Most
products are still priced according to what they cost to produce.
But some manufacturers and IT vendors employ an alternative
approach, using information technology to help estimate how much
value a product would provide to the buyer, then basing its price on
that value.
For example, one pharmaceutical maker priced a new antiulcer
drug, but not by adding up the costs of developing and manufacturing
the medication and tacking on the amount of profit it wanted to
make, says George Cressman, a product pricing consultant at
Strategic Pricing Group Inc. in Marlboro, Mass.
Instead, the company used value-based pricing techniques to
justify a higher price than it might otherwise have been able to get
from medical insurers. Its weapon: studies that showed the new drug
could help patients avoid expensive surgery, which in turn would
lower costs for the insurance companies.
The goal is to avoid setting prices above the ceiling of what
someone will pay -- and also to make sure you don't give away the
store by charging too little.
The problem with traditional cost-based pricing approaches "is
you don't know what value your product offers to customers,"
Cressman says. "You can end up leaving money on the table and not
getting paid what your product is worth."
Pricing Strategies
Strategic Pricing Group is a consulting firm that helps
corporations design and implement value-based pricing strategies.
Its clients include companies in mainstream manufacturing markets
such as chemicals, pharmaceuticals and metals.
Another client, a chemical company, based the price of its
pipe-sealing gaskets on the cleanup costs and potential liabilities
that buyers could avoid because of the products' ability to prevent
chemical leaks and spills, Cressman says. He declined to identify
either company.
Some software vendors, such as i2 Technologies Inc. in Dallas and
Aspect Development Inc. in Mountain View, Calif., use value-based
pricing. Their software license fees depend on the amount of
internal savings that individual customers expect to get by using
the applications -- a figure the two sides try to determine during a
presales consultation.
To assess a product's value for one of its clients, Strategic
Pricing Group starts by conducting in-depth interviews with a set of
the manufacturer's customers that are similar to one another --
sometimes eight to 10 companies, sometimes "significantly more" than
that, Cressman says.
Each interview can last as long as two hours. Shorter surveys of
customers are usually too superficial to produce the detailed
information needed to "show them what impact (a product) will have
on their business and what it's worth to them," he adds.
But on the whole, value-based pricing is still pretty rare. A
recent survey suggests that only about 10% of companies use the
approach, and even that "might be a generous assessment," Cressman
says. "There are very few companies that are doing this right now."
Part of the reason is that value-based pricing can be difficult
to sell to customers, who may be wary that they'll end up paying
nosebleed prices rather than amounts based on what it cost the
manufacturer to make their products. "People have an emotional
problem with the idea of having the price be almost incessantly
variable," says Jim Shepherd, an analyst at AMR Research Inc. in
Boston. "A lot of (buyers) just have a gut feeling that they're
getting screwed."
Value-based pricing sounds like a smoke-and-mirrors way to sell a
product "for however much you can get for it," adds Joshua
Greenbaum, an analyst at Enterprise Applications Consulting in
Berkeley, Calif. "To me, the emperor has at best a G-string on."
Figuring out the value of a product also isn't a simple matter.
"You really have to start with an understanding of your customer,
and that takes a lot of work," Cressman says. "Adding up your costs
and putting a (profit) margin on top of that looks much easier and
more precise."
Technology's Role
While value-based pricing depends heavily on manual work,
technology also has a big role to play.
Manufacturers that want to adopt value-based pricing approaches
without trying to set individual prices for every buyer have to
segment their customers into groups of companies with similar needs
or patterns of behavior. Such a task calls out for data mining
software with the ability to comb through databases and discover
trends and characteristics that customers might share.
Activity-based costing software, which helps users gauge the cost
of individual business activities such as making a product or
processing orders, can also be a useful tool. "You don't want to let
the costs drive your pricing, but you do need to know whether you're
making money," Cressman says.
Airlines and hotels are the businesses that come up first in any
discussion of value-based pricing, but Cressman and Shepherd say
that's something of a misperception of the concept. For example, the
dizzying array of ticket prices charged for the same flight are
determined by sophisticated yield-management techniques meant to
fill as many seats as possible while maximizing the revenue that the
flight produces.
That certainly can increase a flight's value to the airline, but
Shepherd says it isn't really a case of value-based pricing from the
customer's perspective. The justification for the high prices that
last-minute travelers have to pay is "based more on their
desperation" than on any real sense of how much taking the flight
will actually be worth to them in financial terms, he says.
Resource Links
Descriptions and explanations of value-based pricing:
http://www.time0.com/lexicon/glossary/assetsmetrics/valuebasedpricing.htm--
Value-based pricing explained, with links to related terms, from a
guide to setting up online marketplaces developed by Perot Systems
Corp. in Dallas
http://www.gmarketing.com/tactics/weekly_117.html-- A
primer on the factors that need to be taken into account when
pricing products, from Web-based magazine Guerrilla Marketing Online
http://www.onlinewbc.org/Docs/market/mk_4ps_pricing.html--
An in-depth article on pricing fundamentals and comparisons of cost-
and value-based pricing strategies, by the Online Women's Business
Center
Sites 
