With this post, we welcome Erik Grueter of Price Optimization Software Company, Price Intelligently, as our newest guest contributor... Retailers, did you know that a 1% improvement in price equates to an 11% increase in operating profit? “In fact, pricing is the most important aspect of your business,” says Price Intelligently's CEO, Patrick Campbell. Retailers need to employ effective pricing strategy and competitive price tracking and monitoring to take advantage of the impact of pricing -- because a 1% deficit in pricing will mean you’re decreasing your profits by 11%!
If you’re reading this, then you know the importance of price optimization. You also know that pricing is a process that involves knowledge of your costs, your competitors, and your value - using data analysis and pricing intelligence. Another important aspect of pricing strategy is the element called value-based pricing. Here's how value-based pricing can be used to determine your customers’ true willingness to pay, in order to ensure you’re driving as much profit as possible:
Top companies ensure that their pricing strategy is buttressed by knowing the amount of value they are delivering to the customer. Once you determine what that core value is, you can price for it on a sliding scale. Here's how retailers can employ this strategy in their business, first by determining the core unit of value, then establishing a value scale for that unit, before finally looking at an enormously profitable application of value-based-pricing of Apple’s iPhone.
Determining Your Core Unit Of Value, i.e. How Much Is The Product Worth To The Customer?
Your value metric is the core-unit of value that your customer purchases from you. If you want to unleash the power of value-based-pricing, you’ll first have to determine exactly what impels your customer to purchase your product. If you sell eggs, your value metric is a single egg. Your customer is unlikely to purchase anything less than a dozen. If you sell software, your value metric may be the number of users or storage space in gigabytes.
Remember that your customers ultimately determine your value metric. If you sell video-hosting software, you might think your customer is buying your product because of video quality. Yet, in reality, they may be buying because of the number of videos you allow them to upload. Finding this metric can be difficult for many businesses and requires research, but hey, that's why most businesses can make a lot more money!
Ask yourself: "At the core of my product, what value am I providing and how can I simply communicate and charge for that value?" says CEO Campbell.
Amplify Your Value Through Segmentation And Determining Willingness To Pay
Once you’ve determined what the fundamental unit of value the customer is buying from you, you can start to charge based upon the number of value units your customer needs. After all, an early adopter may only need one unit of value, where a power-user may push you to your limit with thousands of units.
You’ll also need to determine the value of each individual unit in the eyes of your target customer. This requires a bit more research by communicating with your customers through surveys, calls, A/B tests, etc.
As you’re going through this process, think about your value metric as a sliding scale based on the number of value units provided. Your mission is to find the three or four places along that scale that your different customer segments would stop at before buying. This way you can display a transparent price and value proposition to each customer. As we will see below, there are many benefits to thinking about your pricing this way.
Use customer data to determine how much your target customers are willing to pay and make sure to put forth a simple pricing model that aligns with the value you’re providing.
Pricing Benefits As Seen Through Apple’s iPhone Pricing Strategy
Let's look at Apple’s iPhone to get a better idea of how value-based-pricing can truly help you grow quicker and more profitably: Forbes Magazine reported that an additional 16GB of memory for your iPhone costs Apple about $10, but increases the price of the phone by $100. If you want a top-of-the-line Apple iPhone with an additional 48GB of memory it’ll cost Apple an additional $32, but it will set you back almost $200 more!
That means Apple is able to charge for memory along a value metric to drive profits. They’ve determined that their customers value more memory and at a much higher rate than their costs. In this manner, Apple is able to pull in significantly more profit from the incremental addition of more memory than if they had they placed a 20 or 30 percent margin on top of the cost of that memory.
Apple also understands the willingness to pay for each customer along its value metric. Notice that the first 16GB of additional memory is the most expensive. Apple is charging for this value on a sliding scale but also clearly understands that the customer’s willingness to pay for that last 48GB of memory is still proportionately less than the first 16GB.
"Pricing is exceptionally important to any business," says Campbell. Pricing obviously has the highest impact on profit. Pricing requires some work, but it isn’t difficult. Simply remember to determine your value metric, test your customer’s willingness to pay for different amounts of that value metric, and keep it simple. Your costs, in most cases, are negligible to the value you’re providing. If retailers find the right value, and the right price, they are in the best possible position to reap the revenue benefits.