Value-based pricing is coming of age. Powered by big data and real-time analytics, companies are now able to offer individual customers unique prices based upon their circumstances. Although there is still some confusion about what value-based pricing is and what it isn’t, the growing number of case studies help show how it works and the benefits from implementing it.
Value-based pricing is all about pricing your products based upon what you think customers are willing to pay for them, rather than on what they cost to produce. Value-based pricing is a continuum. At the simpler-end is differentiated pricing where different people are charged different prices. The pricing of identical smartphones at different price-points depending upon whether you buy them in the USA, Europe or Asia is a good example. At the more complex end is true value-based pricing such as that Amazon was pilloried for experimenting with. Perhaps the most extreme use of value-based pricing is speeding fines in Switzerland, where the size of the fine is proportional to your income. A Swedish man caught driving his Mercedes SLS AMG at 186mph was reputedly fined over USD1 million dollars. This is state-sponsored price–gouging of the worst kind.
Value-based pricing the implementation of the principles of supply and demand at the individual level. If your house is burning down, you are more likely to pay more for a fire extinguisher, providing it is not too late for the extinguisher to do its job effectively. If you need the last ticket to the Opera, you are more likely to pay more for that too. As Harvard philosopher Michael Sandel discusses in his book, ‘What Money Can’t Buy: The Moral Limits to Markets’, markets are amoral in that they don’t consider ethics. This can easily lead to patently unfair pricing that price-gouging laws are there to prevent (except, apparently in Switzerland). Perhaps this is why Financial Time economist John Kay advises his readers, that “if you want a good time at a bar, go with an anthropologist rather than an economist”.
There is still some confusion about what is value-based pricing is and what isn’t. The emergency room is an example of cost-based pricing rather than value-based pricing. It is priced based upon the high costs of providing the complicated facility plus the margin the hospital requires to keep its shareholders happy (at least in the US). It would probably be highly unethical to charge rich patients more when they arrive at the emergency room. It would also clearly violate doctors’ Hippocratic Oath. Consulting is potentially different. Assignments are usually priced based upon the high costs of providing experienced consultants plus the margin the consultancy requires to keep its partners happy. But it doesn’t have to be that way. Some consultants have tried to offer outcome-based contracts but the complexity of their clients’ business systems, the dominant role of client resources in value creation and the phenomenological nature of consulting make it very hard to calculate and agree on a value-based price beforehand.
Big data should have a big impact on value-based pricing. Most pricing today is cost-based at the market rather level than the value-based at the individual level. As companies start to gather more data about individuals, particularly more contextual data about them, they will be able to start to price for individuals based upon their current circumstances. If the insurance company knows – because of the data logging telematics attached to your car – that you are a careful driver they can and should give you a lower price than the average customer for whom they don’t have any individual driving style data.
Are you gathering the big data you need for effective value-based pricing? If not, why not? You are leaving ‘money on the table’ if you don’t.