Big Data, Value-based Pricing and Ethics

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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.

Graham Hill
@grahamhill

3 COMMENTS

  1. Very interesting article! Makes you wonder how far company’s will go with value-based pricing and the number of potential legal issues that will come out of this. Thanks for your insights Graham!

  2. Hi VM

    Thanks for your comment.

    Companies are only just starting to experiment with big data and the value-based pricing it enables. I suspect they have a long way to go yet.

    I agree with you that legislation (and to a certain extent, ethics) has not kept up with the pace of development of big data technologies. Richards & King in an article on ‘Big Data Ethics’ (http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2384174) in the Wake Forest Law Review highlights the gap that has developed between big data technology, the uses the big data is put to by companies and their ethical (or lack of) behaviour.

    We will have to wait and see where big data and in particular, the Internet of Things that is going to provide so much of it will take us. And whether legislators and moral philosophers can keep up.

    Graham Hill
    @grahamhill

  3. I am just now starting to puzzle my puzzler over the right way to do value-based pricing on enterprise software where some optional Big Data capabilities are being added in… The ethics are relatively straightforward on my case, I suppose– it’s not the privacy thing, for example– it’s really about what people will want to pay to run software on 100 or 1000 servers vs. one or two, or what people will put up with paying for deployment on a cloud platform like Amazon vs. on-premise. But Big Data and the platforms on which to run related technologies are opening up so many questions… makes my head spin.

    Software as a service with some kind of pay-as-you-go pricing opens up new questions… One meta-element in my case could be pricing based on usage, where we are able to collect extremely fine-grained data about how our software is used (whether on-premise or in the cloud) and price based on that… our big data software has telematics capabilities that affect how we decide to charge our customers for their activities in using their own big data to figure out how to charge customers. But price-gougi– err, exploring the frontiers of value-based pricing with a Fortune 500 enterprise customer seems morally tolerable– we won’t charge more than they can afford, and we will deliver value for money 🙂

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