A value-based price is the maximum price you can charge relative to market references for your added value and still achieve your market share objectives.
The value-based pricing infographic below will help you visualize the moving parts of a value-based price.
In this model:
- The height of the box labeled “Reference Competitor” refers to the price of your customer’s next best alternative to your solution.
- The height of the “Your Added Value” box, represents the value your solution produces for the customer in excess of the reference value.
- The total height of the “Reference Competitor” and “Your Added Value” boxes represent the price of your solution at full market value.
- Price axis represents the range of all possible prices you could set for your product.
The three pricing levels shown on the infographic are:
- Price at full market value
- Price higher than the reference competitor’s price but below full market value
- Price at or below the reference competitor’s price
The appropriate level for your value-based pricing will depend on the value your solution produces for the customer and your market share objectives.
When you price your equipment at full market value, the customer’s economic outcome is the same whether he purchases from you or the reference competitor. Your customers and your competitor’s customers would likely remain with their current supplier, and you would not gain or lose market share. This might be the right price for you if you are already the undisputed market share leader and have no ambition to capture new customers.
Pricing higher than the market reference price but below full market value can produce market share gains. But two conditions must be present. First, your product must perform better than the reference competitor on customer-value drivers. Second, your total value advantage including price is sufficient to attract your competitors’ customers.
Pricing below the market reference can also be a rational value-based price in a couple of situations. One being your product performs worse than the reference competitor on the most important value drivers, and you need to compensate with a lower price. The second is the case where despite a performance advantage, you need to offer an impossible-to-ignore value proposition to attract your competitors’ customers.
These scenarios illustrate that value-based pricing can be any price that is a function of the value your solution produces for the customer and your market share objectives.
Model Price Scenarios with Comparative Financials
A set of comparative financials will reveal a customer’s financial outcomes among buying choices. Comparative financials take the form of a mini-financial statement that compares the financial outcome of buying your equipment versus buying alternatives. See the figure below for the elemental form of capital equipment comparative financials.
To develop comparative financials, create a direct comparison with your competition and limit the analysis to the buying-decision drivers that you identified when you created your value metric.
An Example:
To illustrate, let’s again turn to Mr. Melty. Suppose we know the following about Mr. Melty and its next best competitor.
| Value Metric Element | Mr. Melty | Competitor |
|---|---|---|
| Charge size | 650 kg | 700 kg |
| Process time | <65 hrs | <75 hrs |
| Yield | >75% | >65% |
| Price | ? | $600K |
You can use comparative financials to calculate your equipment’s value compared to the competition at different value-based prices. See the figure below.
| Units | Mr. Melty at Full Market Value | Mr. Melty at Example Value-Based Price | Competitor | |
|---|---|---|---|---|
| Charge size | kg | 650 | 650 | 700 |
| Process time | hrs | 65 | 65 | 75 |
| Max throughput | kg/hr | 10 | 10 | 9 |
| Mass ingot yield | 75% | 75% | 65% | |
| Yielded throughput | kg/hr | 7.5 | 7.5 | 6.1 |
| Yielded throughput | kg/yr | 65,700 | 65,700 | 53,144 |
| System price | $US | 742,000 | 655,000 | 600,000 |
| Depreciation Expense (5yr) | $/yr | 148,352 | 131,000 | 120,000 |
| Capital expense/kg | $US | 2.3 | 2.0 | 2.3 |
| Difference | 0% | -12% |
You will notice that
- The analysis is limited to the buying-decision drivers,
- Value metric elements, throughput, and yield produce the customer gain of kilograms of product.
- The only cost of gain where material differences exist is equipment price,
- Mr. Melty is compared directly with the competition
- When Mr. Melty’s price is $742,000, the buyer’s financial outcome is the same whether he buys from you or the competitor. Therefore $742,000 is the full market value for Mr. Melty.
- When Mr. Melty’s price is $655,000, the buyer can expect to save 12% in capital expense/kg versus your competitor.
The same data can be expressed using the value-pricing model. See the diagram below.
How Big of a Value Advantage Do You Need?
A universal formula to calculate the market share change rate from a value-advantage percentage doesn’t exist. The number of customers, customers’ buying frequency, sales cycle length, the cost of changing suppliers, and other factors vary widely across equipment market segments. To develop a mathematical formula, you’d have to model historical share-shift dynamics in your particular market segment. This is often not practical or necessary.
However, you can conclude that large value advantages will result in faster market share changes than will smaller ones. See the table below for some market and competitive situation examples.
| Situation Example | Value Advantage Target Implication |
|---|---|
| You are the incumbent supplier with 100% market share at a given customer. | You don’t need a large value advantage to hold your position, especially if the cost of changing suppliers is high. |
| You are targeting a new emerging market where greenfield opportunities dominate. | Since there are no incumbents, the cost-of-change factor is irrelevant. You will gain market share anytime your value is greater than benchmark competitor(s). |
| You are an established player attempting to penetrate an account where your competitor holds 100% market share. | You will need to price your equipment to make your value advantage compelling enough to overcome your target customer’s cost of changing suppliers. |
| You are a higher-performing new entrant looking to capture share from a well-established competitor. | Despite your value-driver performance advantages, your target customers may be reluctant to team up with an unproven supplier. A very large value advantage may be necessary to tilt the risk-reward calculus in your favor. |