioner Ron Baker, the first and second laws of pricing are:

• all pricing is contextual 
• value is subjective

RULE #1 - PRICING IS CONTEXTUAL

If you have two similar soaps on offer, one being "premium" and the other being "standard", the standard one outsells the premim one.  Why? Because it is less expensive and the value proposition suggests that it is just as functional as the more expensive one.  In the contaext of a choice between two items, most consumers opt for the one that offers the vest value - in this case it is the lower priced one.  If a new brand of soap is introduced, and priced above the previously highest priced soap, it becomes an "ultra-luxury" soap.  The price of the middle soap choice is increased slightly, but still becomes the alpa, because pricing sychology indicates that a majority of people will gravitate toward the middle offering when there's a choice of good-better-best.  Recoginzing there are three choices presents a powerful pricing opportunity.

RULE #2 - VALUE IS SUBJECTIVE

What is considered value depends on the product, the organization, the culture, the country, etc. The basis for your pricing decisions become a balance between enterprise, departmental and marketplace expectations. There often can be conflicting internal pricing goals. The CFO requires higher profits, Marketing would prefer promotional discounts, Sales needs pricing flexibility and the CEO wants answers he can deliver in the board room; the list of goals is never ending. The object in sound pricing policy is to find the place in the pricing sphere that will resonate with the marketplace and at the same time satisfy the business requirements for higher profits and revenues.

ABOUT THE AUTHOR

Dave Leonard is the CEO of Advanced Pricing Logic. He has over 30 years of executive management experience in multi-channel retail, distribution, manufacturing, and catalog merchandising. Mr. Leonard has extensive experience in the area of technology analytics as it relates to price optimization for the mass marketer, inventory control and
optimization, purchasing optimization, and consumer pricing psychology.

ABOUT APL

At Advanced Pricing Logic we are dedicated to designing innovative analytic software that makes our customers more profitable. Our software transforms data into insight and provides the platform to turn insight into action. Designed by business professionals, our software follows three guiding principles: encapsulate world class analytics, enable customers to take sound action through easy to use applications and ensure ROI less than a year after purchase.

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