If you’re not sure which pricing strategy to use for your product or service, this blog post is for you. We’ll compare cost based pricing vs value based pricing and help you decide which one is right for your business.
I was recently working with a client who was trying to decide between the two strategies. They had a product that they felt could be priced either way, but they weren’t sure which would be more successful. After doing some research, we figured out the difference between cost based pricing vs value based pricing and decided to go with the former. Find out how we arrived at that decision.
Cost Based Pricing vs Value Based Pricing
There are two main types of pricing methods: cost-based pricing and value-based pricing.
Cost-based pricing involves setting the price of a product or service based on the costs incurred to produce it.
This pricing method is often used when there is little to no competition and when the company is selling a product or service that is unique.
Value-based pricing involves setting the price of a product or service based on the perceived value of the product or service to the customer.
This pricing method is often used when there is significant competition and when the company is selling a product or service that is not unique.
What is Cost-Based Pricing?
A cost-based pricing model sets a floor price for a product that the business cannot make a loss on. This is determined by calculating all the costs associated with making and selling that product.
The ceiling price is the maximum that consumers are willing to pay for a product, and the price of the product is usually set somewhere in between the two. Commodity pricing is effective for products or services that can be bought and sold in large quantities.
Cost-based pricing models can also be hourly.
The biggest advantage that cost-based pricing has over other methods is its potential to generate lower prices. If a company can produce a product more cheaply than its competitors, it can sell that product at a lower price and still make a profit. This allows the company to do more business in volume and increase its market share.
A business owner can set a higher price for a product than competitors but risk losing customers to a cheaper alternative.
Cost-based pricing is a great option for larger companies that can weather the storm of price wars better than their smaller counterparts. Smaller companies need to be competitive, but they will eventually have to sacrifice quality if they want to keep up with the big boys on price.
The main disadvantage of cost-based pricing for services is that it can punish efficiency. For example, if a service technician has an hourly rate, they may be less inclined to work quickly and solve a problem efficiently to earn more money.
One of the most important decisions that any business must make is whether they should use price-based or value-based pricing models.
Commodity-based or cost-basis pricing models are based on what the competitive marketplace will bear.
The value-based pricing model is based on how much the customer perceives or actually values the product or service.
Let’s take a look at some of the benefits and drawbacks of each.
Elements of Cost-Based Pricing
Cost-based pricing models require businesses to determine the cost of making and selling a product, as well as the price that will generate profit.
In cost-based pricing, there is a “floor price”, which is the lowest amount that a product or service can be sold for and still make a profit.
There is also a “ceiling price” which is the maximum price that the market will accept for that product or service.
Pricing your product or service between the floor price and the ceiling price ensures your business is profitable and avoids over-pricing that will drive customers away.
What is Value-Based Pricing?
Value-based pricing is all about understanding your customer and what they need from your product or service. It’s important to take the time to really analyze your customer base so that you can offer them something of value that meets their specific needs.
When done correctly, value-based pricing can be a great way to increase sales and encourage customer loyalty.
While cost-based prices emphasize what a product can do, value-based prices emphasize what it can do for you.
Value pricing says “here are the tools that can help you” while cost-based pricing says “here are a few tools that may help you”.
Brands such as Louis Vuitton, Bentley, and Rolls Royce are luxury items. People buy them not only for their quality but also for their exclusivity and prestige.
Value pricing is not simply a matter of inflating prices. It requires an understanding of customer needs and wants, and the ability to provide what they are looking for. By meeting these needs, you create value for the customer which justifies the price.
The potential disadvantage to value-based pricing is that it could alienate customers who are motivated by affordability.
Not all businesses need to use price-based or value-based pricing models.
Apple is a great example of a product company that uses value-based pricing. They sell their products based on the increased efficiency, ease of use, and quality of life that they provide. This allows them to charge more for their products than other companies who simply base their prices on the cost of production.
Elements of Value-Based Pricing
Value-based pricing is when you charge customers based on how much they’re willing to pay.
As business owners, it is important to understand the needs of our target audience to estimate the value they would place on a product or service. This understanding will help us determine how much our customers are willing to pay for what we have to offer.
The value of a product or service is often determined by the benefits it offers. For example, Rolls Royce is a luxury vehicle that only wealthy people can afford.
BMW knows its customers are willing to spend top dollar for the status, reputation, and exclusiveness of its Rolls Royce line.
The Differences Between Value-Based Pricing & Cost-Based Pricing
A price strategy is either used as a marketing tool or as a way to survive. A cost-based pricing model bases your prices on how much you spend on manufacturing a product and what the market demand is.
Value-based pricing is a great way to use your product’s intangible qualities to determine how much to charge. This method of pricing uses subjective criteria to come up with a price, which can be helpful in many situations.
Pricing your product based on how much your customers value it or how much it costs you to make are both great ways to go.
Cost-based pricing and value-based pricing models are common for services and physical goods respectively.
There are a few things to consider when deciding whether cost based pricing vs value based pricing is right for your business. If you’re not sure which one to choose, we recommend doing some research and talking to experts in the field before making a decision.