November 30, 2020
What Is Value-Based Pricing?
Value-based Pricing is a pricing strategy in which you charge for your services in proportion to the value that they represent to your clients.
The key behind Value-Based Pricing is understanding that value is highly subjective. What's highly valuable for one person might be entirely worthless for another.
Examples Of Value-Based Pricing
Meat And Vegans
According to Forbes, the Côte de Bœuf vintage 2000 is, at $3,200, the most expensive steak in the world. I'm sure a wealthy beef connoisseur would happily pay for it.
But how much do you think a wealthy vegan person would pay for it? Probably zero and would probably get offended at the proposition.
Even if the beef connoisseur and the vegan person have the same resources, they differ dramatically in what they consider valuable. When you're Value-Based Pricing, your goal is to determine how much your help is worth to your client.
The Mac Pro
At the time of this writing, the rack-mounted, fully-spec'd out Mac Pro will set you off you $54,547.98 US Dollars before taxes. It's one of the fastest commercial computers to date.
If Bill Gates, one of the world's wealthiest individuals, wanted to buy a new computer, he wouldn't buy a Mac Pro. He does not need the Intel Xeon processor or the two Radeon Vega Pro Duo discrete GPU. He would probably choose something simple that he can carry in his bag to his board meetings.
But what if your business relies on complex 3D animation graphics, as is the case for people working at companies like Pixar. The roughly $50k cost might pale compared to the revenue their next blockbuster will generate, and it could more than justify the cost of the Mac Pro.
Why Is Value-Based Pricing Difficult To Implement?
Value-Based Pricing is difficult to implement because it requires you to figure out how much the project is worth to your client.
To find out how much a project is worth, you need the confidence to ask your client the right questions while generating trust. You also need to understand business so you can link your service's value with the problem your client needs to solve.
Advantages And Disadvantages Of Value-Based Pricing
Value-Based Pricing it's not a one-size-fits-all technique. It's better suited for custom projects rather than productized services. It might not be the right pricing model for the type of services you provide.
While, in general, Value-Based Pricing allows for larger margins, it's also the riskiest way to price a project. If you charge too much, you might not get the project. If you charge too little, you risk losing money.
Here are some pros and cons of Value-Based Pricing:
Pros of Value-Based Pricing:
- Produces higher margins
- Builds trust with your client
Cons of Value-Based Pricing:
- Hard to implement
- You assume most of the risk
Steps For Implementing Value-Based Pricing
There are three necessary steps for creating a Value-Based priced proposal.
- Identify the root problem
- Understand the numbers
- Capture the value
Let's take a look at each one of them.
Identify the root problem.
" People buy 4 things and 4 things only. Ever. Those 4 things are time, money, sex, and approval/peace of mind. If you try selling something other than those 4 things you will fail." — Colin Dowling
You can trace most projects to money or time. And since time is money, it's ultimately all tied to a number.
Your client doesn't necessarily need a UX Audit. They need to increase their customer retention because their competitor's UX is better than their own, and they're eating away their market share. In this case, your UX audit might help improve their software to keep more customers and increase their revenue.
Similarly, your client doesn't need a new mobile app. They need a way to automate their processes to reduce the amount of manual work their staff does. This will allow them to scale their operations, which will make them more profitable.
Understand the numbers
Once you identify the root problem, the next step is to translate that goal into numbers. Figuring out the monetary value of your intervention takes practice. But it's not rocket science.
Let's say your client wants to automate their customer onboarding process. The way it's done right now, it requires a support rep to book a 1-hour setup video call with each new customer.
Let's say your client pays each of their seven support reps $30 an hour, and they spend about 20 hours per week working on setup calls. Here's the math:
7 reps at $30/h x 20 hours per week x 48 weeks per year = $201.600
If your mobile app effectively automates the customer onboarding flow, you'd be saving your client $201k per year. But what's more, since you removed their staff bottleneck, they can now scale and easily double or triple the number of customers they onboard per year. So we could be talking anywhere between $402 and $603.
Doing that calculation requires practice and earning your client's trust, so they give you the information you need. But you can also do your research. Most SaaS companies have their Pricing on their website, and the rest is easy to figure out.
Capture the value
We just established that the value that your mobile app is creating for your client is in the $400k to $600k ballpark. Once you know how much this project is worth for their business, it's time to capture some of that value in the form of fair compensation for yourself.
If you charge your client anywhere between $50k to $100k in exchange for a software-based solution that will make them between $400k and $600k, and if they are reasonably smart, they'll make that deal with you.
And that's how you value price a project.