Hi Anonymous,

good question! :)

Cost based pricing relies on having a reference regarding the margin that you add to the production cost of your good or service. Such a reference margin does only exist if you are dealing with an established product, or if a very close substitute exists. The same is by the way true for pure benchmark pricing.

If, however, you are dealing with a product innovation, where no closely comparable competitor product or substitute exists, then you have to take the more difficult path of identifying customers' willingness to pay (WTP). The WTP essentially is the value which your new product generates at their side. This then leads you to value based pricing.

So rule of thumb: whenever you deal with a product innovation, value based pricing is most probably the way to go. And this is also what you would almost always see in a pure pricing case at MBB! Because only in a situation of an innovation you would call strategy consultants to help! 

The other two approaches can rather be expected to play a role as sub-issues within larger cases where an overarching question is answered, and pricing is just one out of several sub issues you encounter along the way.

Cheers, Sidi

_______________________

Dr. Sidi Koné 

(Former Senior Engagement Manager and Interviewer at McKinsey | Former Senior Consultant and Interviewer at BCG)

Hi there, 

I am pricing expert at BCG :-) and I would say the price methodology really depends on many factors, but usually cost based pricing is not seen as most suited one, not taking into consideration important factors such as customer's willingness to pay, competition,  substitutes, etc. 

Benchmark pricing pretty much follow the same as cost, it is usually very simple method, which however ignore many important factors. This is particularly risky if your competitors are not much advanced on pricing. 

Pricing in theory compose many factors such as demand, positioning, cost, value, willingness to pay, competition, substitution, etc. In your case you need to choose the factors that make most sense, but you need to consider wider aspects, hence benchmark and cost pricing I would discard them, BUT take into consideration those factors when pricing. 

Good luck!

Lucie

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Hi there,

Great question! Here's how you figure it out:

Question #1: Are there competitors (or is this a new market)?

Q1A: If yes, can I differentiate my product?

If yes, value-based

If no, competitor pricing/benchmarking is eliminated.

Q1B: If no, can I determine the value-add of my product (i.e. if saves x costs or a survey says people will pay x)?

If yes, value-based

If no, cost-based

Summary: If you can, you always want to do value-based. This is the most effective form of pricing. If you have "something" to go off of, you use it, else you use cost-based because you have no other choice.

Value-based occurs if:

1) You are a monopoly

2) You are the first entrant into a market

3) You can differentiate your product from other (I.e. monopolistic competition)

You should use ALL of them.

Cost-plus gives you the minimum you can afford.

Value base gives you how much the customer would pay without competition.

Competitive pricing gives you a benchmark of the current acceptable prices in the market. 

You can look at substitute products as well, particularly if you don't have competition or is a new product.

Cost base is usually relevant when you have a commodity. Competitive pricing when you have competition and some differentiation. You need to adjust your price in order to have a more compelling offer vs. competition. 
Value based is critical for new products (but read comment above on substitute products).

But most importantly, it's not about which one. You should use all (that you can use in the situtation). And then make a judgement based on the analysis.

As pointed out earlier, in the real world cost based pricing is not used to actually price anything. However, we often use cost based pricing as a tool to estimate the margins suppliers/vendors are receiving and especially as a tool to negotiate better prices with them.

Best,

Udayan