Value-based pricing pros and cons

- So the third pricing model is value-based pricing and value-based pricing, as I've already said, is my favorite pricing model and the reason is is that this is the model where you charge based on what the customer is willing to pay. So you have a lot of control over how you can influence a customer in that process. Value is not determined by those who set the price. Value is determined by those who choose to pay it. What a great quote. So some of the advantages that you have and one of the reasons why I like this model so much is that you have a lot of control over pricing, as I mentioned before. You're getting all the value that you're delivering, you're actually getting paid for that value which is also terrific. Usually you can gain a higher margins for that because you're going to be charging higher price because you're creating more value. And also, you can get more for the differentiation that you're actually creating in the market and you can charge for that differentiation as well. The ideal profile for value-based pricing looks like this. Products are more unique. They're differentiated from the competition. They're harder to compare. Products tend to generally be more scarce. They're first-of-a-kind or custom products as well. Again, hard to differentiate. It's usually works where competition is lower, where quality is higher. Products or services can be packaged or add-ons can be created. So, some examples of this include tour operators, cooking classes, software products, jewelry, high-end fashion also fits into this category, high-end resorts and luxury cars all fit within this category of value-based pricing. So there's some advantages to value-based pricing. I think there's a lot of advantages to value-based pricing. Number one is you can maximize your profits or do you think it's probably the most important thing any business can do. You get paid for the value that you're delivering which I think is wildly important. Also you're focused on what the customers want. You're focused on the customer as opposed to your competitors or other things that you might obsess over in the other models. This is all customer-focused on how you deliver value which is why I like this model so much. You get paid for your efficiency. The more efficient you are, the more money you're going to make. It's not like the cost model where you're being dragged down or the market model where you're being compared against competitors, right? And as much as I love value-based pricing, there are some disadvantages. First one is that you must actually have some differentiated value. You can't just kind of create this out of thin air. There has to be something that customers really perceive as valuable and you can differentiate from your competition. So it doesn't actually work for all businesses. Another thing is that it might require more upfront investment in R and D, in marketing, in other types of things that you may or may not be able to do so that can be a disadvantage. Because really, to create that differentiation you have to leap forward and ahead of your competition. And then finally, your price can actually get negotiated. The problem with value-based pricing is customers are going to be looking at it, they're going to be looking at that higher price and they're not going to have as much to compare against so they might actually want to negotiate pricing, negotiate it down obviously. So for value-based pricing, I actually want to use a service example for this. Now, in the service business you can either be one of two things. You can be hourly-based or you can be fixed bid. Essentially, fixed bid is another way of saying package pricing. Now I will tell you from my personal experience of being in the service industry for 20 plus years. In fact, if you fixed bid something and you bundle price it, you're so much better off. You're going to make much more money than if you use it on an hourly basis. Let me give you an example. Talked about my digital agency before called Surge Commerce and essentially, we fixed bid absolutely everything. Now most of our competitors actually price based on an hourly way and when you price based on an hourly rate, the first thing customers do is they start obsessing over the hourly rate and they start to try to negotiate it down. The second thing they do is when they get the bill and they say you spent 20 hours on this, I could've done it in 15. Okay, so then the customer starts to think you're nickel-and-diming them for everything, they get upset. You're bothered because you're not getting as much value and they're negotiating down the value of what you're actually delivering and the price of what you're delivering. That doesn't sound very good. However, if you fixed bid it, well, the fixed bid is generated based on an hourly estimate. But you're now saying I'm going to guarantee, I'm going to fixed bid this so I'm going to guarantee the price. You can actually bid that price up at least 20% and you can even add additional value to increase that price more. And so in the surge business, we actually almost always generate north of 60% margins based on our fixed bid fees which we always fixed bid, and I can tell you it really works. So another example is something that happened recently to me is I remodeled my home and oh boy, what a chore that was. Now, what's interesting about it is is that 20 years ago, even 10 years ago, all contracting out there when people were remodeling their home, were all hourly based. They would line item everything. And of course, what did customers do? They nit picked everything, they nickel-and-dimed, all of that, and they got down to a price. Now what my contractors did and what everybody does today is all pricing was bundled. All pricing was fixed bid and it was all bundled into a nice package, right? It included everything, the paint, the glass, the tubs, the vanities, even furniture and other things, they bundled all into one price. Now I got three quotes. Of course, being a consumer, I took the cheapest of the three and there was a wide variation between the quotes so that's something that you might run into, but at least I know exactly what I'm going to be paying and if I choose to change something, it's a change order, I'll pay for it. But, I don't let them just have an open checkbook and they can pay whatever they want. As a consumer, that is not the kind of relationship you want.