What is 'Value-Based Pricing'

Value-based pricing is a price-setting strategy where prices are set primarily on a consumers' perceived value of the product or service. By contrast, cost-plus pricing is a pricing strategy in which costs of production influence the price. Companies that offer unique or highly valuable features or services are better positioned to take advantage of value-based pricing than are companies with commoditized products and services.

BREAKING DOWN 'Value-Based Pricing'

The value-based pricing principle applies mostly to markets where possessing an item enhances a customer's self-image or delivers unrivaled experiences. Although based primarily on perceived value, value-based pricing also considers other factors such as labor, manufacturing costs, and additional direct and indirect costs. Trends and general sentiments about an item or service also influence pricing under this strategy.

Perceived value is the value of an item or service as constructed in the minds of consumers.  The perceived value of something directly affects the price a consumer is willing to pay.  Quantifying conceptualized value is challenging but attainable using sophisticated marketing techniques.  Luxury automakers effectively quantify customers' perceived value of features and experience. As a result, they use value-based pricing to establish prices for their vehicles.

A company selling basic white cotton athletic socks would likely use cost-plus pricing unless it offers a revolutionary way of making or wearing socks, or it provides heretofore unfulfilled sock benefits. While a cost-plus pricing model primarily focuses on recouping costs, value-based pricing focuses on setting prices high enough to maximize profits and maintain a solid customer base.

Examples of Value-Based Markets

The fashion industry is a business sector where value-based pricing is standard. Popular name-brand designers command higher prices based on consumers' perceptions of how the brand affects their image. As a brand's image diminishes, the pricing strategy will follow a cost-based principle.  

Other industries subject to value-based pricing include the automotive sector, name-brand pharmaceuticals, cosmetics, and personal care. However, not all items within these categories use value-based pricing. For example, generic medications may use a cost-plus model while a name-brand medication uses the value-based model.  Also, some automakers will use cost-based pricing for non-luxury vehicles.

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