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Value-Based Pricing

Introduction

Unlike, cost-based pricing that places a certain markup on top of costs incurred, value-based pricing sets prices based on the benefits provided by the product.

In a Nutshell

Value-based pricing is a pricing method wherein prices are set based on the perceived value to the buyer.

Value-based pricing is common for professional services, such as audit, medical consultation, legal fess, architectural, and other customized services.

The business has to work within a target budget to ensure that it makes profit from its quoted price.

Companies that offer products with unique and distinguished features, as well as highly customized products and services, are more inclined in using value-based pricing over other pricing methods.

Value-based pricing is more applicable in situations where individual quotes are given to individual orders or jobs. Examples include: attorney fees for legal cases, architectural design, general repairs, car customizing, and other custom products and services.

Target Costing

When charging value-based price, the seller still considers relevant costs. Though mark-up is not directly computed on the basis of cost, the selling price must be enough to cover for the costs to be incurred. Generally, those that use value-based pricing tend to ask for relatively high prices; hence, enough to cover costs.

Sometimes, the reverse of cost-plus pricing happens in value-based pricing. The price is quoted first and then target costs are determined to achieve a profit. The seller will have to work on a certain budget to meet a desired income. When this happens, costs must be minimized without sacrificing customer satisfaction.

Example

Mr. Davis wishes to have his car, a 1969 Cadillac Coupe, restored. It has been sitting in his barn for a while and rust has eaten most of its parts. He approached KustomKars Company to do the job. Based on the estimated value of a restored Cadillac legend, the company quotes an all-in price of $30,000. Mr. Davis agrees to the price as he believes that it is a fair measure of the benefit he will receive.

KustomKars now has to work within a budget and make sure that the total cost it will incur will be within $30,000 if it wishes to make a profit. If the company wishes to earn at least $2,000, then target costs must be set at up to $28,000. However, the satisfaction of the customer must not be sacrificed. The perceived value must still be met.

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