Value Based Pricing

We received a talk on pricing this evening which I thought was a great illustration. I present it here for your delight. Yep – this post contains pricing theory and fertiliser. Please keep reading?

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It’s lonely out here, but maybe I should stop mowping

Nobody likes a grass

Your company, Freddy’s Fertiliser, produces regular fertiliser for grass. As you’d expect, the grass becomes greener, and it grows faster.

One day, your R&D people stumble upon a secret formula that makes grass green, but also halves how fast it grows. Strangely, this product is cheaper to make than your regular fertiliser. What do you charge for it?

Pricing To Cost

It turns out that most companies answer the question in this way.

Price = our cost + some margin

As this new fertiliser is cheaper to make, it should be cheaper to buy, right? This is simple to think about, but there are two important problems.

  • It’s difficult to determine what your cost actually is. Do you use variable cost? Do you try to allocate out some of your fixed costs? If you do, you need to know how many you’ll sell, and forecasting can be more magic than science.
  • Most people figure out how much margin they should be make by looking at their competitors, but in a small or nascent market, it’s likely that everyone is guessing.

It’s useful instead to think about pricing in another way.

Pricing To Value

So here’s the other way of looking at it. How about we price a product according to what a customer might pay for it?

Consumer value = usage benefit + emotional benefit - monetary cost - pain in the ass cost

  • Usage benefit: What tangible benefit will the customer get out of using it?
  • Emotional benefit: Does the customer want to be associated with the product? Do they love your brand? Or hate it?
  • Monetary cost: The Benjamins.
  • Pain in the ass cost: This are other costs like having to learn how to use a product, having to buy complementary goods and so on.

Keep Off The Grass

The cool part about having your grass grow more slowly is that you don’t have to mow it as often. That’s of some benefit to end consumers, but it helps most when you have to mow as part of your business costs.

Golf courses.

Golf courses have a huge pain in the rear keeping their grass at a reasonable level, and they have a lot of grass to mow. So how much more should they be paying for it?

Here’s the answer – it’s worth the difference between their current situation and using the new fertiliser, minus a little bit. Let’s think about the two product benefits again:

  • It makes grass greener. The old fertiliser does too, so this adds up to a big fat zero.
  • It makes grass grow slower. Let’s say that it halves the growth rate. That means you need to mow half as much. Take the mowing budget for the year, divide it in two, then divide that by the number of bags you expect to sell over a year. That’s how much you can add to the price.

Marketing Hat

Then, you put your marketing hat on. You’re now making way more margin – the costs are lower, and the price is higher. Use some of that margin to pay for different packaging. Disassociate it from regular fertiliser. Actually, don’t even call it fertiliser any more.

To be honest – this is all fairly logical. There’s no magic in here. You just have to remember to consider it next time you need to price something. Just think of fertiliser.

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