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Expert question: How to use value-based pricing?

Hey all,

I'm wondering how you determine the price when applying value based pricing, let's say I invented a machine that enables teleporting and but the client is unwilling to operate the machine themselves and wants to sell it to another company.

Which price would I command?

1) Cash flows we would generate if operating the device ourselves? Multiplied using a multiple or doing a DCF (running until eternity)

OR do I also need to take into account

2) additional cost savings/additional revenues (i.e. through image increase) the acquiring company would be able to realize due to this device (i.e. airline company purchases the teleporter, thus gets an image increase and sells more flights on top) - I assume this will be difficult since we don't know exactly how much the synergies will be and those synergies will be very dependent on the individual acquirer?

Hope anyone can answer this.

Thanks a lot.

Hey all,

I'm wondering how you determine the price when applying value based pricing, let's say I invented a machine that enables teleporting and but the client is unwilling to operate the machine themselves and wants to sell it to another company.

Which price would I command?

1) Cash flows we would generate if operating the device ourselves? Multiplied using a multiple or doing a DCF (running until eternity)

OR do I also need to take into account

2) additional cost savings/additional revenues (i.e. through image increase) the acquiring company would be able to realize due to this device (i.e. airline company purchases the teleporter, thus gets an image increase and sells more flights on top) - I assume this will be difficult since we don't know exactly how much the synergies will be and those synergies will be very dependent on the individual acquirer?

Hope anyone can answer this.

Thanks a lot.

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Hi,

My short answer would be you should use value-based pricing if the market allows it. According to economic theory your price should depend on the value you deliver and the cost you provide it for (vs the competitor value and cost). And a customer will choose the product where this gap (between value and cost) is highest.

In some very competitive markets (e.g. oil, retail) it wouldn't be possible to do vlaue-based pricing, because competitors are using cost-based pricing and if you would try to use value-based pricing your prices will be too high.

In your case you seem to be dealing with a new technology with no other real substitutes, which would fit value-based pricing. Now you should analyze all the options that you have (selling the product yourself, licensing it, selling the idea to an airline, selling the idea to the governmen..) and choose the option that has the highest value.

Yes, often this is not easy, but making and verifying those assumptions is an important task for a consultant. In this case I wouldn't be too worried about making the assumptions on the synergy level, since the uncertainty on how many people will use the device and at which price is much larger.

Jorrit

Hi,

My short answer would be you should use value-based pricing if the market allows it. According to economic theory your price should depend on the value you deliver and the cost you provide it for (vs the competitor value and cost). And a customer will choose the product where this gap (between value and cost) is highest.

In some very competitive markets (e.g. oil, retail) it wouldn't be possible to do vlaue-based pricing, because competitors are using cost-based pricing and if you would try to use value-based pricing your prices will be too high.

In your case you seem to be dealing with a new technology with no other real substitutes, which would fit value-based pricing. Now you should analyze all the options that you have (selling the product yourself, licensing it, selling the idea to an airline, selling the idea to the governmen..) and choose the option that has the highest value.

Yes, often this is not easy, but making and verifying those assumptions is an important task for a consultant. In this case I wouldn't be too worried about making the assumptions on the synergy level, since the uncertainty on how many people will use the device and at which price is much larger.

Jorrit

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Hi,

Value-based pricing can be done in 2 ways:

  • For existing products, you identify what is the economic value and perceived value for the customer. Also, 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. (e.g. your product may have additional customer support, better packaging, additional features and thus should be priced hire. Or it should be priced the same and you will win the market share due to these differences)
  • For the new products / markets, you can calculate the closest alternatives and think how much additional value we provide by replacing them. Think of the discount airlines compared to trains or buses

Best

Hi,

Value-based pricing can be done in 2 ways:

  • For existing products, you identify what is the economic value and perceived value for the customer. Also, 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. (e.g. your product may have additional customer support, better packaging, additional features and thus should be priced hire. Or it should be priced the same and you will win the market share due to these differences)
  • For the new products / markets, you can calculate the closest alternatives and think how much additional value we provide by replacing them. Think of the discount airlines compared to trains or buses

Best

Hi,

Kotler & Keller (2016) define Value Pricing when companies offer a reasonably low price for a high-quality offering (which has more of an impact on the operational model). It seems to me Perceived-Value Pricing is more suited to your situation as you will need to factor in several elements before being able to price the new invention/product (i.e. product performance, warranty, quality, customer care post-purchase, etcetera). These factors are value-added, but also incur costs on the buyer's end.

Additionally, when selecting the Final Price, you will need to wrap your head around how the product and price will impact the buyer, how would it affect the company after the sale, what risk is buyer going to take on board, especially true when making a big purchase.

I would study the case of Google's Glass product. Not an identical case, however, there are great lessons learnt on Pricing.

References:

  1. Kotler, P., Cunningham, M. H., & Keller, K. L. (2008). A framework for marketing management. Toronto: Pearson Prentice Hall.

Hi,

Kotler & Keller (2016) define Value Pricing when companies offer a reasonably low price for a high-quality offering (which has more of an impact on the operational model). It seems to me Perceived-Value Pricing is more suited to your situation as you will need to factor in several elements before being able to price the new invention/product (i.e. product performance, warranty, quality, customer care post-purchase, etcetera). These factors are value-added, but also incur costs on the buyer's end.

Additionally, when selecting the Final Price, you will need to wrap your head around how the product and price will impact the buyer, how would it affect the company after the sale, what risk is buyer going to take on board, especially true when making a big purchase.

I would study the case of Google's Glass product. Not an identical case, however, there are great lessons learnt on Pricing.

References:

  1. Kotler, P., Cunningham, M. H., & Keller, K. L. (2008). A framework for marketing management. Toronto: Pearson Prentice Hall.

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