Can someone explain cost based pricing vs value based pricing?

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New answer on Sep 09, 2019
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Sasha asked on Sep 09, 2019

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Vlad
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updated an answer on Sep 09, 2019
McKinsey / Accenture Alum / Got all BIG3 offers / Harvard Business School

Hi,

1. Cost based - you actually check what are the costs and apply standard industry / target markup

2. Value based pricing is based on the customer willingness to pay and can be done in 2 ways:

  • For existing products you compare the value proposition and features of your product vs. the VP of your competitors. If you have a significant difference in value prop - you have to define how much value you propose to the customer in $ terms.
  • For new products you have to calculate the value of the closest alternatives and think how much additional value we provide by replacing them. Think of the discount airlines compared to trains or buses

3. Competitor based pricing - basically it's benchmarking against competitors. Make sure you take into account the segment (i.e. in premium higher price may be the proxy for quality)

Don't forget about the pricing strategy - here you define how you will price the product taking into account 1,2,3 and your company strategy. Maybe you decide to have a zero margin if you can crossell other services. Or maybe you would like to subsidize to win the competition. Also, think of price differentiation and having different pricing tiers (e.g. basic, premium or even freemium) and how it helps to drive price perception and fulfill strategic goals

Good luck!

(edited)

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Vlad

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