Magazine Winter 2010 Research Feature

Why the Highest Price Isn’t the Best Price

How to practice value-based pricing that boosts profits and promotes better relationships with customers.

James C. Anderson, Marc Wouters and Wouter van Rossum Reading Time: 24 min 

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Image courtesy of Flickr user Zen.

“Charge what the market will bear” pretty well summarizes the pricing strategy of many suppliers serving business markets. They believe that practicing value-based pricing means finding out what the value of their offering is relative to alternatives for their customers and then charging as high a price as they can. If they think their offering is superior, they include in their pricing the full premium that they think the superiority earns.

The Leading Question

If charging the highest price isn’t the best strategy, what is?

Findings
  • Customers give suppliers they feel good about doing business with a bigger share and mix of their business.
  • Best practice suppliers use pricing tactics that motivate the customer to take action that benefits the supplier.
  • Suppliers that practice value-based pricing increase short- and long-term profits.

But pursuing value-based pricing in that way is usually shortsighted in two respects. First, it
neglects other potential means of profiting from delivering superior value that may result in greater overall profitability to a supplier. Second, it weakens customer relations rather than strengthening them, which a more progressive and comprehensive approach to value-based pricing can accomplish. We’ll propose a framework for practicing value-based pricing in this more nuanced, strategic way. But consider first a recent case that demonstrates how the shortsighted pursuit of value-based pricing can go wrong.

Electron Instruments (a fictionalized name) manufactures and markets scanning electron microscopes. It has focused on the upper end of the market for SEMs, which ranges from $500,000 to $1.5 million per microscope. Even the low end of electron microscopes ranges from $100,000 to $250,000. In 2007, as a new initiative, Electron Instruments developed and introduced a desktop SEM that was intended to compete in the low end of the market and even attract some sales from customers that would upgrade from optical microscopes.

Electron Instruments believed that its desktop SEM was vastly superior to the next best alternative, a desktop SEM from a Japanese competitor. Electron Instruments did not, however, conduct any formal customer value research to validate that belief. Instead, it relied on its engineers’ assessments and marketing’s judgment based on qualitative feedback it received from a few beta test customers. Critically, though, these beta test customers were familiar with SEM technology, and most were users of the company’s top-end, expensive SEMs.

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About the Authors

James C. Anderson is the William L. Ford Professor of Marketing and Wholesale Distribution at the Kellogg School of Management, Northwestern University. He is the Irwin Gross research fellow at the Institute for the Study of Business Markets at Pennsylvania State University and a visiting research professor at the University of Twente, the Netherlands. Marc Wouters is a professor of management accounting at the School of Management and Governance, University of Twente. Wouter van Rossum is dean of the faculty of military science at Netherlands Defense Academy, Breda, the Netherlands, and a professor of innovation, Faculty of Engineering Technology, University of Twente.

References

1. J.C. Anderson, N. Kumar and J.A. Narus, “Profit From Value Provided: Earning an Equitable Return,” chap. 7 in “Value Merchants: Demonstrating and Documenting Superior Value in Business Markets” (Boston: Harvard Business School Press, 2007), 135-164; J.C. Anderson and J.A. Narus, “Selectively Pursuing More of Your Customer’s Business,” MIT Sloan Management Review 44, no. 3 (spring 2003): 42-49.

2. J.C. Anderson, J.A. Narus and W. van Rossum, “Customer Value Propositions in Business Markets,” Harvard Business Review 84, no. 3 (March 2006): 90-99.

3. S. Dutta, M. Bergen, D. Levy, M. Ritson and M. Zbaracki, “Pricing as a Strategic Capability,” MIT Sloan Management Review, 43, no. 3 (spring 2002): 61-66.

4. R. Cooper and R. Slagmulder, “Achieving Full-Cycle Cost Management,” MIT Sloan Management Review 46, no. 1 (fall 2004): 45-52; R. Kaplan and S.R. Anderson, “Time-Driven Activity-Based Costing,” Harvard Business Review 82, no. 11 (November 2004): 131-138.

5. A recent review of research investigating how pricing may benefit the supplier’s operations and reduce its costs is provided in M. Fleischmann, J.M. Hall and D.F. Pyke, “Smart Pricing,” MIT Sloan Management Review 45, no. 2 (winter 2004): 9-13.

6. M.H. Bazerman and J.J. Gillespie, “Betting on the Future: The Virtues of Contingent Contracts,” Harvard Business Review 77, no. 5 (September-October 1999): 155-160.

Acknowledgments

The authors gratefully acknowledge the financial support of the Institute for the Study of Business Markets at Pennsylvania State University.

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Comment (1)
Brandy V
Great article! we have always promoted the value of our product lines, and for us, when we focus on the perceived benefits of our branding strategy, whatever pricing model we choose just seems to "make sense" for our prospective clients.