Different pricing mechanisms are becoming increasingly important in a world primarily anchored on costs to determine the prices of product and services, says Skander Esseghaier, Associate Professor of Marketing and Affiliated Professor at the Africa Business School in Mohamed 6 Polytechnic University, Morocco. In is his research, Esseghaier looks at how companies use pricing strategies to enter markets, sell their products and compete, as well as recommendation systems.
According to Esseghaier, value-based pricing is becoming increasingly important.
“Most businesses in established industries do pricing on the basis of operational costs, but the consumer ultimately only cares about the value of the product or service for them,” he points out.
Holistic price strategies bring more business
Shifting into value-based pricing requires an entirely new way of looking at the business. When done correctly, it can transform the business and the way it makes money.
The traditional way of pricing is determining a number based on operational and production costs, and then adding a margin.
“A value-based approach forces you to take your own glasses off and look at the products or services from a larger perspective, that of the customer,” Esseghaier notes.
In value-based pricing, the business is viewed as a whole, sometimes from an entirely different standpoint.
Esseghaier gives a practical example: Australian company Orica, a manufacturer of explosives for the mining industry, has historically priced its services on the basis of costs. When the rise of low-competition started to put pressure on their prices, thereby threatening the continuity of their operations, they had to rethink their entire approach.
When done correctly, value-based pricing can transform the business and the way it makes money.
What they realized was that their offering enables clients to make operations more efficient overall. In addition to providing explosives, Orica also gives advisory services on how to use them optimally to generate more fragmentation of the blasted rocks, which results in faster and cheaper excavation.
By understanding value that their services provide to their clients, they rethought their pricing approach: instead of their own costs, they linked prices instead to the degree of fragmentation of the blasted rocks they could deliver to their clients. As a result, not only were they able to retain their market share but actually increase their prices.
Stepping away from an internally focused cost-driven mindset to an externally-focused client value driven mindset can thus increase profit. “In the business-to-business context value comes primarily from efficiency,” Esseghaier notes. Moving into the value-based mindset changes everything, from sales to marketing and communications. “It changes what you are actually selling to your clients and therefore which buyers you need to talk to in the client’s organization,” he says.
Value-based pricing can come in different forms
Increased efficiency often leads to reduced waste of all kinds, making the case for sustainability, too. In the retail industry, there are direct links to improving sustainability through pricing.
One simplified example of looking at value-based pricing has to do with the sell-by dates of food produce. Stores are forced, by law, to throw out food that has not sold by the expiration date, hugely contributing to food waste globally. One way to tackle this waste while increasing sales is through dynamic pricing, i.e. reducing prices closer to the expiration dates.
Another way to approach the issue of waste is through the lens of value-based pricing. Expiration dates are set by the manufacturers to drive sales, and products can often be used long after this, Esseghaier notes. Setting a longer period of validity would increase the value of the product in the eyes of the consumer, allowing the manufacturers to charge higher prices.
“This would also reduce waste – consumers will not throw the food out prematurely. Due to this reduced level of waste, consumers might even end up paying less for their shopping basket despite the higher price of the individual items,” he says. Manufacturers might generate a lower volume of sales but would be compensated for through their ability to charge a higher price for more valuable products.
"If someone to listens primarily to jazz on Spotify, their money still mostly ends up in the pockets of hip hop artists or those with the most streaming."
Sometimes processes are not as streamlined. Recently Esseghaier has examined the pricing systems of streaming services and how membership fees are shared among music rightsholders. There is a debate on whether the current system is optimal or the money should be distributed differently.
“If someone to listens primarily to jazz on Spotify, their money still mostly ends up in the pockets of hip hop artists or those with the most streaming,” he points out.
Producing and capturing value
Making the shift towards value-based thinking is not necessarily an easy process. Not only does it require developing a deep understanding of the client’s core business and finding potentially unrecognized sources of value, but this must often be translated and communicated effectively to the client. “Sometimes the customer value is obvious, and sometimes customers need to be educated,” Esseghaier states.
Capturing value is the natural next step of putting effort into producing value. Esseghaier truly believes it is time for a change: “Pricing or monetization is often in the stone age compared to all the sophistication that goes into value generation, R&D, communication and distribution strategies.”
