What is value-based pricing?

Inside-out: the traditional logic
In the traditional approach, everything starts with the intention to develop or market a new product or service, based on the company’s internal capabilities. From there, the finance department is asked to calculate the total cost, considering investments, variable costs, and fixed costs.

With that calculation in hand, a desired margin is defined, which is added to the cost to determine the selling price. Subsequently, the marketing department develops the launch campaign and sets the sales budget. Finally, the commercial team is given the task of selling the solution and meeting the targets defined by marketing.

However, in practice, this process rarely succeeds. It is common for the sales budget to fall short, leading to discussions among sales, marketing, and finance over who was responsible for the failure.

Outside-in: the value-based logic
Unlike the traditional logic, the value-based approach begins by understanding which customer segments you want to target and what their needs are. Based on that knowledge, a solution is designed that truly responds to those needs, incorporating only the attributes customers value.

The price of the new solution is defined considering the alternatives available in the market. Then, a profitability assessment is conducted to verify whether it is financially viable. If it is not, the design is revisited to remove irrelevant attributes and reduce costs.

This process makes it possible to arrive at a final solution that contains only the elements that generate value for the customer, avoiding features that, instead of being perceived as added value, represent an additional cost for the company.

The major differences of the value-based approach
Traditional logic pushes products to the market from within the company. In contrast, the value-based approach starts with the market and moves toward the final design of the solution. Moreover, in traditional logic, cost defines the price, while in the value-based approach, cost is only a checkpoint to ensure the solution is profitable and viable.

This new approach gives rise to an interesting theory: the 5 Cs of value-based marketing. This theory begins by understanding who the target customer is and what their need is. From there, solutions are created with relevant attributes that satisfy that need.

Then, the value offered is communicated, highlighting both tangible and intangible, functional and emotional attributes. The goal is to convince the customer that it is worth paying for the value received. Finally, that value is captured using proper segmentation and the right metrics.

This interpretation can be seen as an evolution of traditional market research, combined with the well-known 4 Ps of marketing: Product, Promotion, Place, and Price.