Written by Yuval A. Harel

A big part of inbound marketing is putting customers first. This means understanding the value customers perceive of a product or service.

That is why value based pricing is an integral part of having a good inbound strategy.

Value Based Pricing according to Investopedia "is a price-setting strategy where prices are set primarily on a consumers' perceived value of the product or service." 

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Using value based pricing assures that you are evaluating the full value of a product or service and not leaving money on the table or asking for more than what the product is worth.

Let's explore the price of a chocolate bar. Let's say that it costs you $5 to make a chocolate bar. What do you price it at? Do we say cost + $1  and price it at $6 (Cost Plus Pricing)? Do we say we want a 95% gross profit and price it at $100 (Targeting Pricing)?

Someone might pay that much of a chocolate bar. It depends on your target customer, but let's assume most will not. Could we price it based on your customer's willingness to pay (Value Based Pricing)? Since this is a value based pricing discussion, let's assume you picked the last choice.

An excellent place to start when it comes to value based pricing is the Next Best Alternative (NBA). The most natural choice is to pick your competitors' products (for a more comprehensive exploration of NBA, see Pricing Strategy – Who decides the price?). A customer's NBA might be a cheap chocolate bar, and the customer does not care (recognize the value) about fair trade, organic, single origin bean, which comes in an artistic wrapper (the price shopper customer).

The price shopper will go for a Hershey bar over your exotic brand because your value does not resonate with them. You can try to compete with Hershey on price but will lose since your costs are so high. So what do we do? We eat a Hershey bar and recognize that your product has more value to offer (positive differentiation value) to the customers who are willing to pay (value seekers) for fair trade, organic, single origin bean, which comes in an artistic wrapper.

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Each one of these attributes has a value to your customer, and through research methodologies (Van Westendorp, Conjoint, Voice of The Customer, and other market price testing techniques) we can understand the customer's willingness to pay and price accordingly.

Once we figure out the total perceived value of a product or service, can we charge them the total value? It depends on the type of relationship you are trying to have with your customer. If you never are going to see that customer again, sure you can price at the full value of the product, but don't expect them to become an advocate of your product. A better approach is to give a little value back to the customer (consumer surplus).

A consumer surplus usually leaves customers with a feeling that they got more than what they paid for and will likely lead to positive reviews or they might even become an advocate of your brand, product, service, or all the above.

We have only touched the surface of value based pricing, but, I recommend reading in The Strategy and Tactics of Pricing by Thomas Nagle should you wish to join me in the practice of Value Based Pricing.