“ It is monsoon sir”, he said with a measured calmness.
I was at park street in Kolkata. It was Sunday afternoon and the place was abuzz with shoppers and hawkers. The road-side vendor did not doubt my knowledge of the season. He was reacting to my disbelief, when he quoted Rs. 300 for a small umbrella. This man clearly understood value based pricing.
Now, your business may not have the luxury to change prices based on seasons without inviting customer backlash. But that does not take away the responsibility of pricing your product. While pricing has multiple nuances based on competition, user behaviour and regulation, value based pricing is a good starting point to set a clear path.
#1. How do I find my value based price ?: To begin with you need two things. Firstly, you need a reference price which is the price of another product is considered to be close to your product by the buyer. Secondly, you need an assessment your additional value that your product provides. Remember, the additional value may be positive or negative
Lets take one concrete example. In October, 2001 Apple launched iPod at $399, which had 5 GB capacity, when its nearest competitor has a price of $300. While ipod appealed to people with its intuitive design and its iconic brand, for now let us work out the economic impact of iTunes ecosystem, on the value provided to the buyer.
People needed to buy a full CD, before iTunes made it possible for them to buy singles for 99 cents. For ease of calculation I have assumed cost of a single as $1. I have further assumed that on an average a user liked 2 songs from a CD.
Change in economics of mp3 player with iTunes
So the total value from iPod is reference price of the nearest competitor ($300) + additional value ($2,000)= $2,300. So the price of your product will lies somewhere between reference price ($300) and the total value($2,300) from your product
#2. Can I charge the full value created ? : I hope you are not serious. If a drug saves some ones life, can you charge the patient NPV of his income from his extended life? Of course not. While setting prices, many other factors such as affordability, buyer acceptance and corporate goals like market share come into play. Moreover, customers are heterogeneous in terms of their willingness to pay. This complicates pinning down the right price. But that is a topic for another blog post.
#3. What if my value based price is lower than my cost? This is not as far fetched as it seems. Once in a while, there are new competitors who come up with better value at a lower price. In early 2000s Indian IT companies started delivering services from India. Their services were of similar quality to those offered by multinational players, albeit at a lower price. In such a situation, the incumbents need to fix their cost structure, re-engineer their offering to improve services or serve another segment. In case of IT industry, the multinational companies created their own offshore centres, acquired software product companies and some of them started offering services to the US government that wanted all the delivery people onsite.
So it is worthwhile to periodically re-evaluate the value from your product.
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