Setting Prices Based on Customer Value

Andreas Hinterhuber (top) and Stephan Liozu write that pricing scholars lean toward customer value-based pricing. They provide a mini case study of how to use this method to make sure that you don’t leave money on the table.

Could you be charging 25% more than you do right now?

Companies generally use one of three methods to set prices, but many pricing scholars think one of those ways is preferable.

Here are some excerpts from Andreas Hinterhuber and Stephan Liozu’s recent MIT Sloan Management Review article “Is It Time to Rethink Your Pricing Strategy?” about how one company came around to a new strategy.

Three pricing strategies are most common: cost-based pricing, competition-based pricing and customer value-based pricing. The authors write: “academic research and our own findings conclude that pricing approaches across industries, countries and companies usually fall into one of [these] three buckets.”

Pricing scholars lean toward customer value-based pricing. As the authors put it, this is often “the most preferable way to set new product prices or to adjust prices for existing products,” and is especially relevant in highly competitive industries. “Customer value-based pricing asks, ‘How can we create additional customer value and increase customer willingness to pay, despite intense competition?’ The subjective and quantified value of a purchase offering to actual and potential customers is the primary driver in setting prices.”

Mini case study: A large European supermarket chain that “planned to launch a private-label version of a yogurt delivering health benefits.” According to the authors, the company used information from cost accounting and a cost of goods of €1.29 to initially choose a retail price of €1.99. This compared well to the €2.99 cost of the branded product. But was it the smartest price?

The yogurt company did not initially pick the right selling price because it didn’t use data on the perceived customer value of the product as the main factor for its decision. That was Hinterhuber and Liozu’s conclusion after the company’s CEO solicited their view (Hinterhuber is a partner at Hinterhuber & Partners, a strategy, pricing and leadership consultancy based in Innsbruck, Austria, while Liozu is president and CEO of Ardex Americas, a manufacturer of specialty cements and substrate preparation products, and a doctoral candidate in management at Case Western Reserve University).

Hinterhuber and Liozu took six steps to come up with a better price for the yogurt company. The six steps: 1) they examined customer perceptions of value of the branded product and the private label; 2) they found that in customer surveys, customers who were mothers liked the private label product because they perceived it to be less damaging to the teeth of their children than the more sugary branded yogurt; 3) they estimated the value of this benefit to be equal to about €0.30; 4) they estimated that the lack of an established brand name reduced the appeal of the private label by about €0.50; 5) they initially calculated the total value of the private label to be about €2.80; and 6) they recalculated the launch price down to €2.49 after running simulations in which customer price sensitivity, competitor reactions and other factors were taken into consideration.

That €2.49 was €0.50 more than the company’s original pricing choice of €1.99. If Hinterhuber and Liozu were correct, the company’s original choice was too low by 25%.

Result: Taking perceived customer value into account worked. Hinterhuber and Liozu recommended that the yogurt’s launch campaign put a heavy focus on the product’s health benefits, and the company took that advice. “Despite the higher price point and thanks to solid communication of the beneficial aspects of the properties of the private label, sales volumes exceeded the volume targets the company had originally set for the product,” the authors write. “Profits were nearly sixfold over plan.”

For more details, see Hinterhuber and Liozu’s full article, “Is It Time to Rethink Your Pricing Strategy?”

Their new book, Innovation in Pricing: Contemporary Theories and Best Practices, will be published later this month by Routledge.