What is 'Value-Based Pricing'
Value-based pricing is the setting of a product or service's price based on the benefits it provides to consumers. By contrast, cost-plus pricing is based on the amount of money it takes to produce the product.
Companies that offer unique or highly valuable features or services are better positioned to take advantage of value-based pricing than companies with products or services that are relatively indistinguishable from those of their competitors.
BREAKING DOWN 'Value-Based Pricing'
A company that sells basic white cotton athletic socks would probably use cost-plus pricing, because its product does not have any special features. However, a company that sold sweat-wicking, extra-padded athletic socks could use value-based pricing and sell its socks at a higher price, because it provides something unique and valuable to athletic consumers.
Value-based pricing is not based on solid metrics, such as material and labor costs, which can are easy to calculate. Instead, valued-based pricing relies on the consumers' perception of the value. Since its basis is not concrete, value-based pricing can be affected by things such as current fashion trends or the general feeling surrounding an item or idea.
While a cost-plus pricing model focuses on recouping costs as the primary pricing guideline, value-based pricing tries to find a price point that is as high as possible without causing too many potential customers to turn away due to the price.
Understanding Perceived Value
In the case of value-based pricing, value is not determined by simply adding up the costs of the materials and labor involved in production, along with any associated costs such as marketing and distribution. While those costs are a factor, the driving force behind the price is how highly the item is desired by the customer, an intrinsic factor that is not easy to measure numerically.
Examples of Value-Based Markets
The fashion industry is an example of a sector where value-based pricing is common. If a particular designer becomes popular, the designer can charge more for the goods they create than if they were not as popular. This same principle can apply to other markets where the idea of the consumer’s outward image may be affected by possessing the item in question. Other industries subject to value-based pricing include the automotive industry, name-brand pharmaceuticals, cosmetics and personal care.
Not all items within the category use value-based pricing. For example, generic medications may use a cost-plus model while a name-brand medication uses the value-based model.