Associate Director Optima Partners
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What are the biggest obstacles to value-based pricing?

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6th Mar 2014
Associate Director Optima Partners
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In an earlier post on ‘Value-based Pricing; Fair or Foul?' I compared the economist’s view of value-based pricing with the moral philosopher’s view of it and asked whether it was ‘fair or foul’ for customers.

Despite the analytical, economic and moral challenges of value-based pricing, it already IS in increasing use. At least, many companies are starting to experiment with it. In addition to Amazon, and airlines, trains, hotels and traditional users of yield management tools, other companies that have used it successfully include Schneider Electric, Intel and Volvo.

Customer insight is the biggest obstacle to value-based pricing

Pricing is one of the most powerful and one of the most neglected disciplines in business. As Hinterhuber & Liozu suggest in their paper on 'Is It Time to Rethink Your Pricing Strategy?’, most companies can significantly improve their profitability by using a structured approach to pricing based upon a deep understanding of what customers value and what they are willing to pay.

The biggest single obstacle to more advanced pricing is the lack of understanding of what customers really value. As Vargo et al describe in a paper ‘On Value and Value Co-creation: A Service Systems and Service Logic Perspective ’, our understanding of value has evolved from a utilitarian model based on benefits minus costs, to a phenomenological one based upon customers’ experience of using a product over time.

Understanding what customers really value

McDonald et al suggest in a paper on ‘Assessing Value-in-Use: A Conceptual Framework and Exploratory Study’ that the best way to assess the customer experience is through immersive ethnographic research. Ethnography is widely used by companies such as Proctor & Gamble to learn how customers use their products. As a CNN Money article on ‘The Consumer is Boss’ shows, P&G’s ‘Living It’ programme –where ethnographers literally live with customers – has been a valuable source of innovations that improve customers’ experience of using P&Gs products.

Strategyn founder Tony Ulwick has created a structured innovation process that assesses customers’ experiences by capturing details of customers’ ‘jobs-to-be-done’ and desired outcomes. As Ulwick & Bettencourt describe in their paper on ‘Giving Customers a Fair Hearing’, capturing details of customers’ jobs and desired outcomes at key touchpoints in the experience provides a good proxy for what customers value. Insights about customers’ jobs and particularly, about desired outcomes, are the foundation for value-based pricing.

Customer outcomes drive value-based pricing

Ng et al show in an AIM briefing on ‘Outcome-based Contracting’ how a company can not only provide customers with products or services, it can also provide them with ‘servitised’ outcomes. Customers only pay for the outcomes they desire, leaving the company to organise how they are created. For example, a [email protected] article on ‘Power by the Hour: Can Paying for Performance Redefine How Products are Sold and Serviced?’ describes how Rolls Royce offers its aero-engines not as products for sale but as ‘Power-by-the-Hour’ outcomes; airline customers only pay when the engines are in use powering their planes full of fare-paying passengers through the sky.

Despite its many challenges, value-based pricing is in wider use than many think. Offering customers’ servitised outcomes is one way to implement value-based pricing. But it is not without its challenges. The biggest one faced by companies is their lack of understanding of customers and what they really value.

If you are thinking of implementing value-based pricing the $64,000 question is, “Do you really know what YOUR customers value?” If not, don’t you think it was time you did?

Graham Hill is a partner at Optima Partners.

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By houstonone
06th Mar 2014 12:37

I agree that insight and understanding must be a problem but I am not so sure it would be the number one problem, which I think is customer acceptance of value based pricing. i think that that kind of pricing model would be a hard sell to customers. how to explain that you are going to pay  more for the same product than another customer. tough job.

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Dr. Graham Hill
By Dr. Graham Hill
07th Mar 2014 08:42

Hi Houstone

Thanks for your comment.

I agree with you in practice, but not in principle. 

If you look at the examples of value-based pricing in the market today I agree with you in practice 100%. Amazon in particular, appeared to set a different price not based on any perception of differential value for customers, but rather because they thought they could get away with charging different prices to different demographic groups. Once the public found out about it there was uproar, not because of the differential pricing but because there was no perception of their being any differential value for different customers. And that is the key point.

We pay different prices at Amazon all the time. Not necessarily for the books they sell, but for the speed of delivery of the books. There is a wide variety of, in-effect, value-based pricing options for delivery. I can pay to join Amazon Prime and get free delivery. I can bundle several books together and get them delivered when the last one is available. I can pay to have books delivered as soon as they are in stock using standard postal delivery. And I can pay to have them delivered tomorrow using expedited postal delivery. I usually pay to have individual books send as soon as they are in stock using standard postal delivery. Occasionally, when it is worth it to me, I pay to have individual books send as soon as they are in stock using expedited postal delivery.

As Amazon highlights so well, people are more than willing to pay value-based prices, but only when the additional value is worth it for them. They will pay more to get a book delivered tomorrow so they can take it with them on a two-week business trip than they will for the same book if they are at home. It all depends upon their circumstances and their perception of value. And that is why I believe the biggest challenge in value-based pricing is not public acceptance per se, although it is definitely a challenge, but understanding what people really value and offering them an appropriate price. The price can of course be less as well as more.

The Amazon example illustrates that there are plenty of opportunities to move from offering customers a product (the book), to offering them a service (the book delivered as fast as you you want), to offering them an outcome (all books delivered as fast as you want through Amazon Prime). This is only one step removed from servitising bookselling. We still have to leave reading the book to the customer. Book publishers like like Pearson, who are also in the education business have shown that you can servitise educational books through offering a range of subscription educational services built around the knowledge contained in their books. Maybe we don’t have to leave reading the book to the customer after all. Now that really would be value I would be willing to pay more for.

Graham Hill

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Mike Boysen
By Mike Boysen
07th Mar 2014 13:24

Graham,

I can see that I've been focused on the B2B consulting version of this term. You're making a great case; especially since I can relate to the Amazon scenario very easily.

MikeB
@mikeboysen

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