There are several ways to arrive at pricing for your online business, but many pricing strategies leave money on the table and can even damage your customer’s view of your brand; this is the case whether your prices are too high or too low.
Finding the right formula for retail markup is one of the most important decisions you will have to make and is vital to the success of your ecommerce business.
Not all pricing strategies put the customer first and as an online business, value-based pricing is potentially the best pricing strategy for your brand, your customer relationships and your bottom-line.
Value-based pricing for ecommerce companies is about arriving at a price that your customers are willing to pay. It is the most highly recommended pricing technique by consultants and academics.
However, despite the obvious advantages of value-based pricing, many ecommerce companies still cling on to other pricing strategies:
Let's look quickly at some alternatives to Value-Based Pricing – and why you shouldn't use them!
Cost-plus pricing is still a popular pricing strategy for ecommerce and works by simply taking the costs of production and adding a fixed margin to create the retail price. However, cost-plus pricing completely ignores the customer’s opinion. You should be aware that customers simply don’t care about your cost of production or what profits you’re hoping for.
Online companies may also resort to competitor based pricing which relies on checking to see what prices similar companies are charging and then pricing their products accordingly. Competitor-based pricing assumes your competitors have done all the pricing research that you don’t want to do - but maybe they haven't done it either! Oh dear!
Value/What It's Worth
Imagine you are at the supermarket and you want to buy a packet of frozen peas. In the freezer
In your head, you are asking yourself if the branded product is worth 70p more so you think of everything that is different between the two packets. You may prefer the taste of the branded product and have been swayed by a television advert telling you how fresh they are when frozen.
It's completely up to you as to what you think is important. After you've determined the important differences, you place a value on them and then decide if the branded packet of peas is worth 70p more than an own-label packet of peas.
People are different and value things differently. From your point of view as an online business owner, the important thing is to find out what your customers are willing to pay. You need to learn how your customers are making their purchase decisions in order to create a calculated price.
Why should you use Value-Based Pricing?
Value-based pricing is the only true win-win scenario for you and your customers.
Value-based pricing ensures that your customers feel happy paying your prices for the value they’re getting. Pricing according to the value your customer perceives in your product prevents you from short-changing yourself whilst creating an experience for customers
You’ll also strengthen your brand name, build better customer relationships, and ultimately improve your bottom line.
Customers that are happy to pay for the value they receive are loyal and buy from you again. One study found that increasing retention by 5% can increase profits by up to 125%.
An Example of Value Based Pricing for Ecommerce
Everlane, a US-based online clothing retailer has developed a pricing strategy that demonstrates how effective value-based pricing can be in strengthening a brand, winning customer trust, and improving profitability.
It is part of the company’s mission to communicate about the factories where their clothes are made, the true cost (in money and effort) of producing the clothes, and their transparent feedback policy.
Everlane openly charges customers more for the clothing than the clothing’s cost of production, yet the price is based on the value that customers are receiving from:
- The item itself
- The ethical assurance of supporting decent conditions for factory workers
- The experience of purchasing from a company they trust
Customers feel good about their purchases, and they’re happy to pay Everlane’s "higher" prices for the value they receive.
How to Execute a Value-Based Pricing Strategy
1. Create Buyer Personas using:
- Market research
- Feature and product preference analysis
- Price sensitivity analysis
You could go into even more detail with your personas to include things like how likely they are to respond to discounts and what other products they might be interested in purchasing.
This three-step framework will provide the foundation you need to create the most accurate and meaningful buyer personas.
2. Conduct Market Research
The market research step involves collecting demographic information on your customers through a survey.
This may include information like age, job, salary and location. It can also include information that’s more specific to your particular ecommerce company and your products:
- Their motivation to purchase
- Their interests (
releventor not to your product)
- Pros and Cons about your products
- Preferred products from your competitors
- Preferred method of communication/form of social media
Perhaps you could incentivise customers to complete a survey by entering them into a contest for a £50.00 Amazon gift card - or similar?
Money spent on incentives like prizes or complimentary items is an investment. The money you spend could save you months of development time by confirming your customer personas early on.
Go to your competitor’s blogs and social media sites and see who is liking and commenting on their material. Use this information to learn about your competitor’s customers and the broader market.
This is especially useful if you've just started your ecommerce company and you don’t yet have a large customer base to survey.
3. Gauge Value Through Feature and Product Preference Analysis
Now you can begin to take a closer look at your customers' opinions of your product(s) – and which they value the most.
Present your customers with several choices, and ask them to choose the one that provides the most value and the one that provides the least value. You can perform a two-step analysis by first asking them to choose their most/least valuable products, and then asking them to choose the most/least valuable features about those products.
If your company offers hundreds or thousands of items, it would be impractical to feature every item in your surveys. In this case, segment your inventory by category and conduct a preference analysis about broader categories.
4. Conduct Price Sensitivity Analysis
The most important step in creating value-based pricing is collecting feedback on concrete price points that customers are willing to pay. Willingness to pay is a reflection of the value that customers see in your products, so it’s your best guide when determining your value-based pricing scheme.
A successful price sensitivity analysis rests on the foundation of strong market research and feature/product preference analysis.
Your market research will tell you how to segment customers when asking them about price points, and your preference analysis will help you determine which products are most important to ask about.
When conducting price sensitivity analysis, use the 80/20 principle: focus on the 20% of your products that provide the most value for 80% of a buyer persona.
For a given product, ask customers in a particular buyer persona the following questions from Van Westendorp’s price sensitivity meter:
- At what price would you consider the product to be so expensive that you would not consider buying it?
- At what price would you consider the product to be priced so low that you would believe the quality to be poor?
- At what price would you consider the product starting to get expensive, so that you wouldn't rule it out, but you would have to give some thought to buying it? This provides you with the highest acceptable price range for this customer.
- At what price would you consider the product to be a bargain? This provides you with the lowest acceptable price range for this customer.
These answers will provide you with concrete numbers to determine the optimal range for a product’s price according to customer value perception.
5. Analyse Buyer Persona Data
Once you have answers about price sensitivity, collect the data to find the best prices to drive sales for a particular buyer persona’s favourite product.You can determine which price captures the largest share of your market with the most profitable prices.
6. Adjust Your Marketing Material
You now have an exact price point that tells you what your customers are willing to pay for the value they see in a product.
You will begin to see patterns in your data, such as certain types of customers who will willingly pay more for certain products and others who want to pay less for them. Some customers tend to make a greater number of more expensive purchases and others make predominantly cheaper purchases.
These patterns will allow you to adjust your marketing and advertising to more directly target customers who are interested in particular products. You can also begin to figure out which types of customers will respond well to promotions/offers, price adjustments, and certain price-sensitive marketing campaigns.
How to Use Value Based Pricing
Adjusting your pricing according to value will make you realise how much customer experience and your company’s brand can play a part in the value a customer perceives in your product.
Even if by taking the steps described here you discover that you are currently pricing correctly they are none-the-less valuable because they force you to think about your customers' decision-making processes and how you can improve on the value you offer.
A customer-first approach and clear, strong communication will always improve value. Start creating more value for your customer in small ways, and you’ll soon see what a huge difference it makes across the whole of your business.
The BlackCurve Ecommerce Pricing Guide
The Strategy and Tactics of Pricing, Tom Nagle and John Hogan 2016
Confessions of the Pricing Man: How price affects everything, Hermann Simon, 2015
Pricing with Confidence: 10 ways to stop leaving money on the table, Reed K Holden and Mark Burton, 2014
Value-based pricing: Drive sales and boost your bottom line by creating, communicating and capturing customer value, Harry Macdivitt and Mike Wilkinson, 2011