Value Based Pricing Strategy

Value based pricing strategy (also known as value optimized pricing) determines prices based on perceived or estimated value the product has for the customer. It's not determined on the manufacturing cost or any different measure. We are frequently using this strategy when the value customer perceives is many times the cost it takes to produce the product. Do you remember our last cost+ pricing strategy article and the Hepatitis C treatment example? It was stated that the price of the highly effective hepatitis C treatment Sovaldi was way off the costs of producing the drug. The costs were in the hundreds of dollars, yet the list price was about 84 000$. How come? It's about perception of the value to the customer.

Let's start with brief excursion to the history of Hepatitis C:

Discovered in 1989. Hepatitis C is liver infection that often leads to serious liver damage. It's in most cases spread when someone comes into contact with blood from an infected person either by sharing needles or syringes when injecting drugs, during birth, in healthcare, having sex with infected person, getting tattoos, receiving blood transfusions, getting organ transplants etc. It has two stages: acute and chronic. The acute phase starts after the incubation period (after first exposure) which usually takes 6 weeks. The acute phase lasts for 6 months. Body can in this acute phase clean the virus. It's suggested that in 15 to 45% of acute cases the body cleans the virus spontaneously without any treatment. In the remaining 55-85% cases it becomes a long-term infection exhibiting itself as liver cirrhosis or liver cancer. The liver cirrhosis takes 20 to 30 years to develop with a liver transplant as the only treatment option. Average liver transplant cost in the US in 2016 was estimated to be 577 100$ with the cost distributed to the period of 30 pre-transplant days and 180 post-transplant days. In 2000 around 150,000 people were diagnosed with chronic liver disease in the US. In 2010, liver cirrhosis, liver cancer and acute hepatitis led to 2 million deaths.

In 2010 the average cost for Hepatitis C treatment (not cure) per person per year was around 10 000$ in the US. Taking into account the 20-30 year period, the total cost per patient was 200 000 to 300 000$.

Sovaldi was discovered in 2007 and approved for medical use in the United States in 2013 with a list price of about 84 000$. Value based pricing in this case takes into account not only the cost to produce the drug, but the perceived value it has for the customer. Every other option at that time on the market was not only more expensive (liver transplant 7 times more expensive, long term treatment of chronic hep C around 2-4 times more expensive), but the quality of life of the patients was drastically reduced during the treatment period too.

The 12 weak Sovaldi treatment in oral form cures the disease with success rate around 90%. What an excellent result of human ingenuity! The cost for the cure is 2-5x below the cost of other treatments on the market, cheaper but still around the perceived market value. This is value based pricing in action.

One of the many ways to determine the price in value based pricing could be:

- find products that are comparable and find value customers are willing to pay for it

- find the differences between your product and competing products

- assess the value (price) of those differences

- check if your costs are lower than estimated price of your product

- explain to customers why you believe the price is justifiable

- analyze, adjust

Value based pricing advantages:

- improves profitability of the company. Higher prices can be charged for the product.

- works great in niche markets, where the company can focus on specific needs of customers

- works great when it's unique product, differentiated, there is scarcity, high quality product

- works great when the product selling is based on the emotions and feelings

- customer loyalty - as your company match the perceived value by customers, the customers tend to be more loyal to company's service and recommend to friends and family

- helps to adjust your product or service to customer needs, price assessment involves quite a big research a helps your company to understand customer requirements

- usually has the highest margins

Value based pricing disadvantages:

- not suitable for commodities used daily and bought out of necessity, for instance selling non-branded groceries where the price closely follows costs with a well defined mark-up added to it.

- difficult to apply in large business, but not impossible; to apply successfully, it usually requires sophisticated pricing software

- enables easy entry for new competition - price gap between costs and value can be very high, thus leaving more options to maneuver for competitors.

- research required

- customers might negotiate the price