signs for promotion with out of focus store behind
PHOTO: JJ Ying

Back in 1992, a study in Harvard Business Review determined a 1% improvement in price resulted in an average profit improvement of 11.1%. As remarkable as that may sound, a few paragraphs later, the same article proclaimed that a “mere 1% price decrease for an average company, for instance, would destroy 11.1% of the company’s operating profit dollars.” 

That’s not exactly enlightening for the ruthless ecommerce space. While the internet spawned new models in products and services since 1992, it didn’t recreate economics. Pricing is still a vital part of running a successful business. SaaS companies today consistently use a few different pricing models — cost plus and competitor-based to name a few — but when done correctly, value-based pricing can have the most positive effect.  

Value-based pricing is the method of setting a price by which a company calculates and tries to earn the differentiated worth of its product for a particular customer segment when compared to its competitor,” according to Utpal Dholakia, George R. Brown professor of marketing at Rice University’s Jesse H. Jones Graduate School of Business. Sounds simple enough, right? Just do that and you’re good to go! Seriously though, what does it really mean and how do you put that model into practice? Below are the three things to know about the value-based pricing model before you bet 11.1% of your profit on it.

Why Pricing Is Important

Every business is trying to make a profit (yes, I understand non-profits are businesses too). So, every opportunity to more efficiently make money should be explored. If pricing only covers the costs of manufacturing or labor and gives say, 10% profit, that doesn’t take into effect what people are willing to pay for it, which is the actual value of the product. On the one side, if you manufacture bicycles for $50 and people are only willing to pay $45 for them, then you’ll lose $5 per bike sold. But if you sell it for $55, you’ll make $5 per bike sold, right? 

What if people are willing to pay $60 for it though? You’re still profiting, but you’re also losing the same amount per transaction. 

For both ecommerce and SaaS, while value-based pricing isn't easy, it’s possible to analyze the willingness of certain segments to spend on certain items and price them accordingly to maximize your profit. In ecommerce, tools such product information management (PIM) platforms easily allow for product segmentation. But getting your customers involved in the pricing process can help with your market insight and add to the overall customer experience.

Related Article: Hacking Price: Finding the Sweet Spot for Growth

How to Find Your Value

Before finding the value of your product, the question to ask is why is segmentation necessary? Quite simply, you need to price for the customer segment that values your product. Those who don’t purchase  or infrequently purchase are not good indicators for your pricing research, simply because they’re not a good gauge for your actual value. 

The fast fashion world, for example, would use late teens and early 20-year-olds in a certain income bracket, while an auto parts retailer might use middle-aged men, likely auto mechanics (perhaps a B2B segmentation). Not to say these are the only people buying, but that they are the most important. 

This is a good practice to learn who your customers are. This is where sifting through data can help strengthen your business. Beyond learning who values your products the most, and eventually understanding what they’re willing to pay, you can also use the data to focus your marketing efforts.  

After you understand the segment that most values your product, you can then do market research to figure out the actual value of your product. Send a survey to your these high-value customers. Find out what they think differentiates you from your competitor. People are willing to pay for certain items for different reasons. Luxury items have a different perceived value than non-luxury items due to the differentiator of being status symbols and often of higher quality, but they offer the same basic functionality as the non-luxury competitors.    

Related Article: How to Get the Price Right, Personalize It

Pricing is a Part of the Customer Experience

While it makes sense to price your products at their value, it's easier said than done. I doubt anyone is banging their hand to their head right now, cursing themselves for not having this idea before. But while we may all have had this idea, how many companies do the market research to find out what their product is truly worth to their audience? There are often too many variables when pricing is dictated, including what competitors charge, the cost of materials and the cost to market to then consider the actual people who buy the product.

While all of the above are important considerations, it would be wrong not to consider the impact of pricing on the customer as well. Most people don’t consider pricing as the sole reason to make a purchase, and if they do, their market is probably not your market. Most people now buy an experience as much as they buy a product. The experience is simply better if the price of a product or service is priced at the value point that they perceive it should be. 

This pricing is not set in stone, and occasionally you may raise it for inflation strategy. This requires you to be actively engaging with your customers to find what they perceive to be your differentiators, how your brand is recognized in the market, and stay abreast of industry standards set by your competitors and remain agile as a result. 

Ecommerce sites are becoming as real as the brick and mortar stores they are replacing. Searchability, product imagery, product descriptions, and the old, location, location, location mantra still matter. As consumers have access to even more options than they ever have, a product strategy that goes beyond the right software solutions to promote the online customer experience but also includes a proactive pricing might be the key to finding 11.1% more profit.